March 9, 2015

Hotel development is on an upswing in the Seattle area  ̶  more than 1,200 rooms are currently under construction with many more planned. There are several factors contributing to the development: tourism growth, increase in hotel room demand and the improved lending environment.

To capitalize on this growth, one of our firm clients recently obtained a commercial mortgage backed security (CMBS) financing package for the refinance of their hotel property to develop another hotel. This was their first time entering into the CMBS financing world and much was learned along the way. They were kind enough to share some of their lessons learned.

Know Your Capital Stack

Before you start looking for financing, know your financing needs. How much money is needed and where will it all come from? Our client found the standard loan to value percentage lenders were comfortable with on hotel property was 65%. If the lender will provide only 65% of the value of your property, where will the remaining financing needs come from? Your capital stack may include equity, multiple lenders or one lender. Do you have sufficient equity to contribute to the capital stack? If not, are you open to bringing in additional investors? Some banks are not comfortable taking on the entire financing needs. More than one lender may be required.

Appraisal Frustration

The appraisal process was the biggest source of frustration. Appraisals on the hotel property were conservative. As a result of the economic downturn over the last several years, distressed properties were the only available comparable properties at the time. There were no sales data with realistic prices available. It took creative thinking on the part of our client. They revised their construction budget and broke it into two different budgets (or phases) based on their facts and circumstances to highlight a more accurate cost per key and provide alternative financing methods for the phases. This provided a positive impact on the loan to value calculation.

Stringent Reporting Requirements

CMBS loans, like other financing options, are facing tougher underwriting standards. Lenders are paying more attention to property cash flow and funded reserves. In our client’s case, they acquired more reporting requirements.
The property budget must be approved by the lender on an annual basis and financial statements must be provided quarterly. A seasonality reserve was required to be funded based on revenue. The measuring point for the reserve is twice per year. Included in the terms of the debt agreement was the authority of the bank to take over the bank account if any of the triggering events documented in the agreement occurred. Debt yield is used as the financial debt covenant instead of debt service ratio.

All in all, the client feels that the benefits of CMBS financing outweigh the challenges. They were able to obtain a 10-year term loan and remove the owner’s personal guarantee. Do the benefits of locking in at low interest rates and removing the personal guarantee outweigh the disadvantage of the stringent reporting requirements? Is CMBS financing an option for you? If so, spend some time getting to know the requirements of a CMBS lender and put together a loan package that will provide them with the information needed to make an informed decision.
(Creativity and persistence pays off!)

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This article contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.