Deciding to buy, build, or renovate a hotel can often be a great financial investment; however, before breaking ground, hotel owners need to secure financing. While hotels are operating businesses, they’re most often financed as commercial real estate, though there are several other methods, from the well-known to the relatively obscure. Many factors go into financing a hotel, including its size, quality and average daily rate, the owner’s experience, and whether it’s flagged or un-flagged. If you’re considering buying or upgrading a hotel, explore these financing options to help make your vision a reality. If you need help immediately, call 817-405-7161 to speak to a hospitality financing expert.

8 Hotel Financing Options for 2020

Hotel Financing Options 2020 Explained

Permanent Loans

Permanent loans are used to buy or refinance existing hotels with stabilized, reliable cash flow. These hotel loans typically allow for up 65 to 70% loan-to-value amounts (LTV) and can provide the funds needed to expand a portfolio of chain hotels. Permanent loans designed for refinancing can help owners access equity capital in an existing hotel, ensuring the most effective use of the available cash.

Bridge Loans

Bridge loans offer short-term financing to “bridge” the gap between repositioning or acquiring an asset and finalizing a permanent loan. Bridge loans are considered to be higher risk, so their interest rates are often higher than permanent loans. Hotel bridge loans often contain capital for renovations or a process improvement plan.

Mezzanine Loans

Mezzanine loans are combined with senior loans to provide additional debt capital to hotel owners, which can provide added flexibility for developers and property owners when acquiring funds for their projects. They can be structured as either short- or long-term financing, but most are short-term, floating rate, interest-only loans that owners try to repay as quickly as possible.

Construction Loans

As the name implies, construction loans are used to build a new hotel. Because construction costs can be high, these loans can be for extremely large amounts. Conventional loans or small business loans can be used to build a hotel.

SBA Loans

SBA loans are loans backed by the Small Business Administration. The two main types are SBA 7(a) and SBA 504. The most common type, SBA 7(a) loans, are commercial mortgages fully backed by the SBA. This type of loan is popular due to its low interest rates and long repayment terms. SBA 504 loans consist of two loans, one from a Certified Development Company (CDC), a community-backed partner with the SBA, and one from a traditional lender.

PACE

PACE, short for Property Assessed Clean Energy, creates low-cost, up-front financing for energy efficiency, renewable energy, and other qualifying improvements to new construction or renovation projects. PACE allows these improvements to be funded by private capital and repaid via a long-term tax assessment. Improvements financed by PACE can increase building value and lower operating expenses.

Crowdfunding

Commercial real estate crowdfunding, also called syndication, relies on many investor contributions to fund one project. Exemptions from 2012’s JOBS Act meant companies could receive smaller investments without having to register for an IPO. Crowdfunding can offer financial accessibility, easy access to investors and information, and versatility.

Direct Lending

Direct lending is a loan that comes from private lenders, not through a bank. Direct lending is particularly popular in hospitality because private lenders are often able to be more flexible than banks and can provide funding solutions for developers that may not be able to borrow from traditional banks.

The Benefits of Financial Advisory

In both the short- and long-term, financial advisory can help increase the chances that you will see a high return on your hotel investment. In the short-term, financial advisors can help you determine which type of financing option is best for you and your business, connect you with investors, and plan for the future. Over the long run, advisors can help you find commercial real estate tax benefits, weigh investment and loan strategies, and help determine if you have the equity to expand or upgrade your properties.

At PRC Hotel Loans, we can help you find loans or other financing options for your hotel investment. We offer direct lending, crowdfunding, and a network of over 1000 capital partners waiting to quote your loan and get you financed quick. In addition, we offer advisory services to help you make financial decisions to keep your investment in great shape. We originate loans from $2 million to more than $500 million for over 1000 capital partners and investors. If you’re interested in securing the best financing for your hotel project, call 817-405-7161 to speak with a financial expert today.

Potential and current hotel owners and investors have several hurdles to jump on their way to developing, buying, or renovating a hotel, and one of the first is qualifying for a hotel loan. Even though hotels are operating businesses, they’re most often financed as commercial real estate. Hotel loans are most commonly used to build a new hotel, buying an existing hotel, renovating an existing hotel, purchasing or upgrading furniture and amenities, and boosting working capital. While hospitality remains a safe investment, lenders will consider several factors to ensure the borrower qualifies for their loan.

Hotel loans are particularly complex because there is such a wide variety of hotels. They can vary from just a few bedrooms to hundreds of rooms, and amenities range from little more than a room to sleep into luxury spas, pools, fitness rooms, and complementary meals. The hotel’s quality can affect its financing. STR, formerly Smith Travel Research, has a classification system based on the hotel’s average daily rate (ADR), which uses the ratings of Economy, Midscale, Upper Midscale, Upscale, Upper Upscale, and Luxury.

In addition, hotel financing is impacted by whether the hotel is flagged or un-flagged. Flagged hotels are brand hotels (such as Marriott or Hilton), and they are either owned directly by the parent corporation or by individual franchisees. Flagged hotels oftentimes will be at least partially financed by the parent corporation. Unflagged hotels, by contrast, are completely independently owned and operated, so they need to be financed by the developers, owners, donors, crowdfunding investors, or other sources.

Common Types of Hotel Loans

Depending on the hotel size and reason for financing, investors can seek out different types of loans. The most common loans used to finance hotels for larger and/or longer-term investments are conventional bank loans and SBA (Small Business Administration) loans, particularly SBA 7(a) and SBA(504).

Conventional bank loans are standard commercial real estate loans that are not backed by the federal government. They can be used to purchase, construct, renovate, address working capital needs, or even refinance hotel properties. There is no loan size limit, and the repayment term can be up to 25 years.

SBA 7(a) loans are commercial mortgages backed by the SBA; they are the most common type of SBA loan. This type of loan is popular due to its low interest rates and long repayment terms. At the time of this writing, in order to qualify for an SBA loan, “Your business must have fewer than 500 employees, and less than $7.5 million revenue on average each year for the past three years. Your net income must be under $5 million (after taxes and not counting carry-over losses), and your tangible net worth must be less than $15 million.”

SBA 7(a) loans can be used for up to $5 million with a typical repayment period of up to 25 years, depending on the loan’s use (e.g., working capital vs. real estate).

SBA(504) loans are also backed by the SBA, but they are comprised of two loans, one from a Certified Development Company (CDC), a community-backed partner with the SBA, and one from a traditional lender. These loans are especially popular because the CDC loan has a fixed rate, but this benefit comes with strings attached. Borrowers must meet the same parameters set by the SBA to qualify, but these loans can typically only be used for fixed assets such as CRE. These loans have a maximum of $5.5 million with repayment terms of 10 to 25 years.

What Lenders Look for in Hotel Financing

Each lender will have their own particular set of metrics that they value the most to help ensure they see a return on their investment, but there are a few that are typically used across the board: the total real estate value or purchase price, the borrower injection (similar to a down payment), the business plan, how long the borrower has been in business, and the borrower’s credit score and credit history. Other metrics, which are highly intertwined with each other, include the following:

Profitability: The lender will assess several metrics to determine profitability. They’ll likely assess the hotel’s cash flow (or projected cash flow), which is measured by the amount of money the hotel is earning, minus the amount being paying out. This is used to ensure that the hotel is operating profitably. For existing hotels, whether the loan is for an acquisition, renovation, or other purpose, the lender will likely examine the Average Daily Rate (ADR) and Revenue per Available Room (RevPAR), which are two of the most common ways to assess profitability, as well as Net Operating Income (NOI).

Loan-to-Value Ratio: This ratio compares the amount of a loan to the total value of the asset being purchased. The ratio is calculated as the principal loan amount over the property value. Most lenders require a maximum LTV of 85 to 90%, but this can vary according to the situation.

Collateral: In most hotel loans, the real estate itself accounts for most, if not all, of the collateral, so many types of loans don’t require additional collateral. Still, borrowers should be able to demonstrate that they have access to outside collateral. In addition, since new constructions don’t have any collateral associated with the hotel building, and they don’t have any demonstrated proof of profitability, borrowers may be asked to provide additional collateral.

Debt Service Coverage Ratio: The debt service coverage ratio (DSCR) measures the ability to repay debt. It’s calculated by dividing the NOI by the hotel’s total debt and interest payments. Lenders use the DSCR to evaluate the financial health of the hotel. Generally, lenders want to see a DSCR of 1.25x or greater.

How to Qualify for a Hotel Loan in 3 Steps

Step 1: Find the Right Loan With a Trusted Advisory

Hotel loans are complex, and navigating them can be overwhelming without the guidance from a professional. Whether you’re planning on building a new hotel from the ground up or just need a loan to upgrade the hotel’s fixtures, the financial experts at Pioneer Realty Capital can help determine which type of loan best suits your needs. We originate loans from $2 million to more than $500 million for over 790 capital partners and investors. If you’re interested in securing financing for your hotel project, call 682-518-9416 to speak with a financial expert today.

Investing in anything always carries a bit of risk, and hotels are no exception. While they require a large initial investment and face competition from AirBnB, building a hotel still offers a great investment opportunity. Many investors are also concerned that we’re approaching an economic downturn; however, research and market projections indicate that the hotel industry should remain strong in the next downturn cycle.

Reasons to Invest in a Hotel

Investing in a hotel is different from the other “big four” assets of CREs for several reasons, the most significant of which is that hotels have nightly leases rather than monthly or yearly. While this means pricing needs to change to match supply and demand throughout the year, it also means that hotel investors can take advantage of seasonal spikes in demand.

Like all CRE investments, hotels also come with the excellent tax benefits of equity growth, tax-free exchange, and depreciation. Like all real estate investments, hotels will suffer from wear and tear over the years, but investors can apply a depreciation expense schedule to reduce their taxable income under U.S. law. Cash equity from a debt refinance is not subject to federal income tax, and investors can avoid tax liability on the appreciated gains of two hotels during a tax-free exchange. In addition to these tax benefits, there are countless other financial benefits to owning a hotel, including leveraging capitalization, operations, and renovations.

Projected Hotel Market Growth

Hotel growth has been on the rise since the end of the recession, though the growth has slowed down in the past couple of years. While the immediate economic future is uncertain, research by statista.com has found that hotel revenue is expected to show an annual growth rate of 4.1% by 2023. Hotel revenue in the hotel industry in 2019 was $368,359, but it’s projected to be $432,095 in 2023. Lodging Magazine also reports that hotels are operating at the highest rate of efficiency since 1960.

Still, while the long-term growth looks promising, HopsitalityNet predicts that 2020 will still have positive growth, but less growth in demand, occupancy, average daily rate (ADR), and revenue per available room (RevPAR) than in 2019. However, they also predict that rates will match or slightly exceed 2019’s statistics by 2021.

Hotels vs. AirBnB and Changing Customer Expectations

Many potential hotel investors are concerned about the changing hospitality market, which includes the rise of AirBnB. However, hotels have not had a long-term impact from AirBnB and continue to remain a safe investment opportunity. There are several factors for this, including business travelers preferring the convenience and predictable amenities of hotels. However, successful hotels need to recognize the current guest expectations in design and operation. Millennials in particular are more interested in eco-friendly hotels with healthy and locally focused amenities, restaurants, and cocktail bars. Consumers are also starting to expect personalized experiences and entertainment, smart in-room technology, and multifunctional spaces. Even though AirBnB isn’t a direct threat to hotels, investors should ensure they regularly renovate and update their design to appeal to guests who want a unique travel experience.

Concerns About Downturn or Recession

Despite the promising long-term projected growth of the hotel industry, our economy is in flux, and we appear to be approaching a downturn cycle. We’ve already given advice on the best ways for CRE investors to weather the downturn, but how much does this advice apply to hotels? Historically, recessions occur at a confluence of high interest rates, high oil prices, and policy issues. While the Fed lowered interest rates in 2019, Bernard Baumohl of The Economic Outlook Group is concerned that it might not be enough to offset decreased global travel as a result of the trade war. In addition, economic uncertainty can cause consumers to spend less, which impacts the hospitality industry. Still, Baumohl estimates that the chance of a recession occurring in the immediate future is low and that we are headed for a slowdown, not a full-blown downturn.

Of course, investors need to be prepared for economic downturns and slowdowns. Hotels can armor themselves in several ways. Investors should actively manage costs with the operations and management team to protect potential slimming margins, proactively plan for unexpected poor performance, and improve the guest experience. In addition, hotels should build themselves as a brand through community involvement and proactive marketing, which can create brand loyalty and higher occupancy rates. Even if a downturn is on the horizon, savvy CRE investors can still take advantage of the growing travel lifestyle and overall increasing margins of the hospitality industry.

Reasons to Invest in a Hotel

Invest in Hotels with Pioneer Realty Capital

PRC has extensive knowledge about the hotel industry, and we can help you build a profitable investment. In addition to market advice, we offer hotel loans to developers, owners, and investors. If you are interested in starting or expanding your CRE portfolio, reach out to one of the financial experts at Pioneer Realty Capital today.