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.
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.