Volume 27, Number 3
Written By: Rebecca Harris
[dropcap style=”normal” title=”L”]ending has never been an easy process in the hotel industry. But today, lenders are actively competing for business in the sector.
“On a whole, this is a very favourable time,” says Chantal Nappert, VP of Finance and Investor Relations at InnVest REIT in Mississauga, Ont. “We’re seeing the base rates at historic lows, and we’re seeing new entrants coming into the market with lending appetites…. They’re still selective in terms of who they’re lending to, but, for the right type of partner, it’s a competitive time for lenders.”
Abid Gilani, the New York-based SVP of the Hospitality Finance Group at personal and business banking institution Wells Fargo, says the Canadian lending market has progressively improved through 2013 and 2014, which he partly attributes to the volume increase in investment transactions. According to Colliers International, Canadian hotel transaction volume reached $1.46 billion in 2014, marking the year as the second highest (after 2013) in deal volume since the last peak in 2007. “We’re seeing more financing opportunities and lenders following that market,” says Gilani.
But that’s not to say all lenders have thrown their doors wide open. There’s still some resistance from commercial banks to get involved in hotel lending, says Michael Rapps, Toronto-based president and CEO of investment company Clarke Inc. “It’s still [primarily] government entities such as BDC (Business Development Bank of Canada), credit unions and specialty lenders,” he adds. “The chartered banks have still been a little slow to open the taps.”
And, while there is collectively more capital available for the hotel sector, each lender’s portfolio is limited in terms of how much they can lend to the sector, notes Mark Kay, president of Markham, Ont.-based CFO Group, a commercial lending company. “Therefore, it’s very important to understand which lenders are active at any given time, their capacity and their lending criteria,” he says.
So, what qualities are lenders looking for in a borrower? The market is favourable to experienced, top-tier sponsors, says Robin McLuskie, VP, Hotels at Colliers International in Toronto. But loan programs, guidelines and pricing vary widely depending on the asset type. “If a borrower is looking for a little leverage, then the spreads can be more competitive,” she says. “If it’s a turnaround hotel, or it’s not performing well and needs capital, more expensive lenders might come in on a short-term, interest-only basis to help turn the property around…. It really is a function of what the cash flow is on the asset, what the positioning is and who the sponsor is.”
Edward Khediguian, SVP of Franchise Finance at GE Capital Canada in Montreal, agrees the availability of capital depends on the asset. But overall, “there is a certain flight to quality in terms of capital chasing the larger, more sophisticated and better experienced operators,” he says. “So they’re getting the bulk of the attention, the better pricing and the higher leverages.”
As a buyer of hotels, Clarke Inc.’s Rapps agrees experience matters. “[Lenders are] clearly looking at the coverage of our loans, and debt service coverage in particular is critical to them. But they’re also looking at the quality of the borrower,” he says. “Because we have a number of hotels across the country, while they are lending against a particular asset, they’re really lending to us. They can draw on our experience and, if necessary, security in the form of equity in our other hotels to protect them. So they’re looking at the quality of the borrower as much as they’re looking at the coverage on a particular asset.”
Lenders are more apt to lend to brand-managed hotels than non-flagged properties, and location also plays a role. “It’s important for lenders to know the hotels are professionally managed,” says InnVest REIT’s Nappert, adding that primary city-centre markets tend to be the most attractive. “It’s much like the housing market: location, location, location,” she explains. “Primary city-centre markets are high barrier-to-entry markets, so it gives lenders a lot of security for the long-term performance of the assets.”
Wells Fargo’s Gilani believes there are opportunities for unbranded assets, but the bulk of these will be located in high barrier-to-entry markets such as Toronto and Vancouver. “But in tertiary markets, such as Northern Ontario, Saskatchewan, Manitoba and the Atlantic provinces, it would be difficult to go unbranded,” he says. While there are many independent properties in those regions, Gilani predicts inventory will get upgraded over the next few cycles. “As there’s more debt financing available, we’ll likely see brands come in and replace those unbranded assets,” he notes.
And, in those tertiary markets, lenders are more likely to be credit unions and smaller regional banks. “It’s very much regionalized in terms of what lenders are looking for,” says Gilani. “In second-tier or tertiary markets, there are more new-build opportunities. There is a lower capitalized amount for each project, so it opens up [the market] for smaller lenders who underwrite that size of loan, which is much smaller.”
While financing really comes down to the numbers, having established relationships between the lender and borrower is also key. “We view ‘relationship lending’ as very important,” says Nappert. “For us, that means having a lender [we’ve] done business with in the past…. You understand the expectations and the key trigger points on both sides, and what each lender may or may not be able to flex on. And it’s facilitated after you’ve done multiple deals with them.”
Having relationships is not just beneficial to the borrower — Nappert stresses that it’s a reciprocal relationship. “We need them to finance our deals, but they also need us to put their money to work,” she says. “Like everything else, we’re all in this together.”
Clarke Inc.’s Rapps concurs that the lending process goes more smoothly if the lender and buyer have previously done business together. “If we have a relationship with a lender, and we go to them for a mortgage on a second or third hotel, we can get those deals done very quickly,” he says. “Everyone is familiar with the documents and negotiation from the last time around, and everyone is familiar with our credit quality.”
As the markets have recovered from the economic downturn, business plans are starting to come into sharper focus. “Lenders have gotten smarter,” says Gilani. “They’re starting to appreciate that this is an operating business — it’s different than lending to other forms of income-producing properties.” He adds: “They’re starting to question borrowers on their business plans, their focus in terms of how they’re going to drive business to the hotels, their reservation system, and their sales and marketing plan.”
Hotel lenders are also increasingly focused on the debt-yield metric (net operating income divided by the loan amount), according to Gilani. “[Lenders] are underwriting the cash flows and the operating performance of the asset, taking into account historical performance, market trends and what’s coming into play in terms of new supply,” he says. That means borrowers need to approach lenders with a defined focus on things such as cost control and knowledge of their target market.
CFO Group’s Kay notes that for new construction or conversion, a feasibility study is a critical piece of a great business plan; it’s key to understanding the demand and supply of the market. “[That] ultimately translates into understanding the cash flow of the hotel and the ability to service a mortgage,” he says.
While lenders’ appetites for hotel business continues to grow, there is a lot more rigour around compliance today. “Your best bet is to have clean, precise and up-to-date [financials], know where you’re at and have the ability to communicate it effectively,” advises GE Capital’s Khediguian.