Mortgage Observer

From Construction to Refinancing, Capital for Hotels is Pouring In

When New York’s largest independent hotel developer and owner, BD Hotels, began exploring sources of capital this year for its latest projects, the company’s co-founders decided to diversify their approach to construction financing due to a growing of number of potential lenders.

Richard Born and Ira Drukier, who partnered in 1986 and now own and operate 25 hotels in New York, including the Maritime Hotel in Chelsea and the Bowery Hotel in the East Village, are in talks with a foreign investor to provide secondary capital for an upcoming development in Midtown, while sticking with a traditional bank for their first construction loan.

“There’s just so much money being designated for New York City hospitality now,” Dr. Born, who did four years of surgical residency before going into the real estate business, told Mortgage Observer. “Especially with all of the foreign sources coming in.”

New York, the country’s premier hotel market, is a ripe financing field for developers with enough experience, brand recognition and equity of their own. At the same time, new entrants coming into the hospitality financing market and the return of traditional lenders have spurred more hotel deals throughout the United States. That increase has most recently led to a major uptick in hotel financing in secondary markets, from New Orleans to Cincinnati.

Illustration By Keith Negley

Illustration By Keith Negley

Hotel loans made up about $5.7 billion of multiborrower securitizations in the first three quarters of 2013, more than double the $2.5 billion of hotel loans contributed to conduits in the same time period last year, a recent study from Cushman & Wakefield shows. Overall, the number of active lenders in the hotel sector today has increased by about 20 percent in the past year, said Ernest Lee, director in the global hospitality group in the equity, debt and structured finance division at the New York-based real estate services firm.

On top of growing interest from alternative lenders and foreign investors, many regional and national U.S. loan originators and brokerage firms are expanding their hotel financing platforms in 2013. “There is a tremendous increase in appetite for hospitality lending,” said Jared Kelso, managing director of Cushman & Wakefield’s global hospitality group, which arranges debt and equity for hotel owners. “We’ve seen the market for transitional assets, or bridge lending, almost double in size, which is incredibly important for the hotel industry. On top of that, we’ve seen over 10 new whole loan platforms for transitional assets enter the hospitality space this year alone.”

In April, Mr. Kelso’s group closed a $55 million floating-rate acquisition loan from Natixis Real Estate Capital for the Hyatt Union Square hotel at 134 Fourth Avenue, among other hotel deals they could not discuss publicly. Mr. Kelso noted that hotel construction financing from banks and other lenders is also picking up as many of them are being pushed into the hotel space for better yields due to “intense competition to lend on other asset classes, such as Class A office buildings.”

But even as capital has started to flow into hotels again, borrowing is still not as easy as it was prior to the financial crisis, Dr. Born said. “The debt market today is clearly head and shoulders above where it was in 2009 when there was no debt market,” he explained. “But it is still not as frothy as it was at the peak of the market in 2007.

Michael Nash, chief investment officer of Blackstone Real Estate Debt Strategies, echoed that sentiment, adding that large construction loans are still a challenge for many developers to get. “New York as an exception has actually had a decent amount of supply, but in other major markets it’s harder to build new hotels. The numbers are hard to justify,” Mr. Nash said. “The financing on the construction side is still virtually impossible, so it makes it easier for us to pick and choose our spots.”

Hotels, by and large, are considered the riskiest real estate asset class to lend on due to their operating models. The average hotel’s occupants move in and out on a nightly to weekly basis, making each month’s income that much more uncertain and upkeep that much more costly. Even in top markets where occupancy remains high, significant capital is required every four to five years to keep a hotel’s maintenance up to standard, according to the hotel developers and financers Mortgage Observer spoke to.

“It’s an extremely variable model and is subject to peaks and valleys more than any other real estate asset class,” Mr. Kelso said. “So the net operating income available to pay debt service can go from three times debt service coverage to a fraction of that in the space of a year.”

As a result, transitional floating-rate capital has always been a vital component of hotel financing. Before the market collapsed in 2008, there were a large number of domestic banks and international lenders providing floating-rate loans to the hospitality industry. Many of those lenders—Capmark Financial Group and Hypo Real Estate Holding among them—shut down their financing platforms in 2009, making it that much harder for developers to secure loans for construction, as well as for less risky upgrading and refinancing, Mr. Kelso noted. As commercial real estate lending as a whole started to pick back up in 2011, fixed-rate capital available for stable hotels came back first, he said.

The pool of those willing to finance hotel projects in October includes private equity, local, regional and national banks, life insurance companies and both floating-rate and fixed-rate CMBS lenders, as well as mortgage REITs, debt funds and foreign investors. As of late 2013, about 85 percent of the lenders that were active in the hotel-financing space prior to the downturn have returned, hotel financing experts say.