Hospitality Credit Markets Are Beginning to Stir After Long Slumber
Hotels, in the eyes of the market, started a comeback in the fourth quarter of 2020.
There was an overall 79 percent year-over-year decrease in dollar volume for loans on hotel properties in 2020. But, hotel originations jumped a whopping 411 percent from the third to fourth quarters, and the sector saw a huge uptick in hospitality financings to close out last year, according to data collected from the Mortgage Bankers Association. Debt funds are leading the way in providing the liquidity that’s propping up the market, but more institutional, conservative shops are now eyeing leaps back into the space.
The hospitality sector was of course one of the hardest hit during the COVID-19 pandemic. “Lenders stopped wanting to do those deals, and borrowers weren’t asking; they were just trying to hang on [last year],” said Gary Otten, head of real estate debt strategies for MetLife.
Still, good news on the vaccination and economic fronts going into 2021 meant a meaningful chunk of commercial real estate lenders have set goals to deploy more than $1 billion into the hospitality space this year, according to a recent survey of lenders released by research and investment banking firm RobertDouglas.
“With that much demand for hotel products, spreads will compress,” said M&T Bank Senior Vice President Jason Lipiec, who oversees much of the bank’s hospitality output across its footprint.
About 67 percent of a variety of lenders surveyed by RobertDouglas are anticipating an increase in hotel valuations this year, and 78 percent expect values to peak again in the next two to four years. About 72 percent also expect their hotel lending volumes to climb this year.
As such, lenders of all stripes are keen to look at hotels that are less dependent on corporate or group business travel; such assets as “drive to” leisure destinations and resorts, as well as some luxury or trophy assets; and, finally, the extended-stay and limited- and select-service hotels. Recent high-profile moves in the market, like Starwood Capital Group and Blackstone’s $6 billion pending purchase of Extended Stay America, have helped bolster confidence.
Most lenders are also looking to states that have been less stringent about COVID-19 guidelines, such as Florida, which is “on fire right now, from an occupancy standpoint,” Otten said. “From a business perspective, hotels in Florida are doing some of the best business in the country. We’ll take a favorable look at those.”
The biggest question among lenders that spoke to Commercial Observer is how do you underwrite the future after such a strange, anomalistic year? “That’s where people’s views separate,” Otten said.
Lenders are currently requiring anywhere from six to 12 months of interest reserves, no matter the cash flow exhibited by any given asset, according to recent analysis from JLL, which said those requirements are “unchanged” from last year. Lenders are also requiring reserves for operating shortfalls that extend out “several months or longer” than six to 12 months. And, while the amount of leverage lenders are willing to extend on hotel loans still remains quite low, carry guarantees for debt service and operating expense shortfalls are a must, depending on the profile of the lender and its specific constraints.
JLL said it expects those structural features within hospitality loans to remain until the hotel sector’s operating fundamentals begin to fully rebound.
A debt yield north of 10 percent is a “good number. We’d like to see it higher than that, but in hotels, 10 is the ticket to entry for the asset class; that would be a minimum,” Lipiec said. He added that M&T has consistently been a recourse lender on hotels, due to the fact that it’s an operating business with daily inventory that needs to be sold.
Bank lenders are being particularly selective, preferring to refinance an existing asset with a track record of strong performance, according to recent analysis from JLL. Lipiec said it’s “safe to assume” that spreads on the bank-lending front sit in the high-300s to mid-400s over LIBOR for non-recourse financings.
“Projections are an issue,” Lipiec said. “Where we are normally going out to 65 percent [loan-to-cost], we’re in the low 50s right now, with higher reserves. We’d project a slower stabilization, so some operating reserves might be necessary to get you to that stabilized basis.”
Lipiec said the bank, which is mostly focused on working with existing clients, is looking at pre- and post-COVID performance, but also vaccinations and the speed at which they’re getting done, as well as airport arrivals, so that the bank can get a sense for “who’s traveling and from where.”
MetLife has put a lot of onus not only on pre- and post-pandemic performance in its underwriting, but also “years before that, and if it’s available, we’ll look at performance post-Global Financial Crisis. It allows us to underwrite future occupancies and [average daily rates]. It’s a combination of looking at a three- or four-year return to normalcy on hotels,” Otten said. The company, which is one of the industry’s foremost life company lenders and investors, has continued to quote and fund hospitality loans through COVID-19.
Life companies are pricing loans anywhere from the low to high 400s over LIBOR with leverage that doesn’t eclipse 60 percent, according to JLL’s findings. However, Otten said what he’s experienced on the life company lending front in the last 12 months would put spreads at a “starting point” of 500, but “generally, it’s in high 400s, maybe even 500s.” He also said the company is exploring strategies to provide more leverage in hotel deals, although he was unable to go into further detail.
In the commercial mortgage-backed securities (CMBS) universe, historically a prominent funding source for hospitality assets, there are a number of large investment banks that have started to quote 5- and 10-year, fixed-rate CMBS loans on hotels — with very stringent underwriting — at rates ranging from 4.25 percent to 5 percent, according to a JLL report released last month. That sentiment is a sign the market is beginning to warm to the asset class and is growing in confidence about a recovery.
CMBS lenders are making loans at roughly 60 percent leverage today, and are going as high as 65 percent for acquisitions, according to JLL’s analysis. They’re also sizing to debt yields reaching 10 to 12 percent based on 2019 cash flows that have been discounted by upward of 10 percent. Borrowers can also expect these lenders to require 12- to 18-month debt service or carry reserves as an additional safety net against operating losses.
The CMBS single-asset, single-borrower (SASB) space is open for floating- and fixed-rate debt capital north of $200 million and backed by limited service and extended stay hotel portfolios and resorts, JLL said. There were several SASB lodging deals that came to market toward the end of 2020. Despite the increased interest, existing lodging loans in CMBS are still laboring, according to March servicing data from Trepp; a little over 24 percent of all existing lodging loans are currently in special servicing.
There’s also ample availability for hotel construction financing at “reasonable pricing” for the “best assets and best sponsors,” according to JLL. Pricing for construction loans, though, remains “very bespoke,” with most lenders offering leverage below 60 percent. Senior mortgages are also generally between 40 to 50 percent loan-to-cost.
A lack of sales activity and wide bid-ask spreads still have lenders unsure when the floodgates will completely blow open.