Getting creative with hotel financing

Real Estate Weekly, June 9, 2004 by Peter M. Berk

What a difference a year makes. At this time last year we were looking at year over year of RevPar growth that was either flat or slightly down from the previous year.

With the end of the war and all of the uncertainties gone in the spring of 2003, the summer of 2003 saw a turnaround in our industry that has not only given encouragement to owners who have been through a few tough years, but also to those in the capital markets who provide the debt and equity capital so vital to keeping the industry moving forward.

One of the most important barometers that capital providers evaluate when looking at prospective hotel financing transactions, is the hotel's performance over the prior 12 month period.

In 2004, as each month progresses and the new '04 month replaces the same weaker month for '03, a hotel's prospects for achieving the most competitive financing rate and term available in the market improves.

With the improved performance, we have seen many new providers of capital to the lodging sector.

These providers are not the traditional first mortgage providers, but are "mezzanine loan providers" who bridge the gap between what a traditional first mortgage provider is willing to lend and the proceeds the owner needs in order to complete their financing. Mezzanine loans can be used for both new construction and for refinancing.

The mezzanine provider is betting on the continued improved performance of both the hotel and the overall hotel market continuing to rise.

The mezzanine provider gets paid well for providing this service and providing greater financial leverage. Where the typical first mortgage provider only provides up to 70% loan-to-value financing, the mezzanine provider is willing to increase those proceeds to 85% or 90%. The cost for the incremental 15% to 20% of leverage costs the borrower an interest rate of 9% to 15% on the additional proceeds above the first mortgage.

At the expiration of the loan in 3 to 5 years, with the improved performance of the hotel and the market, the mezzanine provider is counting on their initial 85% to 90% loan-to-value loan, now being only a 60% loan, easily financeable with new first mortgage proceeds. The mezzanine loan is not structured as a second mortgage, but rather as a pledge of the ownership equity as the form of collateral for the investment, with the mezzanine provider having the ability to step into the owner's shoes if they are not repaid.

An example of a recent transaction which the AFC Hotel Finance Group completed which had a first mortgage and a mezzanine financing component to it was the financing of a portfolio of 8 hotels for a western hotel owner/operator. The owner had a $27 million loan coming due on the properties and was only able to achieve traditional first mortgage financing proceeds of $24 million at an interest rate of 6. 10%. This was all the risk the first mortgage lender was willing to take, as they viewed this $24 million loan as 71% loan-to-value.

AFC then went out to their capital sources who provide mezzanine financing, and was able to raise an additional $3 million in proceeds priced at 9.5% for the loan term. The result to the owner was that they were able to raise $27 million--enough proceeds to refinance their original loan at a blended interest rate of 6.48% which includes both the $24 million first mortgage and the $3 million mezzanine piece.