Deal Basics Remain The Same
Economic slump changes source of capital, but deal dynamics unchanged.
Contributed by Rick Kirkbride -- Hotels, 5/31/2008 11:00:00 PM
Not long ago the key question at industry conferences was: “How long can the good times last?” Now we know the answer. In the United States, underwriting of new hotel and resort development deals, as well as purchase and sales (and refinancings), has drastically changed and made some transactions “unfinanceable” until confidence in the capital markets returns. The end result is that great projects with great sponsorship will get done, while those in fringe locations or with fringe sponsorship will not (even though they would have over the last five years).
The biggest change may be in “following the money” as the money today is international—whether international in the sense of foreign money chasing U.S. properties or international in the sense of largely western branded hotels and resorts being developed in far away places located throughout the world.
In easy credit markets and in extraordinarily tight ones, a group of core questions marks the initial exchanges between borrower and lender. Acquisition, construction and refinancing loans share a thorough review of three deal characteristics at the outset: (a) the property itself, its physical characteristics, condition and potential; (b) the market or submarket in which the property is located; (c) the relative strength or weakness of the existing or proposed brand opposite the development of the property.
Generally, it is preferable to be “close to signature” with at least one major brand company before the financing package will go the lender's committee. The competition among brands for distribution, the growing prevalence of integrated mixed-use projects (such as those combining hotel with residential owned and fractional ownership) and the revised industry projections concerning the growth of RevPAR in the hotel sector will flavor the conversation. The brand company may be asked to bring more than simply its signage and its front desk support systems. Key money, operator loans and credit enhancements have entered the discussion. Territorial restrictions have come under renewed scrutiny as a result of the proliferation of new brands and brand segmentation by established brand companies.
Next, the lender will focus on harmonizing three sets of metrics concerning the property: (1) the borrower's projections of income, costs and expenses; (2) the lender's projections of income, costs, underwritten yield and assumptions concerning the timing of the “takeout” or refinancing of the loan; (3) the brand company or hotel operator's projections of ramp up timing, RevPAR, and its operating expenses, including any initial or other investments for “re-dos” or FF&E investment.
These points on revenues, costs and expenses all translate into agreement on one key element: timing. Whether acquiring an operating and branded facility, commencing construction or a substantial renovation, or completing an efficient conversion, both lender and its borrower, with the involvement of the management company, should agree on (i) the duration of any period of construction, renovation or conversion opposite the “down time” for revenue generation; (ii) the velocity and duration of the ramp up period, if applicable, and how “ramp up” may be impacted over time by competitive market entry and the cycles of the general economy through which it may pass; (iii) revenues and expenses at fully stabilized operation.
Certainly there will not be precise agreement on each of these elements, but there will need to be general agreement on at least the range within each category for a very practical reason: the lender will generally structure the loan, particularly interest reserve amounts and reserves relating to the projected but possibly unmet expenses of operation (such as taxes, insurance, carry and pre-opening) to mitigate the risk of the estimates “running short” as the asset stabilizes.
Discussing these points before the term sheet is exchanged fosters an agreed understanding on timing and metrics and a collective sense of the property's ability to fund the reserves from revenues and pay all the bills. Lender, borrower and brand company share a common goal: a profitable property with a predictable income stream and strong market performance. The credit markets may evolve around us, but the basic goal will always remain. n
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| Contributed by Rick Kirkbride, partner, Paul, Hastings, Janofsky & Walker LLP, New York City |
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