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How 2021 could change industry’s debt environment

In the words of industrialist J. Paul Getty, “If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.”

However, the state of the hospitality industry and its associated debt probably more closely conforms to this quote by British novelist Sax Rohmer: “I gain nothing by having a rock in my boxing glove if the other fellow has one too.” Currently both lenders and borrowers have rocks in their gloves.

Getty Images
Getty Images

Richard Stein is an associate at Beverly Hills, California-based real estate capital advisory firm Max Benjamin Partners.

At present, nearly every hospitality loan is in violation of at least one loan covenant. The breach may be as benign as accepting a PPP loan without the prior consent of the lender, or it may be more serious, such as falling below loan to value coverage requirements or other violations that could lead all the way to the closure of the hotel. 

According to Trepp, using the latest September remittance data, the CMBS loan forbearance total has risen to US$31.2 billion encompassing approximately 800 loans. About 64% of the forbearances granted thus far have been for hotel loans.

Trepp estimates 12% of all CMBS loans will be foreclosed on as a result of the coronavirus crisis. Half of U.S. hotel owners claim they are in danger of foreclosure by their lenders due to the pandemic (American Hotel & Lodging Association) – an amount that dwarfs the US$100 million alluded to by Mr. Getty.

Punch and counterpunch

The pain derived from the pandemic and its associated closures and restrictions has not been evenly distributed. Full-service hotels suffered a 61% drop in cash flow when compared with underwritten levels, extended-stay properties a 35% drop, and limited-service hotels are down 44%.

One possible solution, if a sponsor has multiple properties, might be to sell some assets in order to shore up their balance sheet. We will revisit this shortly. The other solution is attempting to work out some type of cure. 

Some of these cures result from forbearances being granted and borrowers being authorized to use reserves to make the loan current. Other solutions may include payment suspension for three to six months with interest and principal payments deferred to the back end of the loan’s term.   

Unfortunately, most banks likely calculated restrictions and lockdowns would ease after a few months (remember the V-shaped recovery?). As the pandemic continues, fears remain that banks will not extend the flexible payment terms and forbearance that were offered in March and April. Lenders question how many hotel foreclosures will actually materialize if banks or commercial loan servicers play hardball.

The usual demand-generating measures, such as lowering rates or rebranding, are unlikely to resurrect cratered occupancy and revenue. Foreclosure is often a last resort. However, foreclosures are not entirely off the table, despite the desire by borrowers for continued bank flexibility and alternative lending arrangements.  Many lenders are willing to renegotiate the terms of the existing loan and possibly originate a new or modified loan, but typically lenders will require an injection of additional equity. Loan modifications may also include cash management arrangements where a lender holds all the cash or excess cashflow, increased guarantee protections, and other onerous covenants.

A solution to the problem might be selling the property. A primary obstacle is valuation. The duration of the pandemic and the residual effect upon the subject property is challenging to estimate. Other issues include depletion of reserves and carrying costs incurred until the current disruptions subside.  

An even bigger issue may be financing: How will the new buyer finance the purchase of the hotel? Currently, assumable loans are a real benefit; qualified buyers may be able to assume the current loan.

I receive calls regularly asking me if I have any off-market hotels available, but at a substantial discount. Well-capitalized private equity funds and family offices are mobilizing to deploy capital into hotel assets, and pricing expectations assume a discount of 25% to 50% below pre-coronavirus valuations. Distressed asset resolutions have yet to emerge in any meaningful quantity. Forbearance, lack of valuation certainty and the absence of new financing constitute root causes.

In lieu of foreclosure, some lenders and borrowers may choose to sell their paper at a discount. For now, most hotels are current or in some state of forbearance. Hotel lenders do not want to be part of an avalanche of non-performing loans. There are buyers for the hotels or their paper, but only at significant discounts, and over time, the equation changes and the cost of forbearance works against the lender.

Hitting the market

Harvesting what can be salvaged may be the most logical solution. As we head toward the end of this year and into the first quarter of 2021, if significant travel restrictions remain in place and rolling lockdowns persist, it is likely that a significant number of hotels or their paper will hit the market. For the most part, hoteliers have not capitulated, but once forbearance is denied or lenders require more onerous loan provisions, hoteliers’ outlook and expectations may change and the current disparity in pricing expectations between buyers and sellers should narrow. The dicey part for the buyers will be to determine which hotels are likely to recover and which ones will not. 

The elephant in the room (no political reference intended) is the effect all these issues will have on future hotel originations. The hotel lending herd was culled considerably after 2008, and it is logical to assume there will be significantly fewer hotel lenders, especially for construction, post COVID-19. Larger, more liquid ownership groups will likely receive the bulk of available funds.

Brands favored by consumers and institutional buyers will get preference, and less popular brands, along with smaller developer and investor groups, will find financing very challenging and expensive.

The likely consequence will be more consolidation in both ownership and brand affiliation. In the words of David Byrne, “Same as it ever was… Same as it ever was.”

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