Hotel Lenders' Purse Strings Tighten

Fitch sees an impact from Basel III regulations on hotel lending.

NEW YORK CITY—For hotel financing , it may be premature to declare the party over, but at the very least the guest list has gotten more exclusive. Summing up key takeaways from panelists at last month’s Americas Lodging Investment Summit conference, Fitch Ratings on Friday predicted “a more challenging debt financing environment” this year as lenders respond to the broad repricing of risk across most debt capital markets and new regulations. “Borrowers can expect higher interest rates and tighter underwriting standards for loans backed by hotel collateral as lenders adapt to more challenging debt capital markets conditions,” says Stephen Boyd , director of lodging and REITs at Fitch. Sponsor quality will distinguish hotel debt capital access for the balance of this up cycle, with lenders taking “a holistic approach” to judging sponsorship quality. Among other considerations, banks will take a closer look at a sponsor’s experience and prior behavior, especially when faced with tough decisions. “Unlike loans made earlier in this recovery, lenders can no longer rely on the rising tide of hotel fundamentals to offset poor credit decisions,” Boyd says. Basel III regulatory requirements will continue to temper hotel development growth at the margin, says Fitch. Commercial banks have curtailed their development lending activity due to the high capital charges for so-called high-volatility commercial real estate loans that apply to many highly-levered development loans under the new regulatory regime. “Some banks are making non-recourse development loans at higher spreads to compensate for the higher capital costs,” according to a report from the ratings agency. “The majority of commercial banks require at least 50% recourse for construction loans.” However, just as JLL Hotels sees growth arising from more capital sources coming into investment, so Fitch anticipates that alternative capital sources will step in to fill the void left by banks. Lodging C-corps are expected to increase the pace of their management and franchise investments to use their balance sheets to support unit growth, as the cost of development financing increases and availability decreases. Alternative lenders—including private equity, hedge funds and mortgage REITs—that specialize in mezzanine debt and preferred equity will play an increased role in hotel financing this year, Fitch says. “Shadow banks are uniquely well positioned to solve hotel financing challenges given their greater flexibility than commercial lenders to take down the entire debt stack and sell off the senior piece of debt while retaining the riskier, higher-return mezzanine portion,” according to Fitch’s report. Underscoring lenders’ increasing caution, there are signs that the “rising tide of hotel fundamentals” cited by Boyd won’t continue rising indefinitely. The 2016 edition of the annual “Expectations & Market Realities in Real Estate” report from Situs Real Estate Research Corp., Deloitte and the National Association of Realtors notes that hotel fundamentals “have slowly climbed to new heights” despite slow economic growth. “However, according to PKF Hospitality Research , occupancy is expected to increase 120 basis points to 65.6% by end of 2015, which is 100 basis points less than the growth rate from 2013 to 2014,” according to the “Expectations & Market Realities” report. Occupancy growth is expected to slow even further, increasing by just 40 bps to 66.0% by the end of this year. Additionally, the report notes that PKF expects hotel supply to increase 1.1% in 2015 compared to the prior year, while demand is expected to increase by a respectable 3.0%. “However, annual supply and demand growth has slowed and is expected to slow further, so that demand is likely to be only 60 bps higher than supply in 2016.”