White Paper - How To Obtain A Hotel Loan In A Difficult Lending Environment

HOW TO OBTAIN A HOTEL LOAN IN A DIFFICULT LENDING ENVIRONMENT

Things have changed. Successfully obtaining reasonable hotel mortgage financing during the bottom of the current hotel business cycle requires rigorous management of the entire process.

THE CHALLENGE & A BETTER APPROACH

Hotel performance fundamentals have been hammered by the economy since our industry peaked in November 2007.

The subsequent down-sloping trajectory of Revenue Per Available Room (RevPAR) triggered knock-on effects as predictable as the cyclical nature of the hotel industry: Declining occupancy followed by flattening (then falling) Average Daily Rate (ADR), rising new room supply, climbing cap rates, slowing property sales transactions, sinking Net Operating Income (NOI) and an increasingly difficult financing environment.

What was less predictable, however, was the severity of the collapse of credit markets that has made hotel financing as challenging as any the industry has ever seen. A sobering statistic tells the story: According to the Mortgage Bankers Association, hotel lending volume is down 97% since the second quarter of 2007.

As a result, a better approach to hotel financing has become a business imperative. Things have changed.

Our clients own hotels. Engage the professionals. We handle their financing.™ Contact us. (469) 916-8518.

NOVEMBER 2009Vol. 1, Rev. 2

The severity of the credit market collapse has made hotel mortgage financing historically difficult.

A better approach is called for.

www.larkinhf.com

The Challenge.............................1The Hotel Credit Crunch..........2Media Influence...........................3The Valuation Conundrum.....3The Economy & Outlook..........4

A Better Approach....................57 Principles For Success..........5Process Management..............6Fact & Fiction................................7The Solution..................................8Conclusion.....................................8About The Author........................9

http://www.larkinhf.com


THE HOTEL CREDIT CRUNCH

Credit market players (i.e. banks, private lenders, insurance companies, etc.) always overshoot on both the optimistic and pessimistic sides of upturns and downturns in the hotel industry.

From 2005 through 2007 we faced a celestial convergence of perfect funda-mentals in the lodging industry that led to several years of outsized profits, valuation growth, and transaction activity. Optimism prevailed, loan underwrit-ing weakened, and easy and inexpensive hotel loans became the norm.

The aggressive hotel expansion cycle ended abruptly in November 2007 as the U.S. economy contracted. Adding insult to injury, the global credit markets vir-tually collapsed in September 2008 with Lehman Brothers’ failure and, subse-quently, several other Wall Street and Main Street titans: Bear Stearns, Merrill Lynch, AIG, Fannie Mae, Freddie Mac, Countrywide, etc. So far in 2009, 115 banks have failed, compared to 25 in all of 2008 and only 10 bank failures from 2003 through 2007. Further, the FDIC is tracking 416 more “problem” banks.

As a result, we’ve returned to the “old days” of hotel lending where underwriting is cautious to over-the-top conservative -- if you can even find a lender willing to take your call. As a matter of policy most lenders simply will not look at a hotel financing project today.

Worse still, hotels now hold the dubious distinction as the asset class with the highest proportion of loan delinquencies according to Fitch Ratings. Delinquencies will rise appreciably in the near-to-medium term as hotels are expected to suffer the highest peak-to-trough income declines among all commercial property types. According to Real Capital Analytics, (see chart below) distressed hotel loans total approximately $18 billion across 1,066 hotel properties, or roughly 2% of the 50,000 hotels in the U.S; likely a low estimate.

Outstanding commercial loan balances total $3.5 trillion. In each of the next three years between $123 billion and $147 billion of that debt matures and needs to be refinanced. In all of 2008 a total of just $181 billion of new commercial loans were originated across all asset classes.

There is simply not enough available liquidity across the credit markets to fund new commercial projects, much less refinance all maturing debt. Only the best managed loan requests can effectively compete for the limited debt capital.

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Hotels now hold the dubious distinction as the asset class with the highest proportion of loan delinquencies.

As a matter of policy most lenders simply will not look at a hotel loan request today.

There is simply not enough available credit market capital to fund new commercial pro-jects, much less refinance all maturing commercial loans over the next three years.

Only the best managed loan requests can effectively compete for the limited debt capital today.

Source: Real Capital Analytics

THE MEDIA INFLUENCE & LODGING PERFORMANCE

My father-in-law has been in the hotel and financing industries for over 30 years, and he firmly believes that when bad news about the hotel business makes it to the front page of the Wall Street Journal, hotel lending dries up quickly. Since that has now happened, only the best structured hotel financing deals will make it to credit committee.

The hotel business is already poorly understood by most lenders -- it’s not formally one of the four main “food groups” in the commercial lending world (i.e. Multifamily, Office, Retail, Industrial) -- and poor press only reinforces prejudices against the perceived complexities and management intensive nature of the “24-hour lease” lodging business.

The messages lenders are hearing about hotels the past two years are not good. According to Smith Travel Research, Revenue Per Available Room (RevPAR) dropped -1.8% in 2008, is expected to fall another -17.1% in full year 2009 and slide yet again -4.0% in 2010 before finally turning positive Q4 2010 and beyond.

Lenders are a conservative group and are looking for positive signals before meaningfully returning to lending on hotels.

THE POST-EXPANSION VALUATION CONUNDRUM

In the absence of draconian expense cuts, falling RevPAR will lead to falling NOI. Falling NOI, in turn, leads to both lower debt service coverage on the existing hotel mortgage and diminished value of the property.

Reliable nationwide statistics on hotel NOI movements don’t currently exist, but in all but the most special cases it is safe to assume that NOI has fallen across the board from 2007 to 2009. But even if we assume steady-state NOI during that period, hotel values have fallen inversely to rising capitalization rates by an average of -18.6%.

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Lenders are a conservative group and are looking for positive signals before meaningfully returning to lending on hotels.

Due to rising cap rates, hotel values have fallen an average of -18.6% since the cycle peak in 2007, even if you assume no change to NOI.

In the current environment of bad press for the hotel industry, only the most prepared deals will make it to credit committee.

Amid weakening hotel fundamentals, investors have been re-evaluating their required rate of return on commercial properties, leading, in part, to a sharp rise in cap rates and resulting lower market valuations. Cap rates have also risen due to higher interest rates -- both the investors required rate of return and the mortgage constant are calculated in a weighted average to derive the “true” cap rate for a particular hotel.

Falling property values have made financing harder to obtain. The new maximum leverage, or LTV, hoteliers should expect is 65%. Leverage is unlikely to move higher for at least the next three to four years, but prudent hotel investors understand reasonable debt levels protect their equity during these uncertain times. If structured properly, loan requests up to 65% LTV can be approved today.

THE ECONOMY & OUTLOOK FOR HOTELS

According to Stewart Title Guarantee Company chief economist Ted Jones, the recovery in every recession since 1949 has been led by a recovery in the housing market.

There is growing evidence both that the housing market bottomed and the U.S. economy started to grow again over the summer of 2009. But ordinary individuals and businesses may not notice for some time. If the economy is in fact growing, it’s not yet creating jobs, and if the housing market has indeed bottomed, consistent data does not yet show it is rising.

This recession recovery, according to economist Erica Groshen of the Federal Reserve Bank of New York, is likely to mirror the structural shift in the U.S. labor market started in the 1990’s. In more recent recessions, more employers are using downturns as an opportunity to close inefficient facilities, cull the workforce, and change production process. This recession was also severe enough to kill many businesses outright.

As a result, we are likely on track for our third “jobless recovery” in as many recessions. After losing over seven million jobs since the U.S. recession started in December 2007, unemployment will likely grow from the current 10.2% to 10.8% before starting to fall over the summer of 2010.

In line with historical precedent, the hotel industry should begin to recover with some lag to the broader U.S. economy; in this case, toward the end of Q3 2010. According to Smith Travel, both occupancy and RevPAR should turn slightly positive in Q4 2010. ADR recovery will likely lag into early 2011.

Our outlook is for a moderate economic recovery through 2011. We should move into the expansion phase of the hotel business cycle starting in Q4 2010. Outside of some unforeseen global or domestic terrorism event, we see no reason to expect a “W” economic pattern or return to recession.

Obtaining hotel financing will remain historically challenging until at least 2012 due to the severe nature of the collapse in the credit markets.

As we draw near to the pending recovery, now is the time to approach the business imperative of your hotel’s mortgage debt financing differently. How your loan request is structured, negotiated, and managed will determine whether or not you obtain hotel mortgage financing over the next two years.


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If structured properly, loan requests up to 65% LTV can be approved today.

Growing evidence suggests the recession technically ended over the summer of 2009, but the recovery will be slow and relatively “jobless”.

We should move into the expansion phase of the hotel business cycle starting in Q4 2010 with hotel financing remaining historically challenging through at least 2012.

How your loan request is structured, negotiated, and managed will determine whether or not you obtain hotel mortgage financing over the next two years.

A BETTER APPROACH

7 PRINCIPLES OF EVERY SUCCESSFUL HOTEL LOAN REQUEST

For over a decade I worked at GE Capital where I drank deeply from the Kool-Aid Jack Welch served up. In his day, Jack was to business what Patton was to war; both known for a rigorous approach to winning.

Earlier this year Jack rolled out of retirement to speak at the Asian American Hotel Owners Association (AAHOA) annual conference. There he said to the assembled hoteliers, “This recession offers more opportunities than it offers troubles.” I still enjoy hearing from Jack, and I happen to think he’s as right about the opportunities during a recession as he is the opportunities during the upcoming slow recovery period.

Those who worked for Welch knew he’d expect a plan of action to achieve a goal, so we’ve highlighted the key attributes of any successful hotel loan request in a difficult lending environment like today.

(1) Analytical rigor behind the hotel financials, performance data, sponsorship financials, and market data will make or break each deal.

(2) Organization and presentation of are key to differentiate each loan request from the pack.

(3) One person must be responsible for overall management of the deal from start to finish. This includes management of responsibilities among the bank, attorney, title agent, appraiser, surveyor, environmental engineer, etc.

(4) Be realistic and flexible. Unlike during the “go-go” lending days of 2003-2007, it may not be possible to meet all of your financing goals. Don’t put off accepting a good deal with expectations of a better one coming along.

(5) Only work with the best. Do your research, background checks, and get references. Working with professionals saves time and money. Working with less buttoned-up people and firms wastes valuable time and puts the deal at risk.

(6) Protect the equity. Prudent leverage, and an analysis of global sponsorship cash flow ensures the hotel loan will not go into distress through a potentially prolonged recovery.

(7) Be patient. Today everything takes a bit longer, from the lender negotiation process to the more intensive underwriting process.


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The starting point in any successful endeavor is adherence to a set of principles that guide all actions toward the goal.

Each successful loan closing starts with deep analytical rigor.

If following these principles was easy, more than 15% of hotel loan requests would be getting done today.

http://www.aahoa.com/




PROCESS MANAGEMENT & WORKING WITH PROFESSIONALS

The key to successfully obtaining reasonable hotel mortgage financing during the bottom of the current business cycle is in the rigorous management of the entire process.

Obtaining hotel financing calls for creativity, tenacity, and flexibility. But it is the professional management of the overall process that leads to a a successful financing closing, whether it’s an acquisition, refinance, or new development project.

It’s important to understand that hotel owners are aggressively competing for a constantly changing pool of funds (both debt and equity). As a result, demand for hotel loan dollars far exceeds available supply. In addition, owners are having to deal with increasingly complex loan terms and conditions, lengthy underwriting cycles, and amplifying uncertainty throughout the loan process.

Rigorously managing the above processes may look easier than it is. The investment in time alone is substantial, and the specialized skills of those who are good at it are rare. Even rarer are those who can close deals in a down market.

Hoteliers are hospitality experts, and the particularly successful ones don’t try to be their own attorney, insurance agent, tax preparer, general contractor or mortgage broker. Stick to your core competency and engage a hotel financing professional.

If you engage the right professional you will save more in both time and money than you could trying to do it on your own.

Working with a firm that focuses exclusively on hotel financing engagements is critical to ensuring certainty of execution of your financing needs.


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Professional management of the overall financing process leads to a successful financing closing, whether it’s a hotel acquisition, refinance, or new development project.


Hoteliers are hospitality experts. Stick to your core competency and engage a hotel financing professional. You will save more in both time and money than you could trying to do it on your own.

FACT & FICTION - ENGAGING A BROKER OR INVESTMENT BANKER

Both hospitality and banking are relationship businesses. Success in each relies on how well guests or clients are treated. As former bankers, we at Larkin Hospitality Finance adhere to a code of ethics that guide every action on behalf of our hotel clients. It is with that same spirit of honesty and integrity that we help our clients to separate fact from fiction.

FACT: Regardless of the size of the intermediary you select (i.e. mortgage broker, hotel investment banker), there will only be one to two people at the firm dedicated to placing and closing your financing. A large firm will tout significant infrastructure and internal resources that can be applied to each transaction. In reality, however, large firms are collections of individual contributors and only 1-2 people will allocate significant time and energy to your deal.

FICTION: Only a large firm has access the best hotel loan programs. FACT: Larkin Hospitality Finance has access to all of the most active hotel lenders (banks, private credit companies, insurance companies, REITs), market studies, industry performance data, and best public/private data/news sources. Further, Larkin has what is likely the most comprehensive and sophisticated hotel lender database in the industry, as well as long-term, deep relationships among the most active hotel capital market participants.

FACT: Simultaneously giving your financing assignment to multiple brokers hurts your deal. You lose control of how your hotel property and personal data are being used to market the loan request, and when banks are presented the same deal by multiple sources they will quickly pass on the opportunity -- it’s apparent the deal is being “over-shopped”. In particularly challenging markets some owners feel you have to throw a lot of “stuff” against the wall to see what sticks. This is a fallacy and will hurt your chances. Let one intermediary “run the auction” for you. Quality is much better than quantity.

FICTION: It costs more to engage a hotel investment banker or broker. FACT: The monthly mortgage payment savings on a professionally negotiated and managed hotel loan program will save the owner well in excess of the typical investment bank/broker fee, typically 1% or less of the loan amount.

FACT: The commission programs at large firms require originators to simultaneously juggle 15-20 financing engagements in order to meet annual quotas, billing targets, and overhead expenses. As a specialized, boutique firm, Larkin Hospitality Finance deliberately restricts the number of engagements taken on at any given time to ensure outstanding client service is delivered on each assignment.

FICTION: All mortgage brokers and investment bankers are the same. FACT: Most mortgage brokers and investment bankers are generalists that likely spend most of their time working convenience store and apartment loans. Real hotel expertise is rare. Only a small number of professional firms exist that focus exclusively on hotel financing projects. Fewer still are licensed professionals with the depth of experience of Larkin Hospitality Finance.


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Both hospitality and banking are relationship businesses. Success in each relies on how well guests or clients are treated.

The mortgage payment savings on a professionally negotiated and managed hotel loan program will save the owner well in excess of the typical broker or investment banker fee.

THE SOLUTION - LARKIN HOSPITALITY FINANCE

Based in Dallas, Larkin Hospitality Finance is a nationally recognized investment banking firm focused exclusively on meeting the debt and equity financing needs of hotel owners and developers. The firm was established by banking professionals with nearly two decades experience both financing hotels and the financial industry.

Larkin has earned the trust of, and delivered results for, hotel owners across the country -- in good and bad credit markets. We’ve originated and closed competitive financing for our clients during all phases of the hotel business cycle.

The team at Larkin Hospitality Finance delivers results because we understand both the business of running a hotel and a bank. As a result, we’re more than generalist lenders or commercial mortgage brokers. We specialize in managing the entire, end-to-end hotel financing process for our clients, and we stay involved with our clients even after the deal closes.

CONCLUSION

For hotel owners seeking to obtain reasonable mortgage financing, no other firm delivers like Larkin Hospitality Finance. With our decades of experience, hotel business understanding, and talented, licensed team of professionals, we are the better solution.

To learn more about Larkin Hospitality Finance and our solutions to your hotel financing needs, visit www.larkinhf.com or contact our hotel financing professionals at (469) 916-8518.

We welcome any feedback related to this published white paper.


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With our decades of experience, hotel business understanding, and talented, licensed team of professionals, we are the better solution for the hotel owner’s financing needs.

Larkin has earned the trust of, and delivered results for, hotel owners across the country -- in good and bad credit markets.

Example 2009 Larkin Hospitality Finance Closed Deal (Refinance - Orlando)

The team at Larkin Hospitality Finance delivers results because we understand both the business of running a hotel and a bank.



ABOUT THE AUTHOR

Cameron J. Larkin founded Larkin Hospitality Finance with a mission to provide hotel owners with the highest level of client service in the execution of hotel debt and equity financing.

Mr. Larkin has nearly two decades experience in the lending and management consulting industries.

Prior to founding Larkin hospitality Finance Mr. Larkin was with GE Capital for 10 years. He worked across six of GE Capital’s financial operating units in the U.S. (Dallas, Cincinnati, Stamford, Richmond, Denver) and Europe (Prague, Czech Republic).

Other career history includes three years with Andersen Consulting (now Accenture) in the consultancy’s Hartford and Denver practices.

Mr. Larkin is the author of many hospitality financing articles and research papers and is frequently published and cited in the major industry periodicals.

He is a graduate of Columbia University (MBA) and the University of Vermont (BS, Business Administration).

RESOURCES USED IN THIS WHITE PAPER

• Mortgage Bankers Association Q2 2009 Quarterly Survey of Mortgage Bankers Originations - Commercial/Multifamily, MBA Commercial Real Estate/Multifamily Survey of Loan Maturity Volumes, and several other weekly and monthly MBA reports including: Mortgage Finance Market Commentaries, Economic Commentaries, Mortgage Finance Market Forecasts, Economic Forecasts

• Fitch Ratings U.S. Gaming & Lodging Liquidity Report

• Real Capital Analytics US Commercial Troubled Asset Radar Reports

• Smith Travel Research Reports

• Stewart Title Guarantee Company, Chief Economist Ted Jones, Ph.D.

• Federal Reserve Bank of New York economist Erica Groshen


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www.larkinhf.com

Experienced hotel and finance professionals, trusted advisors, recognized industry leaders.

You can bank on our reputation. Example 2009 Larkin Hospitality Finance

Closed Deal (Refinance - Maryland)



Documents

White Paper - How To Obtain A Hotel Loan In A Difficult Lending Environment