With the continued fear of terrorism and a weak economy, these have not been the best of times for the travel and hotel sectors. Fortunately, low interest rates have helped even underperforming deals continue to meet their debt service requirements.
The deals that are fairing best are hotels that were fortunate enough to put floating rate debt on their property and are now enjoying interest rate coupons in the 5.0% range. These low rates can go a long way to carry a project through a weak economic period.
Those owners in "drive-to" locations with a mid-priced product are also performing better than those in the high-end segment of the market. In weak economic times, even those with deep pockets are conscious about how far their dollar will go.
For owners with loans coming due, this current period of uncertainty has created the most stress. Often the new loans available from lenders to refinance existing debt are less than the funds needed to repay the existing mortgage. This is because permanent loans are often sized not on the actual debt service constant (a rate that includes the actual interest rate and amortization), but rather on a "stress constant". A stress constant (sometimes referred to as a refinance constant), is a rate used by lenders (typically in the 8.0% to 11.0% range) to assure that, at the end of their loan term, they will be able to refinance out of their existing loan position. The assumption is that in a few years, interest rates will return to a more normalized level and the new lender will size the loan with appropriate coverages based on prevailing interest rates.
This juxtaposition between a temporary depressed cash flow and lenders using a "stressed" underwriting criteria, has created problems for some owners in refinancing their current loans. Owners are faced with a choice of either losing their property because they cannot payoff the existing loan or putting in additional cash to bridge the gap between the new lower loan proceeds and the amount necessary to payoff the existing loan.
As with any capital market "stress" situation, those who can think creatively to help owners overcome a temporary "stressed" situation become an invaluable member of the borrower's finance team. This current capital situation is no exception.
In the last 18 months there have been many new entrants into the market who possess the money necessary to bridge the gap between a current loan sizing and the funds necessary to payoff the existing mortgage. Sometimes referred to as mezzanine lenders, these lenders typically secure their loans by taking an interest in the partnership equity, as opposed to the real estate, and offer a cost of funds to the borrower of anywhere between 7.0% and 20.0%, depending on the leverage level.
The loans typically have a life of less then 5 years and often require amortization during their term. These funds are offered by opportunity funds, insurance companies, hotel owners and private investors.
The common thread between all of such funds is that they understand the hotel operating business in addition to realizing the value of the underlying real estate. They are savvy enough to know that if they have to step into the shoes of the owner and take over the property, that they have the expertise to execute such an action and operate the hotel.
These lenders serve a temporary need in the capital markets and provide an invaluable tool to owners who are currently having trouble refinancing their property.
The AFC Hotel Finance Group has extensive relationships with "mezzanine" lenders in addition to all types of first mortgage lenders. When the mortgage proceeds available from a new lender are not sufficient to payoff the existing loan, AFC has been successful in creating a "debt auction" among potential mezzanine lenders.
This assures the borrower that they get the best possible terms available in the market. It also gives the borrower a "menu" to choose from in terms of alternative financing options.
Case in point: AFC Hotel Finance Group recently secured a first mortgage and an additional layer of mezzanine financing for the Holiday Inn Select in Atlanta. The owner needed to refinance their property to emerge from Chapter 11 bankruptcy.
While traditional lenders would not be able to execute the transaction at the levels required, AFC completed the deal by utilizing traditional first mortgage proceeds coupled with mezzanine financing.
The first mortgage lender and the mezzanine investor provided the required capital by bifurcating their funds between first mortgage and mezzanine rates. The result was a seamless transaction to the borrower, who was able to achieve the required loan proceeds at a blended coupon rate of 8.5%.
Through creative financing structures like this, the AFC Hotel Finance Group has been bridging the troubled waters for their clients. It is likely that this, and other creative financing tools, will be necessary until the hotel market returns to stabilization.
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