Financing has become the dreaded “F” word over the past few years for many hospitality investors. The terms and costs surrounding traditional options have become even harder to swallow for those with excellent short-term memories. Yes, it wasn’t so long ago that one could obtain dirt-cheap debt in a market where capital was abundant, underwriting was competitive, and the rebound from Covid-19 shutdowns had created a sense of urgency – perhaps even opportunity – within the hospitality sector.
But that was then.
Fast forward three years (or so), and inflation has surged, as have interest rates. What hasn’t surged is the lending volume from traditional debt sources. Some of this is due to borrowing costs doubling or even tripling. It’s also due to banks becoming far more selective.
Whatever the reason(s), the swing from "cheap and easy" to "costly and constrained" was as jarring as it was decisive for hospitality investors. But the show must go on. There are still opportunities to capitalize on, momentum to maintain and…maturing loans to face.
Total commercial real estate loan maturities are expected to hit $957 billion this year, according to Afshin Kateb, CFO and head of hospitality at Palladius. This is roughly a 67 per cent increase from early 2024, most of which is attributed to the mass extensions of maturity loans. About $48 billion is hotel-related loans expected to mature by 2025.
“This historically high volume of loan maturities is anticipated to increase transaction activity, mainly impacting the owners that face NOI erosion due to increase operating costs and pending PIP (property improvement plan) requirements,” Kateb says. “Given the capital expense and operational complexities, borrowers are looking for institutional private lenders.”
Going private
Whether institutional or not, Jared Schlosser, executive vice president of hotel originations and head of CPACE (Commercial Property Assessed Clean Energy) for Peachtree Group, notes that private credit is having a moment thanks to today’s fundamentals.
“Private credit has significantly increased its footprint in hospitality financing due to a combination of market dislocation and structural shifts in lending behavior,” he says.
One of the major catalysts was the wave of regional bank failures that began in 2023, which included Silicon Valley Bank.
“These events led to a pullback in bank lending, particularly in the hotel sector, which was already perceived as a higher risk,” Schlosser continues. “The result was a pronounced liquidity gap that private credit stepped in to fill.”
It’s worth noting that traditional lenders weren’t necessarily overly enthusiastic about hospitality assets even before these bank failures.
“Lenders have been cautious about hospitality since the pandemic,” adds Emin Aboolian, senior vice president of iBorrow. “Since Covid-19, bank lenders have been highly selective on hospitality assets across the nation. For any segment with a higher risk profile, traditional lending will be significantly more challenging to obtain due to cashflow and borrower requirements.”
CMBS underwriting has also become more conservative, with many lenders moving from a 10 per cent debt yield to 12 per cent on stabilized deals.
“Anything below that threshold generally doesn’t qualify, further narrowing the pool of eligible transactions,” Schlosser says. “This has created even more room for private credit to be the capital solution.”
Private credit has not only stepped in to fill the gaps left by traditional lenders, but this alternative financing solution can offer more flexibility in terms of custom deal structures, more opportunities to acquire or recapitalize distressed or transitional properties and fewer bureaucratic hurdles…all with an expedited closing.
“Private credit is offering solutions for a broad spectrum of hospitality assets, whether or not they have strong in-place cash flow,” Schlosser continues. “Private lenders can price to risk and tailor terms to match the asset’s profile and business plan, giving them more flexibility than banks or CMBS.”
Palladius, for example, offers less stringent financial covenants that may include an interest reserve and, in some cases, a personal guarantee with sunset provisions.
“To eliminate rate risk, most of our borrowers have opted for a fixed rate,” Kateb explains. “However, in certain cases where the borrower is requiring a floating rate, we protect our position by requiring a floor rate.”
Kateb believes these types of terms can generally be more favorable than the strict loan to value (up to 60 per cent), debt yield (12 per cent to 14 per cent) and debt service coverage ratios (1.40x to 1.50x) offered by traditional lenders – and that’s if they choose to lend at all.
“[These tight lending standards are] punitive to the assets that are beginning to recover from the elongated Covid effect and need a bridge to stabilization,” he argues. “Debt funds tend to be more aggressive by allowing a higher LTV and accepting a lower DY, allowing the sponsor the opportunity to execute their stabilization business.”
Terms of endearment
Private credit lenders may be a viable alternative financing solution for some, but that doesn’t mean they’re giving money away. Like every other entity, these solutions providers must maximize their income while minimizing their risk.
“When assessing a hospitality investment, we focus first and foremost on the sponsor's experience and track record, specifically how they've performed over the past five years, including during the pandemic and during more recent periods of volatility,” Schlosser says. “We're looking for proven operators who can navigate both stable and uncertain markets.”
Peachtree also evaluates brand, market and location. It seeks to determine whether the brand affiliation will hold up in its market/submarket, and how it compares to other flags within the same competitive set. In terms of market fundamentals, Peachtree is particularly focused on demand drivers, supply risk and long-term viability.
Aboolian notes that iBorrow pays special attention to the exit strategy – the most important factor being whether the investor has one.
“The borrower’s business model and experience are important because, obviously, they must have experience in the sector and a clear glide path to improve operations and cashflow,” he adds. “But we want to lend to groups who are confident in their plans and have the data to back up their expectations. IBorrow is looking two to three years down the road, so we want to know if they can achieve their business plan in that timeframe, and whether they will be ready to refinance or sell if that is their exit.”
Kateb adds that Palladius evaluates each opportunity based on the quality of management, the soundness of the business plan, the sponsor’s historical track record and the market’s historical recovery trends. Domain expertise, the right management company, and a well-substantiated and supported thesis and business plan are also imperative.
Those who want to secure the most favorable terms with the company should be able to demonstrate a straightforward capital stack, consistent cash flow trends, and a strong credit history free of bankruptcies or past issues with financial institutions.
The future of financing
Whatever the future holds for hospitality financing, there are certain fundamental truths that will likely remain. Like seasonality and risk, for example.
“In hospitality, unexpected events are part of the landscape, whether it's a slower ramp-up, a PIP or broader market volatility,” Schlosser says. “You want a lender who understands the operating realities of hotels and can be a constructive partner, not just a capital provider.”
That’s why it’s critical for borrowers to prioritize experience when selecting a private credit partner. They should consider how a lender supports them throughout the loan process, whether the group has a proven track record of lending to hotels, whether they have navigated challenges before and, most importantly, how they respond when issues inevitably arise.
This criteria may become even more imperative when assessing private credit lenders as Schlosser believes they may remain a significant source of capital in the hospitality space for the foreseeable future.
“Over the next 12 to 24 months, broader macroeconomic trends will heavily influence private credit lending in hospitality,” he says. “If we see further economic decline or enter a recessionary environment, it will likely become more challenging for lenders to get comfortable with hospitality deals. Volatility – whether in interest rates, the consumer, administration policies or capital markets – tends to cause traditional lenders to pull back, historically creating more demand for private credit.”
In response, he expects to see continued innovation in private credit structures. Tools like CPACE financing and other incentive-based or creative capital solutions may become even more important, particularly for construction or certain bridge loans where capital gaps are more challenging to fill with conventional sources.
The increased demand for private credit may also ramp up competition.
“The large private credit players are becoming involved…which is a double-edged sword,” Aboolian says. “It is beneficial for the borrower because the cost of borrowing will decrease and there will be more flexible capital. However, whenever more capital is available, there is also the risk that more projects may remain overleveraged as the capital competes on strong assets in gateway markets.”
It may also compete within the extended-stay sector, which Aboolian believes may be rife with opportunities.
“These will be found in market segments where consolidation and economies of scale can make a significant difference to the bottom line,” he adds. “The extended-stay sector is dominated by smaller players. It is a fast-growing subsegment of the industry, and many of the properties require updates and amenities that travelers expect.”
Aboolian can also foresee a scenario where private credit surpasses traditional lending in the next few years, particularly as banks show increasing interest in lending to private credit lenders, as opposed to financing borrowers directly.
Schlosser doesn’t necessarily echo that sentiment, but believes both types of financing – traditional and private credit – have earned a permanent seat at the table.
“Each capital source has its time and place,” he explains. “Banks and CMBS are still well-suited for stabilized, lower-leverage deals with well-capitalized borrowers. But for anything outside of that – transitional assets, complex business plans, or borrowers needing speed and certainty – private credit has become the go-to solution.”