Despite a proliferation of lenders, finding the right finance package for an acquisition or capital project has become challenging for hotel investors – and the stakes are getting higher with the rising cost of debt.
“We’re still actively pursuing new opportunities throughout trading hotels, refinancing new acquisitions and on the development side as well,” says Louise Gillon, head of hotel finance at Leumi UK, and reassures that the funding partner is “not withdrawing offers”.
In fact, Leumi recently agreed to lend £34 million to Juniper Hotels Holdings Limited (JHHL) to finance the acquisition of the leasehold interest and refurbishment of a Holiday Inn hotel in London.
However, she continues that lenders will be carefully considering the lending structures as we enter a high inflationary environment: “Every bank needs to take a step back and do some stress testing, make sure that all of the facilities that were put out still make sense.”
Elizabeth Davies, head of real estate finance – hotels with HSBC UK, says the bank will continue to assess the merits of each deal and customer individually, as well as the liquidity within an asset and, when it comes to new builds, what the stabilised earnings before interest, tax, depreciation and amortisation (EBITDA) could be once works are completed.
“We want to de-risk that stabilisation period as much as possible, so we are creative around structures we put in place within the facilities,” she says.
But, she adds, HSBC is “highly selective and always has been”.
“In terms of new customers coming into the book, absolutely we need to make sure that we’re onboarding customers with facilities that aren’t going to breach, so we’re really looking at the stress test analysis across each of those loans. So [we’re] not necessarily withdrawing support, but we need to work with customers to make sure that the debt is sustainable,” she explains.
In uncertain times, points out Ben Barbanel, head of debt finance at OakNorth Bank, the focus turns to the quality of the borrower – their experience, holding power and ability to deal with headwinds.
“We’ll continue lending to the right borrowers,” he says, emphasising that OakNorth is open to construction and new build opportunities as well as longer-term investment. The group recently loaned £15 million to JMK Group to help finance a freehold buyout of two London hotels as well as upgrades to an existing hotel.
Lack of development and acquisition opportunities
However, the market is still not seeing many quality assets coming to market, and at the same time developers are facing the challenge of rising build costs – good for existing products with less competition entering the arena, but bad for those looking to enter it or expand.
William Kirkpatrick, partner and head of hotels and extended stay at real estate advisor Gerald Eve, warns that the fixed price contract “doesn’t exist” at the moment and the new build market is “severely dampened down”.
Barbanel agrees: “Those opportunities have dried up a bit while people are figuring out what’s happening today.”
Consequently, investment is instead being funnelled into existing products – “lots of borrowers are spending capex on existing assets to keep them where they need to be as we enter a tougher time,” says Barbanel.
What Kirkpatrick says he is seeing is the maturity of the budget sector, with groups like Whitbread closing certain properties and opening elsewhere in the same city, including smaller formats like Hub by Premier Inn, as well as growth in the serviced apartment and aparthotel sector. OakNorth recently agreed a five-year £30 million loan facility with aparthotel operator Staycity Group as it looks to guard against economic slowdown.
Getting creative with lending structures
But what exactly are lenders looking for, and what are they willing to offer? Investors say they’re happy to look at creative lending structures, with some willing to work alongside mezzanine providers, for instance.
“The refinancing coming up is going to need a mezz partner on it if it’s going to get refinanced in a satisfactory way. It’s going to be outside of senior lenders’ appetite in isolation,” argues Gillon.
Davies says she would “struggle” to take on a new-to-bank customer needing to include mezzanine debt in the lending structure – but for existing customers, she says mezzanine “could be part of the solution”.
“But I do like my mezz to behave more like equity,” she adds.
“I don’t think there’s anything wrong with having mezz in a capital stack if it’s the right time for it… if it’s the right capital stack and situation,” says Barbanel. He says that OakNorth is less keen, meanwhile, on ground rent structures, “particularly in a market like this where you’ve got that fixed escalating cost that becomes even more uncertain as you go forward”.
Kirkpatrick says that the question that is not asked often enough is, will an asset follow RPI or CPI inflation? “If the answer to that is no then it should never be ground rented – it’s a very basic question which a lot of people seem to forget,” he says.
He suggests that ground rent, however, can be very attractive in prime locations like central London – LaSalle took on the Crowne Plaza Blackfriars earlier this year on a 2% ground rent, he points out. “If you look at those yields, they are quite attractive if you’re trying to build that stack to make it work and if you’re in good cities.”
Prioritising green investment
Lenders are prioritising green projects, says Davies, which she adds must be “measurable, deliverable and monitored” to ensure there’s no greenwashing. “Every deal we look at, be that a refinance or new money, has to have a strategy. It might not be that it’s delivered right now but we want to understand where they’re moving to,” she says.
“Because we’ve seen so much of that [greenwashing] we’re quite sceptical,” says Kirkpatrick, who suggests the industry needs its own verification process.
“While there are a lot of great hoteliers out there spending money trying to improve and keep up with the competition coming in, there is a real challenge on the ground getting the contractors, getting the price right… and then trying to define what is a green hotel, because the BREEAM definition doesn’t work for hotels… we do need to invest but we also need those costs to come down,” he explains.
“Nobody really understands what they’re working to,” agrees Barbanel.
But ultimately, lenders want to see detailed business plans and borrowers that are conscious of market pressures – from that, they can build products that work for the individual situation.
“A narrative has to come with the cash flow. We want to understand where people have fixed their utilities, what their individual staffing issues are,” says Gillon.
“You’ve got labour challenges, cost inflation, interest rate challenges and the added complication of weak sterling, which makes it more attractive for tourists – understanding the dynamic of how all those things interplay is critical. If I had a pound for every business plan that I saw where interest was in the model at an already ridiculously historic rate… borrowers have to be realistic and demonstrate that they’re thinking about cost pressures in their business,” adds Barbanel.
All those quoted in the article appeared on stage at the Annual Hotel Conference held in Manchester between October 3 and 4, in a session called: The Borrow Market: Horses for Courses.