Random Hotel Exterior

So you want to buy a cash flow distressed hotel asset and finance the acquisition? – read on.

March 2, 2021 11:34 am

In a previous Post, we described a segment of the hotel investment market that has been quite active, and that is, those cash flow offerings of $5MM and under.    We further described what one might expect as one attempts to finance one of these assets, particularly those that cash flow and particularly in the Covid environment.   We included a number of suggested steps in order to approach a lender for financing. 

There is another subset of properties that fit into this price range that are much more challenging to finance and therefore to purchase.    As was described in our earlier Post, there are not many hotel properties (that we have seen) that are unaffected by the impact of Covid 19 and some more than others.   And, there is no doubt the market does feature motivated sellers and includes good properties that are temporarily distressed.  In those instances where the property was producing nice enough numbers in 2019, but has been adversely affected in 2020, do present a definite challenge to finance.   Distress in the marketplace has always attracted investors who wish to buy at distressed prices, and this current environment is no exception.   So, finding such deals are not that hard, but finding that motivated seller and then getting the deals to the finish line is not so easy.

When we stand back and look at the overview of the financing climate, the increased difficulty in financing hospitality assets should not be a surprise.  It has happened in every recession/downturn since the late 80’s.  However, in this crisis, the flight from hospitality was much more sudden and widespread.   Many of the community and regional banks have placed hospitality on hold, at least temporarily.  For those banks/lenders still in the business of considering hospitality, at the above price point, SBA or USDA support is almost universally required, unless there is a significant increase in equity.  As a side note, we have recently posted another brief article about the recent SBA benefits issued by the new stimulus package.  From a financing standpoint, it has never been better to seek SBA financing than right now.   The package includes 3 months of principal and interest payments made by SBA (capped at $9K/mo), and payment of the loan origination fees.   There has never been a better time to finance using SBA support.

We have and are currently marketing a number of nice properties that have been affected by Covid, some to the extent that there is little net cash flow (to even service any new debt).   It is obvious why this would be an issue with a lender.   Furthermore,  many of the buyers of these assets have the preconceived notion that one can still do an SBA loan for 15% down, even if the property is distressed.  We just have not seen that case for over a year and don’t anticipate that we will for the foreseeable further.  For this reason, the following represents a number of suggestions that you should consider as you contemplate buying a distressed asset.

  • Be prepared to contribute more equity that you thought. In most cases usually 25%, but as much as 40 – 50%……it just depends on the level of distress and the risk tolerance of the lender.
  • Be prepared to show other sources of income (cash flow), besides the hotel acquisition.  
  • Lenders will look hard at your “global” cash flow (from other hotel/businesses), and if you don’t have any other source of income, the task has become much more difficult.
  • Be prepared with enough equity to have a cash reserve (perhaps 10 – 20%). Your lender will need to see a path to profitability, where you can work your magic, and your reserves will need to cover the time from acquisition until the time to stabilization.  If you plan on spending every dime of your cash on the equity requirement, then the financing will be much harder because you can show no path to stabilization……there is no margin for error. 
  • As we mentioned in an earlier Post, be prepared to provide your personal tax returns, your ownership interests (including liabilities) and tax returns in other businesses, and a personal financial statement of you and any partners.
  • Be prepared to provide a 3 – 5 year projection of income and expense, under your new ownership.
  • If your projections include increased revenue, your projections should include precise steps on how you will accomplish the increase. Provide additional support for your assumptions, including STR data, historical income,  and new sources of business.
  • If your projections include decreasing a number of expense ratios, be prepared to provide specific steps you will take to reduce those ratios, including examples of operations from your own holdings, industry standards, and even doing some of the work yourself.
  • If you are considering a franchised hotel, you will need enough equity to satisfy the lender, but also pay any franchise fees and PIP related costs.  Franchise or not, finding a property where one doesn’t need to spend anything after acquisition would be unusual, so be realistic on what you want to accomplish and the show the lender how you will pay for it.  With the new stimulus, the SBA now pays for 3 months of the path to stabilization (with limits).
  • As with any loan, debt coverage ratio (DCR) will be a ratio that the lender will consider in his evaluation. In the case of a distressed asset, DCR will represent the ratio of projected net income to projected debt service.  Your projections should reflect a reasonable DCR.
  • If you have local banking relationships, those are the ones to connect with first, especially if they have confidence in your operational expertise. Many of those lenders will say no to new hotel clients, but might say yes to an existing customer with a stellar track record.  

Buying a distressed asset in distressed times can be challenging, but very rewarding.  However, not everyone can pull it off.  If you approach a lender with the foregoing points in place, then you have demonstrated a thoughtful plan and increased your chances of getting a deal to the finish line.