As published in Scotsman Guide's Commercial Edition, April 2005.
Hotel-owners will note with interest the recent actions of the Federal Reserve and its effect on 10-year fixed-rate loans.
Under Chairman Alan Greenspan’s leadership, the Reserve gradually increased short-term interest rates during the second half of 2004. Utilizing a “measured” approach, the Federal Reserve increased the Federal Funds Rate from 1 percent in June to 2.5 percent in February 2005. The prime rate, which is directly related to the Federal Funds Rate, rose in tandem. In June 2004, the prime rate was 4 percent, and as of February 2005, the prime rate was 5.5 percent. The Federal Reserve has hinted at more 0.25 percent increases, likely resulting in a 3.5-percent Federal Funds Rate and a 6 percent prime rate by some time in the spring.
For hotel-owners, these increases are serious. Many hoteliers utilized floating-rate loans tied to the prime rate to construct or acquire hotels in the past five years. Interest rates on floating-rate loans have been attractive since 2001, when the Federal Reserve finished a year-long effort to reduce the Federal Funds Rate (and thus, the prime rate) to spur a sagging U.S. economy. In addition, hotel financing in general was difficult at this time as hotel performance began to weaken in 2000 and deteriorated significantly after the events of Sept. 11, 2001. Hotel defaults increased during the period, and fixed-rate lenders shied away from providing hotel loans. This left floating-rate financing based on a margin over the prime rate — typically 1.5 percent to 2.5 percent — as the only option for many borrowers. In addition, financing through government-sponsored U.S. Small Business Administration hotel-financing programs — extremely popular for hotel borrowers because of the possible high loan-to-values — almost always has a floating-rate component.
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