As published in Scotsman Guide's Commercial Edition, July 2012.
The underwriting of hotel projects is critical to determining whether a lender will proceed with the financing process or shelve the loan request altogether. With that in mind, commercial mortgage brokers who work with hotel developers and investors must be knowledgeable about the specifics of hospitality underwriting in order to avoid pitfalls that may complicate their clients’ loan requests.
To start, it’s important to understand the process that leads to underwriting. A hospitality project’s development begins with just an idea that’s later tempered by the market cycle. This idea is put on paper by a team of designers and architects, and the developer may seek a hotel brand at this stage, as well. A management group also is typically engaged to put together feasibility plans and financial scenarios.
When the project is submitted for underwriting, it’s important to demonstrate its feasibility to investors and lenders alike. The lender will need to see a complete package that describes the project and an underwriting document that details its financial goals.
This is a crucial juncture: Based on underwriting, the project can proceed or be removed from further consideration. You should be aware of what a lender will be looking for in a project’s underwriting. There will be plenty of information from feasibility studies and appraisals but to decipher the materials related to a hotel investment, lenders will look into the following areas.
The hotel industry normally has a cycle that runs between seven to nine years. If a project is presented near the end of a prosperous cycle, the project could go bust shortly thereafter — even if it makes good financial sense at the time of submission. For example, many projects that were financed in 2006 and 2007 have recently faltered, an outcome that wasn’t expected by lenders at the time.
Conversely, if the market is rebounding from a down cycle — similar to our current market — the time to lend on a project may be excellent. The project will open during the rise in the cycle and take advantage of the future years of positive results.
Skin in the game
One lesson lenders have learned from the financial crisis is to make sure that the investor has enough skin in the game. That’s why you should be sure that your client is able to demonstrate willingness to take a share of the responsibility and investment with the lender.
To make sure you’ve got the right customer, ask the right questions regarding the development, such as:
What is the goal of the investment?
What is the exit strategy of the investor?
Keep in mind that if an investment produces positive cash flow and achieves benchmarks but does not provide a clear path for a future sale or refinance, this could spell trouble down the line.
Underwriting is a tool that forecasts the future of an investment. It is your role as a commercial mortgage broker to ensure that the lender is able to decide whether this document represents a realistic look at the future or falls into wishful thinking. By doing so, you’ll be poised to help your client get financing.
Jay Litt is a partner for JLitt Inc., a hotel advisory company located in Boca Raton, Fla. His company specializes in advisory services for the hospitality industry. Litt previously was executive vice president of operations for Wyndham International and also served as Wyndham’s chief procurement officer. His
portfolio included 28 resorts in the United States, Caribbean and Mexico. Reach Litt at (214) 336-0666 or firstname.lastname@example.org.