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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   April 2005

Fed Provides New Twist for Hoteliers

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.

These borrowers face rapid increases in rates and interest payments. Cash flow is eroding in a highly competitive business environment that does not allow for increases in room rates to offset increases in mortgage payments. With no end in sight for prime-rate increases and generally, no caps on how high their mortgage rates can go, many hotel-owners are facing a bleak outlook in the near term.

However, the Federal Reserve has provided another solution. The Reserve’s adept Federal Funds Rate management has resulted in low U.S. price inflation for the past five years. Low inflation has translated into record-low long-term interest rates as measured by the 10-year Treasury rate, which generally has fallen between 3.5 percent and 5 percent since 2000. In January of 2005, the 10-year Treasury rate yielded 4.1 percent. It has not increased with boosts in the Federal Funds Rate, as it is influenced by the long-term inflation outlook. These rates are well below historical levels experienced in the 1970s and ’80s.

With improving hotel performance in 2004 and continued positive trends expected in 2005, fixed-rate lenders are back in the market of making hotel loans. In addition, the margin in the 10-year Treasury offered by lenders for 10-year fixed-rate loans has never been lower. With the combination of low 10-year Treasury rates and low margins, 10-year fixed-rate-loan interest rates are lower than the floating rates borrowers pay now. The 10-year fixed-rate loans are offered at spreads of 2 percent to 2.5 percent over the 10-year Treasury rate, which results in mortgage rates of 6.1 percent to 6.6 percent.

Hotel-owners with floating-rate loans should seriously consider refinancing their loans into 10-year fixed-rate mortgages. A window of opportunity is open thanks to the Federal Reserve’s successful battle with inflation. However, economists suggest that modest inflation pressures exist in the economy for 2005. The prospects for fixed-rate loans remaining low past 2005 are unclear. Thus, hotel-owners should act now.


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