Hotel Investing/Down payment

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Hotel Investing/Down payment

Kyle Davis
Appraiser · Ottertail, MN · Member since 2016 · 53 posts · 5 votes

Hello My BP friends.  I have a situation.  I'm getting into the hotel investing scene and have a situation.  I'm planning on building a franchised hotel in my market location and already have many of my "ducks" in a row.  I got a slam dunk financing package, I hired a 3rd party feasibility study to create the feasibility study and give me a 10 year pro-forma (Which looks great by the way), have my contractor lined up and have everything ready to go except the down payment that the bank is requiring (20% down).  So here's the rub: The franchise actually recommends having at least 25% down (which in our scenario is $1,000,000).  I currently have 500k raised.  Technically, the bank will allow us to go forward if we only have 20% down (which is 800k).  I have a strong chance to lock in a gap loan fund to get us the remaining 300k, but at the end of the day that is a loan and I will have to pay it back.  The interest on it is slightly higher then the banks.  For the record, the bank quoted me 4.25% interest over 20 years, balloon at 5 years.  Gap loan is around 5% with same year terms.  Personal guarantee for the main bank is 125% of your cash in the project.  SBA is making one of the partners (probably going to have to be me) sign an unlimited personal guarantee on $1,000,000 of the loan.  (The other main bank is doing $2,000,000).

I've done many 0 down deals with single family homes, tri-plexes, etc etc etc and I'm perfectly comfortable with that model as I know the local real estate like the back of my hand and know how much to pay for properties to cover my rear end in case I need to liquidate. (Making sure I'm at 70-75% LTV AFTER I repair the property). But the properties I invest in are very cheap and if crap ever hit the fan with them I could easily pay for the monthly costs until they sold. But now this project is in the millions and if crap hit the fan and I couldn't work out a loan modification, I would have to declare bankruptcy. I could weather the 125% of my money in the project, but the unlimited personal guarantee on the $1,000,000 would screw me.

So where I'm struggling on is that I know it's a slamming good deal, the demand is there, the numbers make sense and I'm very confident in the project.  I've already spent 24k on the project so far so I've been putting my money where my mouth is.  But on all the other deals I've ever done I have always ran a "worst case scenario."  And I've always been comfortable with that scenario if it ever hit.  This one is different though as it would basically mean bankruptcy.  

That being said, is anybody on here in the hotel industry or large apartment complex industry that could throw a couple pointers my way?  

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Scott Snow
Lender · Salt Lake City, UT · Member since 2016 · 35 posts · 19 votes
10y

@Kyle Davis you sound like you are on the right track. There is no getting out of the personal guarantee especially in SBA lending and $3.2MM loan amount. It is a little unusual to be honest that you can get a loan to do a ground up construction hotel without any hotel ownership experience but if you have a strong personal and other assets or investors they can maybe look past that. 

The bank is going to take a hard look at your feasibility study to make sure they area needs the hotel. You may want to work with the bank to have them choose and order the feasibility study so the person you use is on their approved list and they feel like they have the expertise to do the study. Also, there will be a STAR report which will provide average occupancy, average daily rate, revenue per available room, supply, demand, etc. Your contractor will be underwritten to make sure they have the experience to build the project. 

They will also consider what tier of your franchise flag will be used compared to others and for the location. The franchise will suggest you have 25% because you need post-closing liquidity while the hotel ramps up to reach stabilization and occupancy. I would think the bank will require that as well as the number 1 failure of businesses is lack of working capital. 

Your rate is very good but your terms could be better as you could go with a higher rate that adjusts every 5 years but get a 10 year balloon note and a 25 year maturity or even some will do no balloon note 5 year adjust on a 25 year amortization. Remember if your note balloons you will have to renew which means going through credit process again and probably more fees/appraisals so something to weigh as far as lower rate with short term vs higher rate with longer maturity. Ever bank prices a little different. 

You probably have a pretty good handle on things as an appraiser but I would suggest maybe getting a partner with hotel experience to help you out but that is definitely a personal choice. 

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  • Scott Snow
    Lender · Salt Lake City, UT · Member since 2016 · 35 posts · 19 votes
    10y

    @Kyle Davis you sound like you are on the right track. There is no getting out of the personal guarantee especially in SBA lending and $3.2MM loan amount. It is a little unusual to be honest that you can get a loan to do a ground up construction hotel without any hotel ownership experience but if you have a strong personal and other assets or investors they can maybe look past that. 

    The bank is going to take a hard look at your feasibility study to make sure they area needs the hotel. You may want to work with the bank to have them choose and order the feasibility study so the person you use is on their approved list and they feel like they have the expertise to do the study. Also, there will be a STAR report which will provide average occupancy, average daily rate, revenue per available room, supply, demand, etc. Your contractor will be underwritten to make sure they have the experience to build the project. 

    They will also consider what tier of your franchise flag will be used compared to others and for the location. The franchise will suggest you have 25% because you need post-closing liquidity while the hotel ramps up to reach stabilization and occupancy. I would think the bank will require that as well as the number 1 failure of businesses is lack of working capital. 

    Your rate is very good but your terms could be better as you could go with a higher rate that adjusts every 5 years but get a 10 year balloon note and a 25 year maturity or even some will do no balloon note 5 year adjust on a 25 year amortization. Remember if your note balloons you will have to renew which means going through credit process again and probably more fees/appraisals so something to weigh as far as lower rate with short term vs higher rate with longer maturity. Ever bank prices a little different. 

    You probably have a pretty good handle on things as an appraiser but I would suggest maybe getting a partner with hotel experience to help you out but that is definitely a personal choice. 

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  • Kyle Davis
    OP
    Appraiser · Ottertail, MN · Member since 2016 · 53 posts · 5 votes
    10y

    @Scott Snow Thanks for the input, Scott.  We did use an approved feasibility study company to get that STAR report.  

    Of the $500,000 raised so far, $400,000 of it is with other partners/investors.  Unfortunately, none of them have hotel experience but simply believe in the project and want to be a part of it.  

    The other idea I had last night was instead of me being the only person to sign the personal guarantee on the SBA, I think all the investors should.  That way nobody feels slighted for taking on extra risk and not getting any reward for it.  If everyone takes equal amounts or risk, (at least in regards to the SBA personal guarantee), then everyone should be compensated equally in proportion to their ownership in the project.  But that down side to that idea is pitching to the investors that not only are they on the hook for 125% of their investment in the project, but now a $1,000,000 loan.

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  • Scott Snow
    Lender · Salt Lake City, UT · Member since 2016 · 35 posts · 19 votes
    10y

    Anyone one that is 20% or more owner are required by SBA to sign a personal guarantee and the bank at it's discretion can still ask for others. Depending on how much everyone is putting in and their involvement in the hotel you may want them to sign a guarantee but that could be a tough sell like you said. Structuring the deal like that is tough. Just depends on what you want in the end really vs what your investors will do.

    Has the bank prequalified or otherwise looked at your deal or where are you in that process?

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  • Dan Wallace
    Vendor · Denver, CO · Member since 2015 · 63 posts · 20 votes
    10y

    Kyle, a couple of things. First, Scott hit on a number of very important aspects of the financing and I will only re-emphasize that the financing package you are getting is very "ok" especially with a balloon after only 5 years and only a 20 year amortization. I would also echo Scott's remark regarding hospitality experience. Hotels can be great investments but like any specialized industry there is a great need for industry-specific knowledge. As for the personal guarantees anyone with a 20% ownership or more will have to provide an unlimited personal guarantee to the SBA.

    From my experience in both lending to hospitality projects and liquidating hospitality loan portfolios after the 2008/09 crisis I can tell you that a balloon after 5 years is very risky. The hotel property may just be getting stabilized. We are a boom/bust economy and regardless of how strong you think your project may be if there is an economic downturn around the time of your balloon you will be in big trouble. The franchisors recommendation for 25% in the project may be to account for cash flow issues while the property gets stabilized and to weed out under-capitalized franchisees.

    One final thing, if this project is so great then invariably others will see the opportunity and will also move to fill the void in this market. Just ask all of the hotel owners in North Dakota how they are now doing after many moved to fill the housing void in the ND oil fields.

    Best of luck

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  • Dan Cho
    Latham, NY · Member since 2016 · 64 posts · 9 votes
    10y

    @Kyle Davis Hi Kyle I'm in your position too, recently came across a great hotel deal for $2.2 million w seller financing with $500k down. I'm not too familiar with the hotel industry but have a few friends in it and came across this deal. Could you tell me how you went about analyzing this deal? who did you talk too first? how did you raise the money? where do you find hotel feasibility group? Thank you.

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  • Kyle Davis
    OP
    Appraiser · Ottertail, MN · Member since 2016 · 53 posts · 5 votes
    10y

    @Scott Snow Yeah SBA told me about the ownership of anyone over 20%.  Since nobody at the moment has that amount of ownership in the business, I asked my SBA rep what would happen.  He stated that he would look into multiple people having that personal guarantee.

    The bank has prequalified the deal.  They looked at the pro-forma and are happy with it.  They just want to see at least a 20% (800k) down payment.  I'm over half way there with 500k, but just wrestling with getting a gap loan to do the rest.  One company said they would do it with a 150k loan at 3.5% over 10 years which is very attractive, but at the end of the day it is a loan and not straight cash in the project.  So that is my struggle at the moment!

    @Dan Wallace I'm double checking with the bank to see if it's just a rate adjustment at 5 years or a balloon.  Hopefully will have answers soon.  I'm skeptical on others coming into the market with another hotel as the town is small and only has 1 hotel at the moment.

    Mr. Cho, as far as analyzing the deal my project is a new construction and not a purchase so I did not have 3-5 years of financials to go off from, so I had to hire a feasibility study company to do it for me.  Their names are Hospitality Marketers Inc out of Florida & Wisconsin.  They were very professional and very intricate on everything.  I would give them a call and bounce ideas off their owner, Greg Hanis.  

    I raised the money by creating a thorough business plan with a 5 year pro-forma and called almost everyone I know.  I also offered an incentive to other people that if they brought an investor to the table, I would give them a 1% referral fee.  So if a friend brought another friend to the table, and that friend invested $50,000 I would pay the first friend $500.  It may not seem a lot, but all it takes is a phone call.  (And I would love to get paid $500 for just making a simple phone call).

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  • Dan Cho
    Latham, NY · Member since 2016 · 64 posts · 9 votes
    10y

    @Kyle Davis would you mind giving an estimate on how much a hotel feasibility costs and how long a report takes?

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  • Kyle Davis
    OP
    Appraiser · Ottertail, MN · Member since 2016 · 53 posts · 5 votes
    10y

    @Dan Cho  Mine was $13,000 including a 5 year feasibility study.  It took 2-3 months to complete.

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  • Kyle Davis
    OP
    Appraiser · Ottertail, MN · Member since 2016 · 53 posts · 5 votes
    10y

    @Dan Wallace confirmed with the bank that it is a balloon after 5 years, but, and I quote "As long as their is no new money involved (cash-out refi), we would not need to do a new appraisal.  You would be charged a doc prep fee and that is it."

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  • Dan Wallace
    Vendor · Denver, CO · Member since 2015 · 63 posts · 20 votes
    10y

    Your risk at 5 year is not what fees the bank will charge but whether you will be able to get the note refinanced. All that has to happen is that the bank does want to have a hotel loan on their books any more, your financials do not meet their then current underwriting guidelines, the bank has been sold and the new owner no longer offers hospitality loans, the bank has a concentration in commercial and/or hospitality loans and regulators are requiring them to reduce their exposure, etc. All of these scenarios I have seen over the past few years. My point is a balloon note with a fairly quick term can be very risky considering there are comparable alternatives without any balloons. There may be rate adjustments but generally as long as you make your payments you will only have to worry about a rate adjustment versus the note coming due. Furthermore I am confident that the bank will not put in writing that they will automatically extend your note at year 5 or what the rates, terms and fees will be at that point. If this is a small market then you may be limited to your financing options but you should be aware of the possible financing hazards.

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  • Kyle Davis
    OP
    Appraiser · Ottertail, MN · Member since 2016 · 53 posts · 5 votes
    10y

    Thank you, @Dan Wallace for that input.  I'll delve deeper into those scenarios with the bank and see if we can negotiate further.

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