Construction Loans

What financing products are typically employed for hotel construction projects?

Hotel investors employ different types of debt and equity financing products to create the capital stack which is used to fund the construction of hotels.  We offer many different financing options to our customers.  Two of the primary differentiators between financing products is your choice between low lender fees or high loan-to-cost ratio (lower cash equity injection) and then your choice between a fixed interest rate or a floating interest rate.  Additionally, sometimes you may have a choice between a personally guaranteed recourse or a non-recourse type of loan. 

Government Guaranteed Loans

Through our expert knowledge of the loan programs developed by the United States Small Business Administration (SBA) and the United States Department of Agriculture (USDA) we assist hotel investors nationwide to obtain very attractive financing for their businesses.  These government programs provide senior construction-through-permanent loan type of financing.  If you are searching for a long term loan with a 20-30 year term and a 20-30 year fully amortizing payment schedule with up to 85% loan-to-cost ratio and a reasonable rate of interest, you should consider the new and improved loans offered through the SBA, as well as the USDA (in rural areas).  Loan amounts for these types of loans can range up to $50,000,000 and are available for any type and size of hotel or motel— franchised or independent. The reason these loans are called government guaranteed loans is because if the borrower defaults on this type of loan the federal government will reimburse/pay the lender up to 70-80% of the amount of any losses of their principal. This guarantee gives the lender a much better comfort level with and thus a higher probability of approving your loan request than would be the case without such a guarantee.  The lender typically requires the owners of the company to personally guarantee this type of loan. 

 By utilizing SBA’s 504 Green Loan Program a single hotelier can obtain multiple SBA loans for multiple “green friendly” hotel construction projects with no limit on the lender’s 1st mortgage; thus, there is no limit on the size of these projects as long as they are financially feasible. In many cases, qualified borrowers with projects exceeding $20 million can still obtain up to 85% financing.

 By utilizing SBA’s new 504 Green Loan Program there is no limit on the number of SBA 504 green projects allowed to each borrower which means that business owners looking for additional 504 financing may be eligible even if they have committed or outstanding SBA loans. This means funds for this program are not limited by the SBA’s usual aggregate lending limit of $5 million per borrower, which means business owners who previously reached their SBA maximum now have the ability to receive additional SBA loans.

 Conventional construction-through-perm loans

Conventional loans are mortgage loans secured by a senior position lien that have traditionally been made from banks and credit unions although today private equity debt funds and mortgage REITs are increasingly making these types of loans.  Conventional loans have a set term and amortization of up to 20 years and typically offer a fixed interest rate for long term permanent loans.  For construction projects the loan-to-cost (LTC) ratio of conventional loans is typically in the 60-70% range.  These loans are made with funds directly from the lender’s balance sheet and are typically held on the lender’s balance sheet for the duration of the loan.  They are not backed by any government agency in case of borrower default.  These loans usually have the most favorable interest rates and repayment terms for borrowers and the least amount of fees, but they are the most difficult to obtain.  The lender typically requires the owners of the company to personally guarantee this type of loan. 

Preferred Equity and Sponsored / Direct / JV equity

At the other end of the hotel capital stack opposite the senior mortgage loan is located equity, which is divided into two types–preferred and sponsored (which is also known as common, direct, or JV equity).  Equity has the highest returns for investors because they get paid last in the case of the failure of the business, and therefore they have the highest risks, and they are compensated accordingly. 

 The fundamental difference between preferred equity and sponsored equity is that the preferred equity generally has a minimum return requirement, and they get paid a minimum return first, and then the sponsored, or common, equity gets whatever is left over.  The sponsored equity, on the other hand, is entitled to the highest returns. Because they are paid absolutely last, after all the other capital stack participants are paid, they get the highest return.

 Mezzanine loans

 In the capital stack between mortgage debt and equity is located “mezzanine” debt.  With its origin in the Latin language, the word mezzanine means “in the middle.”  Mezzanine funds generally constitute no more than 20% to 30% of the total capital stack, and the owner of the property generally sees obtaining mezzanine debt as a substitute for giving up ownership equity.  Mezzanine debt may be a desirable substitute for equity because it is slightly less expensive than equity, and you do not have to take the mezzanine lender on as an equity partner.  Mezzanine loans generate significantly higher returns (have higher interest rates) than mortgages.  In the event of a borrower default they are paid second, in the middle, after the senior and junior mortgage holders and before the equity investors.  Thus, their risk and reward is in the middle.  They have moderate returns and moderate risks in exchange for being paid after the debt capital but before the equity capital. 

C-PACE

Commercial Property Assessed Clean Energy (C-PACE) is a state policy-enabled financing mechanism that allows building owners and developers to access the capital they need to make energy related deferred maintenance upgrades in their existing buildings, support new construction costs, and make renewable energy accessible and cost-effective.

C-PACE makes it possible for commercial property owners to obtain low-cost, long-term financing for ener­gy efficiency, water conservation and renewable energy components of a new building. Hotels qualify for C-PACE financing.  C-PACE can be used to pay hard, soft, and associated costs connected to mechanical, electrical, plumbing, building envelope and renewable energy sources. Examples include HVAC, LED lighting + facility controls, boilers, windows, and solar.

 The program starts with a state-level government policy that classifies clean energy upgrades as a public benefit – like a new sewer, water line or road.  These upgrades can be financed with no money down and then repaid as a benefit assessment on the property tax bill over a term that matches the useful life of improvements and/or new construc­tion infrastructure (typically ~20-30 years). The assessment transfers on the sale of the property.  While facilitating sustainability efforts, the program reduces property owners’ annual costs and pro­vides dramatically better-than-market financing for “green” elements of a new construction project.

EB-5

EB-5 refers to a program that is authorized by Section 203(b)(5) of the Immigration and Nationality Act.  Its name derives from the fact that the EB-5 regime is set forth in the fifth subparagraph of the “Employment-Based” immigration programs provided in Section 203(b). EB-5 offers an expedited visa processing for foreign investors making a minimum required investment in a project that creates at least 10 new jobs in the United States.

 Thus, EB-5 is both an immigration program giving wealthy immigrants the opportunity to earn a “FastTrack” to US citizenship, and a source of financing for new enterprises that provide communities the benefit of economic development created by investment and new jobs. This financing or investment must be made in qualified projects, and developers are often able to execute a new development with the EB-5 capital when they could not otherwise complete their capital stack.  EB-5 has incentives to develop infrastructure and other projects located in a “rural area” or an “area of high unemployment” designated by the Secretary of Homeland Security (a qualifying rural or high unemployment area is called Target Employment Area or “TEA”). Incentives include a reduction of the minimum investment from $1,050,000 to $800,000 for a project located in a TEA.  Additional incentive is provided by offering prioritized processing with United States Citizenship and Immigration Services (USCIS) for rural projects.

 The critical requirement is that the minimum number of 10 new US jobs for each investor will be created within a specified period of time. However, in order to raise money from foreign investors, the project must satisfy the investors’ need for certainty that the project will be completed on time and create the necessary jobs so that the EB-5 investors will obtain their green cards. Secondarily, the project must also be attractive from an investment standpoint, providing a high degree of comfort that it will be able to repay the investment in 5 to 7 years (whether the EB-5 financing is structured as debt or preferred equity).

 Analysts estimate that up to 70% or 80% of all EB-5 investors select real estate-related investments, particularly those that create a large number of new US jobs such as hotels, restaurants, night clubs, resorts, hospitals, and senior living.

 Construction-Only Loan

 This type of short-term bridge loan can be used to fund the construction phase only.  It must be repaid once the certificate of occupancy for the building has been issued.  This course of action can be problematic when a permanent lender cannot be obtained once the construction has been completed.  The interest rates, fees, and repayment terms of such loans reflect this inherent risk.