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Hotel Financing : Here Are Your Options
Hotel Financing essentially provide the capital necessary to buy, build, renovate, furnish, or even refinance a hotel or motel. Since these undertakings typically require a lot of capital, most hotels will need some form of hotel loans at some point, whether it’s through small business loans, an outside investor, or a combination of both.
It’s hard to overstate the importance of financing in the hotel industry. While hotels, bed and breakfasts, and motels can rake in a lot of cash, they usually require huge amounts of investments upfront. Furthermore, even a highly profitable hotel will require huge capital amounts to expand or renovate.
Fortunately, over the past few years, a major change in hotel financing has been occurring, with more and more sources of financing becoming available to hotel developers. The result of this is that nowadays, hotel financing doesn’t necessarily have to come from a bank loan. This shift has been great news in the industry, especially for the business owners who don’t exactly meet the rigid criteria that traditional bank loans demand from borrowers.
Further good news is that for the U.S. based hoteliers, it’s possible to get an SBA loan through the US Small Business Administration loan programs. This means that you can lock down the funding you need and focus on running your business.
In this guide, we’ll discuss everything you need to know about obtaining a loan for your hotel.
Hotel Financing Options
There are many different forms of hotel loans available today, and the best kind of loan for your hotel will largely depend on what you need the funding for. So, before you choose which of the following forms of hotel loans you want to go with, ensure that you have pinpointed your intended use of the loan first.
Are you planning to purchase furnishings, renovate, access equipment, grow, or buy real estate? Or, do you need the financing to access an advance for an outstanding invoice or meet your operational costs? Once you’ve solidified what you need the financing for, it’s now time to consider the top hotel loan options outlines below.
SBA Hotel Loans
SBA loans for hotels are a financing option offered through the Small Business Administration loan program. These loans are used for the purposes of building, refinancing, gaining, or acquiring working capital for a hotel business.
The SBA ideally works in partnership with approved lending partners, including national and local banks, nonprofits, and even non-bank lenders to guarantee a percentage of the loan’s proceeds in case the borrower defaults. This kind of an arrangement enables the lenders to approve loans for small business borrowers who might not otherwise qualify for bank loans due to the high-risk nature of small business lending.
There are two main types of general purpose SBA Loans tailored towards hotel financing: the 7(a) loan program and the 504 loan program. Both are well suited to meet the most common financing needs of hotel businesses.
SBA 7(a) Hotel Loans
This is by far the most common SBA loan program. SBA 7(a) loans are suitable for hotel funding in that they carry low interest rates, are available for up to $5 million, and feature long repayment terms. Here is the outline of the loan terms:
• Maximum of 2.72% interest rates + Prime Rate (usually between 5% and 10%)
• Loan amounts of up to $5 million
• Possible guarantee fee of 0% to 3.5% based on the dollar amount guaranteed and the loan’s maturity
• Repayments terms of up to 7 years for working loans, 10 years for equipment loans, and 25 years for commercial real estate.
These are highly desirable loan terms that can essentially meet almost any funding need for any hotel, including working capital, business acquisitions, construction, commercial real estate, etc.
SBA 504/CDC Hotels Loans
Although these are some of the most complicated loan products available on the market, the 504 SBA loans can be quite attractive for hotel funding/financing because they allow for higher loan amounts and carry fixed rates. They have the following characteristics:
• Loan amounts of up to $5.5 million
• Fixed interest rates at about 5% or 6%
• Repayment terms of 10 to 20 years
• Fees of about 3% of the loan value – can be financed into the loan repayment plan
The SBA 504 loans combine a loan from a bank with a loan from a nonprofit Community Development Corporation (CDC) to create a low-interest, long-term loan. This unique partnership makes the 504 loans more easily accessible to borrowers who might struggle obtaining an SBA hotel loan. The only drawback is that these loans can only be used for select business purposes – usually purchasing fixed assets like heavy equipment or commercial real estate.
Keep in mind that for both SBA hotel loans, you will need to meet the SBA’s criteria for a small business. For hotels, the SBA outlines its size standards based on average annual revenue, and the threshold is $32.5 million.
Business Line of credit
As an alternative, if you’re looking to set up your hotel business with a more sustainable access to capital, you should consider a business line of credit for your funding. These typically offer revolving lines of credit, from which you can draw funds as needed. When you draw funds from your business credit line, you will repay the borrowed amount plus interest, over the agreed upon repayment term. As soon as you pay in full, your credit limit bounces back to its original amount.
The repayment term can be short term or long term based on the line of credit product you choose. Plus, your hotel financing rates will also depend mostly on how short or long the repayment term is. All in all, if you’re looking for a sustained access to hotel loans, then a business line of credit should be on your list of options.
Hotel Bridge Loans
If you’re looking for a hotel loan immediately, your best bet would be a hotel bridge loan. A commercial bridge loan is a short-term financing solution that a business owner can take to seize a time-sensitive opportunity, and doesn’t mind refinancing the loan later on. A hotel bridge loan is a quick loan solution that, in most cases, allows the borrower to access funds and for instance purchase a hotel quickly.
However, keep in mind that by definition, the bridge loan will have to be refinanced by other, presumably more affordable loans in the future. Fortunately, SBA hotel loans can be used in refinancing short-term hotel bridge loans.
If you’re looking for a loan to finance a hotel purchase, then you could consider the option of accessing a hotel loan from the owner you’re purchasing from. Also known as seller financing, owner financing is when the original owner of an asset offers an interest-bearing discount on the price of a business to the buyer.
In other words, if you find a hotel that you can purchase with owner financing, you’re quite lucky. This is one of the rarest types of hotel loans, and you still have to prove to the original owner that you are a reliable borrower to access it. So, unless you’re certain that the seller offers owners financing or it presents itself as an opportunity, we’d suggest you look more into the other available hotel financing options.
Invoice financing ideally lets your business access advances for its outstanding invoices, which makes it an ideal option for small hotel loans. The loan amount you receive through invoice financing is secured by the invoice itself, which means it’s a form of self-collateralized business loan.
So, if an opportunity presents itself; say your boutique hotel has landed a huge project to host a big show and you’re short on liquid cash required to finance it, invoice financing lets you access an advance for the invoice you send out to your clients. This type of hotel loan is ideal for fulfilling events and conferences, especially if you aren’t handling massive revenues as the big hotels do.
If you’re in the process of constructing a hotel and you aren’t able to access other hotel construction loans, equipment financing is still a great option. Through it, you can access capital to purchase the equipment you need, and you will essentially secure the loan by the very equipment you purchase.
Since this is a self-collateralized type of loan, the terms are quite solid, even if you might not be getting the all-encompassing loan you initially wanted. Equipment financing can also be used to acquire large furnishings and fixtures. In fact, it’s often referred to as Furniture, Fixtures, and Equipment (FF&E) Financing.
What Lenders Look For when Underwriting Hotel Loans
Typically, hotel lenders consider many business credentials when underwriting hotel loans. While these are quite similar to the underwriting guidelines for business loans, some are specific to the hotel industry.
So, besides time in business, business and personal credit, and annual revenue, what other details do hotel lenders consider?
• Cash flow: this is the amount of money entering your business minus the amount leaving your business at any given time
• Debt service coverage ratio (DSCR): This compares the hotel’s cash flow over a period to the potential debt obligations. It’s calculated by dividing the annual net operating income by your potential debt payments you’d have to make for the loan in question.
• Net Operating Income: This is your hotel’s revenues minus all of its necessary operating expenses. The numbers are pretax, and they don’t take into account capital expenditures, debt payments, and depreciation.
• Loan to Value ratio: This is simply the amount of loan awarded divided by the appraised value of the given property. Not all lenders will look at your loan-to-value ratio, though almost all commercial real estate lenders will.
• Debt yield: This is your hotel’s net operating income divided by the potential loan amount. It indicates the returns the lender would have if they were to foreclose on your hotel from the first day.
• Revenue per available room: Just as it sounds like, Revenue per room gives the lender an idea of how efficiently the hotel borrower runs the hotel.
• Branding: Some lender will also consider the name of your hotel when underwriting the loan. If you have a renowned and respected brand, this should play in your favor.
There you have it. As you can see, there’s quite a number of great loan options for your next hotel project. Each of the loan products has its perks, though the SBA loans offer a potential low-cost option in comparison to most other hotel financing options.