Investing in commercial real estate is often complex, and investing in a new hotel can be especially so. Individuals seeking a construction loan need to prepare for a particular set of challenges.A distinctive asset class
Hotels are distinctive among commercial real estate asset classes, because hotel investors have to place their security not only in real estate but also in the viability of the business. Multi-family, office, and retail assets involve long-term leases that provide ongoing, predictable sources of income; hotels, by contrast, draw their income from daily check-ins and check-outs, which fluctuate. Occupancy changes daily, and thus so does revenue. When seeking a loan to build a new hotel, a first-time developer’s biggest challenge can be convincing a lender that s/he understands the cyclicality of the business, has the knowledge to manage the business side of the venture, and understands how to mitigate the risk of fluctuating daily income.
Lenders often look first and foremost for a prospective new hotel developer to have prior experience in the hotel industry, since operations is an important piece of hotel ownership. If the prospective owner lacks such experience, s/he should partner with a hotel management company or seek out an experienced partner to submit a joint application.
Lenders look for a number of other factors as well, including:
- The ability to make a significant equity injection—typically no less than 20% of the total cost. Leverage for a construction loan is generally available at a loan-to-cost of 50-80%, so, a first-time hotel developer can expect to be on the lower end of this spectrum.
- A well-regarded hotel brand with a clear value proposition within the subject market. Brand selection is often key to a successful loan application. A few questions to ask when choosing a brand are: What kind of hotel would provide the best return? What can the applicant’s team physically manage? What is the brand’s unique selling point?
- A financial analysis demonstrating—among other things—that the applicant understands the cost to develop and operate the hotel as well as inclusion of construction contingencies and other cash reserves once the hotel is operating.
Experience trumps all
Of all these factors, experience is the most important. If a first-time hotel developer lacks relevant experience, s/he should seek out a hotel management company or a strong joint-venture partner with hotel expertise. From there, the applicant can assemble the right team and begin collecting the reams of information needed to embark on one of the most challenging—but most rewarding—ventures in commercial real estate.