March 4, 2015

Benefits of Carving FF&E Expenses Out of New Hotel Construction Loans

New hotel construction has begun to thaw out from the standstill the industry experienced as a result of the recent recession. The economy has shown improvement; interest rates are still low; and raw building costs have only slightly increased. Today as a whole, the hotel industry is doing well with increased occupancy, higher average daily rates and surges in RevPAR in desired markets.

Despite the healthy industry stats and the uptick in the economy, traditional lenders are having a hard time seeing the demand for new rooms. Still fresh in the banks’ minds are the foreclosed and distressed hotel projects they had to sell off as a result of the financial collapse. Lenders are selective about the deals they accept. Banks are typically limiting lending to only the healthiest of hotel developers where they believe there is a low risk of default. So, if you plan to pursue a construction loan for a new hotel property, it is important to know how to best secure the financing.

One option to more easily secure new construction financing is to carve FF&E expenses out of the overall construction loan. What does FF&E include? Typically these costs consist of casegoods such as beds, bookcases, cabinets and other equipment ranging from HVAC units to door locks. In new hotel construction, FF&E typically accounts for 10-20 % of the total project cost.

There are three main benefits to separating FF&E expenses from your construction loan. First, if you carve out FF&E costs, it lowers the risk for the construction lender. For example, most lenders will only extend 60-65% Loan to Cost (LTC) to qualified borrowers, requiring the hotel owner to put down 40%. Carving out FF&E reduces the construction lender’s capital commitment which spreads out the risk between you, the construction lender and the FF&E lender.

Second, when a construction lender is evaluating new loan risk, they take into account the fact that the FF&E lender has also evaluated the risk and has deemed the deal credible. From a new construction lender’s perspective, they have two priorities: to collect interest on the loan and to be paid in full at the end of the loan term. Even though you are sure your new hotel development is in a desirable market, and you’ve provided an adequate financial pro forma statement, from the lender’s viewpoint your loan application looks the same as all the others. But having the approval of another lender for the FF&E expenses sets you apart.

The third benefit of an FF&E carve out is the hotel developer is able to secure more borrowing capacity for their project. With two lenders involved, chances are you will be able to secure greater total funding for the project, requiring less of your capital.

According to PKF Consulting USA, the overall 2015 U.S. lodging industry will realize a 65% occupancy. This is the highest national occupancy rate since STR, Inc., a company dedicated to hotel industry data, started providing figures nearly thirty years ago. And, PKF estimates demand for accommodations by the end of the fourth quarter will have gone up 25.8% from the rock bottom low in 2009, while supply will increase by just 5.6%. With these favorable projections, now seems to be a great time to move forward with new hotel development. And, considering the FF&E carve out as part of your strategy enables you to smoothly secure appropriate new construction financing for your project.

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