As the world struggles to understand the impact of the Coronavirus (COVID-19) pandemic and its impact on various markets, only one thing is certain; with the ongoing travel restrictions and entire countries and regions closed for business, hospitality has taken a direct blow to the gut and is, without question, one of the hardest hit sectors of the global economy. Perhaps the most distressing aspect of the downturn is the uncertainty that we all face. No one can predict with any level of accuracy just how long the pandemic will last, how long the related restrictions will be in place, or how much worse things could get for our industry. We also don’t know if or how traveler behavior will change post-pandemic or the final, net impact on the economy.
So, with all of these variables and little historical data to go on, what can industry stakeholders expect from a financial standpoint? To cite a recent report by HVS, “We do know that the hospitality industry is extraordinarily resilient. Past ‘shock’ events and downturns have caused business to plummet; however, the industry performance has always recovered. Even though the pace and degree of the COVID-19 downturn is unprecedented, market participants believe that the hospitality industry will recover and, as in the past, this cycle will create the opportunity for strong returns through well-timed and well-executed investment strategies.
In the meantime, the hotel finance landscape has undeniably changed for the foreseeable future, as lenders have become understandably more conservative in their approach to potential borrowers and deals. For instance, the loan to value (LTV) ratio that lenders are comfortable with has dropped from a maximum of 70% to around 55% today. The same applies to loan to cost (LTC).
Although typical loan terms and personal/corporate guaranty requirements remain unchanged, proforma underwriting guidelines have shifted to match the new financial reality. Prior to COVID-19, typical stabilization occurred in Year 3, with the proforma only majorly adjusted if there was new supply coming online soon or if supply had recently been delivered. Under the adjusted standards, discounts will be applied to the projected cash flow for the hotel by up to 20% in year 1 and 15% in year 2, prior to an in-depth market analysis review, which could discount the cash flow further.
Lenders are also looking more closely at borrower experience. In the strong pre-COVID economy, the borrower only had to demonstrate a baseline of industry experience or be able to identify that their operating partners had successful management experience. In order to secure financing today, a borrower must be able to demonstrate how they are effectively managing their current assets during the COVID-19 Pandemic. They must also show how they are controlling costs to minimize any potential losses. Financial performance standards have also shifted, with market analysis needing to support an overall Debt Service Coverage Ratio (DSCR) of 1.40-1.50x upon stabilization, vs. the 1.25-1.30x that was expected previously.
That said, there are still opportunities in the marketplace and funding has not dried up completely, as some suspect. Choosing an established lender with which you have a strong existing relationship is key to being able to identify and leverage those opportunities as the inevitable recovery begins. In our next blog, we’ll explore strategies for working with your lender during the crisis. For more information, please visit www.accesspointfinancial.com or reach out to us for a private consultation to discuss your current financing needs.