In the US Hotel business real estate finance sector, holiday cheer never really made it in.
As we move into a new year, the country’s commercial real estate capital markets. Are still dealing with a general lack of confidence that has stopped both lending and transactions.
Many factors contribute to the problems, including much higher interest rates on both fixed- and floating-rate loans. Stricter and more expensive loan terms, declining property values, waves of billions of dollars in upcoming debt maturities. And a banking sector that is more cautious because it knows regulators will be closely watching it.
Because of this, refinancing and getting new loans have slowed down a lot. The debt market has experienced a slowdown in property purchases. Both buyers and lenders are wary of the extra costs and risks that come with hotel financing these days. So many deals just don’t work out.
When you put out a bid for refinancing before rates went up in 2022. Maybe a dozen lenders would look at it. Now, you might only get three or four,” said Sean Hehir, CEO of Trinity Investments. “Who you’re with and the relationship are what matters.”
Michael Straw, executive vice president of CBRE’s Institutional Hotels Debt and Structured Finance team. Said that there is a natural sense of optimism about the next 12 months, especially in the hotel market. This is true, even though there are fights going on across CRE to get deals funded.
Activity levels are increasing.
The amount of money lent against commercial properties dropped dramatically in 2023. But the number of hotel loan deals that closed actually went up by 2% in the third quarter. According to data from the Mortgage Bankers Association (MBA). Office and industrial properties were the only other asset classes that saw an increase in deal activity from the previous quarter.
According to Straw, there is debt execution for every type of hotel asset. Up and down the chain scale, and in every situation. Whether it’s new construction, a bridge, or stabilized assets, as well as some areas of distress. He also said that bank balance sheet debt is the “most elusive” to get.
According to figures from MBA, the total dollar volume of loans made on hotels fell 52% year-over-year in the third quarter. Lenders are still interested in hotels, even though other asset classes did not do any better.
According to Fitch Ratings research that used data from the Federal Deposit Insurance Corporation. The smallest banks in the United States have increased their exposure to that type of debt. While the biggest banks have usually pulled back from lending to commercial real estate. Smaller local and regional banks may understand and be more confident in commercial real estate lending in the areas where they’re based. Also, Straw said, many of these banks don’t have to deal with the heavy layers of bureaucracy that could get in the way of a debt deal with a larger, more strictly regulated bank.
Lack of banking
Sources told Hotel Loans that debt funds and other lenders. Like those backed by big asset management firms, have also stepped up to fill the funding gaps left by banks. Even though they are also unsure about the market.
Due to high interest rates, all forms of debt used to finance commercial real estate contain these funds. This includes cheaper senior loans, more profitable mezzanine debt, and preferred equity. This is because they can hit their high return goals at all levels of the capital stack, according to Straw.
In the past 12 to 18 months, the market has swung strongly in favor of lenders. According to Chatham Financial Managing Director Casey Irwin. Hotels offer strong risk-adjusted returns to those willing to put debt capital into the space.
Debt lenders are mostly getting what they want in a market that is unsure and short on cash. Lenders want strict loan terms for refinancing and the occasional new loan origination. To protect their rates and protect against downside risk. Sources say that lenders are not willing to give the same amount of money for different deals. As they were 18 to 24 months ago.
Deals are available for hotels
a tried-and-true asset class that performed better after the pandemic. People are looking forward to a better 2024 thanks to strong hotel performance. Improving economic indicators like falling prices and rising wages, and positive consumer spending and unemployment rates. There’s also hope that the sales and debt markets may become more fluid next year. As predicted by the Federal Open Market Committee (FOMC).
But last year was full of boring things. According to the MBA, the total number of commercial real estate loans originated dropped by 49% year-over-year in the third quarter and by 7% from the second quarter. Debt funds and private lenders, which MBA calls “investor-driven” lenders, have cut the amount of money they lend by more than half since last year. This is because depository institutions, such as banks, stopped lending money to CRE borrowers in the third quarter, which is a 73 percent drop from the previous year.
Straw’s powerful team at CBRE usually creates more than $7 billion in hotel debt in a “stable year,” but in 2023, they did less than half that. This was mostly because there weren’t many hotel sales on the market.
Rate increases
The benchmark federal funds overnight borrowing rate has gone up almost twelve times in the last two years, which has been hard on commercial real estate owners and developers. The rate went from almost zero at the beginning of 2022 to 5.33 at the end of 2023, according to data from the Federal Reserve Bank of New York. The Federal Reserve’s fastest round of tightening monetary policy in 40 years caused business asset values to drop and made it harder to buy and sell things. It got harder to plan for higher interest rates on loans, which could sometimes be higher than the rate of return property investors could expect.
A string of larger banks failing in the first half of 2023 occurred at the same time that rates were rising. This made things more uncertain for banks and gave them more reason to limit new lending.
Due to a number of bad office loans, lenders have also been delaying loan due dates. For instance, in 2023, lenders changed or extended $13.6 billion in securitized CRE debt. Office ($4.6 billion) and residential ($3.3 billion) loans made up more than half of that amount.
In September 2023, Trepp, a financial research company, announced that they had extended the terms of nearly $6 billion in securitized loans during the first eighteen months of the year. 69 percent of this total received extensions ranging from one to 24 months. We anticipate that CRED iQ will continue to rely heavily on loan extensions to manage its $210 billion in securitized debt due in 2024.
A key part of the CRE market
The U.S. commercial real estate market is based on banks, especially local and regional banks. They hold almost half of the $6 trillion in outstanding debt in the sector, according to new figures from the Financial Stability Oversight Council (FSOC). Next to debt from life insurance companies. Bank debt is usually the cheapest type of debt for a real estate owner, following debt from life insurance companies. Straw said that when that money pretty much runs out, it changes how a real estate deal usually works.
Julie Solar, a credit officer at Fitch Ratings Group. Asserts that capital optimization has emerged as a crucial strategy for U.S. banks, particularly those with assets exceeding $100 billion.
This is partly because of the Basel III endgame proposal that regulators put forward in July 2023 in response to the financial crisis and banks going bankrupt earlier that year. It would create stricter capital buffer rules for the largest banks to ensure that they can handle stress on their balance sheets.
In 2023, federal agencies and politicians got more involved. They encouraged lenders and borrowers to collaborate on loan workouts and passed laws that made it easier for financiers and borrowers. To negotiate loan extensions and changes.
There are those who possess and those who lack.
In a way, Irwin said, access to banks has turned into a story of the rich and the poor.
Irwin said, “Banks care a lot about relationships.” “I keep hearing the phrase ‘looking for strategic or selective investments,’ which means they want to add to their cash on hand. Unfortunately, this means that many are still looking for partners to help them finance their deals.”
In the three years since COVID-19, Hehir’s Trinity Investments has provided some of the largest and most well-known hotel loans. Trinity completed two huge refinancing deals with major banks in 2023. One of them was a commercial mortgage-backed securities (CMBS) execution. This was possible thanks to its strong private equity backing, long history, and good relationships with its big lenders.
Solar said, “Right now, there is a very careful approach to capital use because of pending capital rules. And that puts an enormous burden on the largest banks.” “I don’t know what will happen in the end, but I think there’s a general split between the bigger and smaller banks right now.”
She said that her investor clients are becoming more eager to connect with neighborhood and regional banks.
They ask, “If we have good relationships with a few larger regional banks and put our deposits there. Does that give us the chance to use some of their balance sheet or get access to it?” He told me. “That can be good for hotel investors, but it doesn’t always work because banks are usually cautious about lending money.”
Others think that life insurance companies will change their minds about CRE loans in 2024. Especially when it comes to hotel credit, which has a high return profile.
An update on life insurance company lending levels could start a conversation. Irwin said, “We are having different conversations with different people about hotel lending.”
In today’s market, the CRE credit game is a good one. And the flexibility of hospitality makes it a great choice for debt tactics. Room and service prices are constantly changing, and a lot of tourists are willing to pay cash. Which has kept hotels open despite inflation, rising rates, and the subsequent financing mess. And because hotels had to change their prices after the pandemic, many of them are ready to get loans.
In 2024, could the dam start to break?
Straw said, “There’s hope because of the Federal Reserve’s December meeting and the way things have been going in the hotel industry over the last year.” “Rates are likely to go down, performance looks better, and inflation and unemployment are under control.” “There is some hope for the next twelve months compared to the last twelve months.”
