Examining Debt Solutions for the Hotel Landscape

Providing insight on the hospitality sector’s varying debt solutions in relation to the current, on-going crisis, Alan Cohen, chair of Akerman LLP’s real estate finance practice and co-office managing partner of the firm’s New York office, recently connected with GlobeSt.com to answer a few questions regarding payment options within the hotel landscape.

Are lenders permitting deferred payments from certain hotel borrowers in order to withstand the crisis and generate income to pay debt service?

We are all well-aware that the current slowdown is vastly different from that related to the Great Recession. Upon the onset of the COVID-19 pandemic, almost overnight, people isolated themselves in their homes, travel and tourism ceased staying at hotels became a non-viable option.

Many major urban hotels’ average daily occupancy dropped into single-digits and, as a result, many were forced to close; excluding those that were able to serve medical personnel and other first responders. Subsequently, cashflow ceased and operators and owners were unable to pay debt service and operating expenses without coming out of pocket.

Considering the flood of defaulting hotel loans in mid-March, servicers had to quickly engage with borrowers to provide temporary solutions in order for borrowers and operators to get through the cashflow crisis.

Uncertain of how long the pandemic would last, many lenders and servicers, including CMBS servicers, responded by utilizing cash reserves built into loans to cover debt service payments as well as other operating expenses, in order to keep the loans from defaulting and/or deferring a portion of the monthly debt service or converting to interest only for a period.

For instance, if the loan had FF&E, seasonality, PIP or CAPEX reserves, the servicers might permit the borrowers to dip into these reserves for a portion of the required payments. Servicers have also triggered the cash management provisions of loans to secure and control cashflow and payments. Most of the initial accommodations or deferrals covered three month periods in order to keep the loans performing, although in some instances, depending on the type of hotel, servicers granted six month accommodations, rendering three month solutions inadequate. Such lengthier accommodations were permitted for hospitality classes including resorts, big box urban hotels and comparable hotel types, where cashflow would likely be severely diminished over longer periods of time.

That being said, some lenders and servicers are unwilling to absorb the pain and provide borrowers with a “free ride” to get through the crisis. Therefore, many servicers require borrowers’ sponsors to share the burden by covering at least 50% of the operating shortfalls to meet debt service and other expenses by way of capital contributions. The logic being: if a sponsor is not willing to go out of pocket to keep the hotel viable, then why should the lender agree to accommodations? Consequently, some of the less capitalized sponsors are “giving the keys” back to the lenders.

As the cashflow crisis commenced in mid-March, the three month solution period ended in June and the six month solutions will end in September. At the end of these periods, borrowers and servicers will further examine the quality of the assets to determine which assets should receive longer-term solutions for debt servicers and covering operating shortfalls. Presumably, upon these decisions, lenders and servicers will impose added, unrelenting burdens on borrowers; at which point, many borrowers may abandon their assets.

Are some hotels better-positioned than others? What factors come in to play?

Of course, a borrower or operator’s ability and willingness to work with loan servicers in order to make it through this crisis is dependent on a number of factors, including the type of hotel, geography, level of management and sponsor capitalization. Borrowers with outdated hotels, ‘big box’ urban hotels or hotels located in overbuilt markets might be less willing or unable to contribute large amounts of capital in order to cover operating shortfalls; even when subsidized by servicer deferrals and accessing existing cash reserves.

The same holds true for sponsors who are not well-capitalized. It comes down to a sponsor’s business decision as to the hotel’s prospects and whether it makes sense to invest good money.

Large, branded chains with professional management will usually have access to capital in this regard; but again, it’s a business decision as to whether it makes economic sense to support the hotel or simply give the keys back to lenders.

Updated hotels situated in busy, business corridors may be more willing to cover operating shortfalls in order to make it through the crisis. However, even these sponsors will need assistance from lenders and servicers.

What are loan servicers taking into account as they generate strategies to provide hotels with breathing room?

In addition to the previously mentioned, various factors, servicers will, of course, revise their original underwriting for these loans and stress many of the initial assumptions. Factors such as the type and classification of the hospitality asset (e.g., full or limited service, hotel quality, standalone or brand, management quality and the sponsorship’s capitalization) will play a major role into the extent and willingness with which servicers will enter into longer-term accommodations.

An additional factor that servicers have recently articulated is whether a borrower has recently cashed-out proceeds from an asset and to what extent they have done so. If a cash-out has recently occurred, a servicer may require the sponsor to inject a portion of those proceeds to cover shortfalls.

The general consensus within the market is that the hotel industry may not return to pre-COVID occupancy levels until 2022 or 2023. Accordingly, only those sponsors who have quality hotel assets, access to capital and sound business plans will be able and willing to commit the capital necessary – when combined with lender modifications and flexibility – to cover shortfalls during such an extended period.

Optimistically assuming that the pandemic will cease in the coming six to nine months, the industry remains hopeful that people will begin to travel again for business and/or pleasure, and therefore, tourism will rebound and destination resorts will reopen and thrive once again. That said, servicers would be willing to bet on well-capitalized sponsors with quality hotels in sound markets that are able to cover shortfalls. In order to satisfy servicers’ current underwriting concerns for such assets, sponsors would need to provide convincing, updated business plans, exhibiting sustainable strategies to endure the extended slowdown.

Given the increasing number of hotel loans in or around default, it behooves lenders and servicers to find and achieve acceptable, long-term solutions for hotel borrowers. However, considering the various factors presented above, servicers should not hesitate to reclaim assets for which recovery prospects are uncertain or doubtful.