The lender's mortgage proposal was on my desk--a proposal
that had variable--and fixed-rate interest options to consider.
I had to make a financial decision that would have a monthly
impact on our hotel's cash flow for years.
My choice was a 15-year amortization schedule with a
loan balloon after seven years, a fixed rate 175 basis
points higher than the variable-rate option I could have
taken advantage of, and a loan to value of 50 percent,
though the lender was perfectly happy to go as high as
70 percent. The debt profile I opted for was, under the
circumstances, unique to the hotel investment being mortgaged.
But it got me thinking about the potential dangers tomorrow
of accepting easy money today, with a focus on variable--or
short-term fixed-rate loans with terms of less than 10
years.
Hotel entrepreneurs are in the fortunate position of
being courted by an increasing number of lenders. Nominal
interest rates on first mortgages are low, and as confidence
in the economy and lodging industry improves, debt levels
approaching 75 percent to 80 percent of value are more
common. So, with cautious optimism in the air and much
liquidity in the marketplace, borrowers are in a good
position to negotiate on a relatively level playing field.
But investors must be careful what they wish for.
Higher leveraged properties that are financed at today's
low variable-rate first-mortgage debt levels, possibly
combined with higher rate mezzanine debt or a quickly
amortizing furniture, fixtures and equipment loan, run
financial risks.
What might be the potential fallout of "reaching"
to do an acquisition, development or refinancing deal,
and justifying the economics by financing it with temporarily
low priced variable--or short-term fixed-rate debt?
Variable-rate loans are priced at a compellingly attractive
rate that's often 150 to 200 basis points lower than fixed-rate
debt. Junior debt pricing can run between 450 and 1,200
basis points above London inter-bank offered rates. And,
often the loan being offered is for a term of seven years
or less.
What happens to your hotel's cash flow when the cost
of your variable--or short-term fixed-rate loan jumps,
perhaps because Asian nations stop buying hundreds of
billions of dollars of our federal debt each year? Or,
what if the Federal Reserve starts having to rein in inflation
by jacking up interest rates? What's the degree to which
hotel asset valuations decline when interest rates return
to their more historic norm, roughly one-third higher
than today's levels? What happens when you need money
for the next round of upgrading and there's not enough
equity available to borrow against because your senior
debt provides insufficient cash flow coverage to a junior
lender?
The answer to these questions is that your hotel's cash
flow will get squeezed as your debt service significantly
climbs, and you might face a large principal balloon payment
that might have to be significantly paid down to get refinancing.
I closed on a conservative level of financing for a seven-year
term at a fixed rate. I tried to push the lender to 10
years, but that option wasn't available.
hmm@advanstar.com
Jeff Wilder is president of Wilder Ventures LLP, a New
York City-based asset management company, and an adjunct
professor at New York University. E-mail him at jswilder1@aol.com.
COPYRIGHT 2004 Advanstar Communications, Inc.
COPYRIGHT 2004 Gale Group
