Bridging the Gap: How Deals Are Getting Done in a Difficult Debt Market

The hospitality industry is facing an unusual challenge. With rising consumer demand, hotels are hitting — and even exceeding — pre-pandemic levels for revenue per available room (RevPar) and EBITA. Yet interested investors are finding it difficult to seize opportunities in the sector, not least because it has become difficult — in some cases, impossible — to obtain traditional debt financing.

What’s causing this unusual dynamic?

Attendees at this year’s American Lodging Investment Summit (ALIS) were cautiously optimistic about the hospitality industry in general — and luxury destinations and group business in particular. Considering recent and expected dynamics, that is no surprise.

In the US, RevPAR reached an all-time high in 2022, even as other asset classes in commercial real estate faltered. Moreover, consumers are increasingly acting on their pent-up desires for travel, and group and international bookings are coming back as China and other countries remove travel restrictions related to COVID-19.

Yet major hotel investors that are actively looking to deploy capital indicate that they have been unable to find deals. In part, they may be waiting for prices to come down. Indeed, prices may drop in the not-too-distant future — although maybe not in the way that investors once expected. Another factor is the limited availability of attractive assets. See the “Other factors” sidebar for more on these points.

In the meantime, interested buyers are actively looking to deploy equity capital but are stuck on the sidelines due to rising costs of debt and difficult, if not frozen, debt markets. Active lenders are carefully limiting loan-to-value ratios and managing their exposure to hospitality assets. Even the lenders that appear to be “open for business” are pricing buyers out of competitive deals due to associated debt costs. Thus buyers cannot easily access debt necessary to get a deal done in this environment.

 

What can investors do to bridge the gap?

To capture hospitality opportunities, we have helped interested buyers consider creative solutions that enable them to obtain financing, despite tight debt markets. These include:

• Using seller financing when traditional financing is unavailable or unattractive
• Helping buyers close on assets with an increasing reliance on equity or otherwise closing on all cash as a short-term solution with the goal of securing more permanent debt financing once the debt markets normalize
• Securing mezzanine debt, preferred equity, or similarly structured debt to fill in holes in the capital stack
• Exploring alternative lenders or regional banks
• Navigating existing relationships with senior lenders to allow for the assumption of an existing loan

As effective as these alternative approaches can be, they do present unique challenges for dealmakers. In particular, as owners resort to more novel financing structures, gaining buy-in from multiple stakeholders — including senior lenders, management companies, brands, franchisors, and hotel unions — can be more challenging and more important.

Potential buyers should involve legal advisors early in the process to discuss the various creative solutions available to them. This will help them increase the likelihood of getting a deal done and maximize their opportunities for achieving their investment goals.