Item number one on the checklist – gathering a skilled team consisting of a real estate agent, a lender, an architect, and a contractor. The success of this team determines that of your hotel construction project. Their support and advice aids in critical finance and design decision making. Consulting with your assembled “dream team” can make your hotel project run smoother and quicker because there are plenty of aspects of the construction process that must be considered such as funding, the build-out schedule, estimation, capitalization, and the proficiency and expertise of your architect and contractor. Now, we realize that meeting a lender and convincing them to invest will be a stressful if not nerve wrecking appointment. So, to prepare you for that meeting here are a few key questions they will ask before they chose to invest in your project:
• What is your business plan? Write up a simple yet detailed business plan. Be aware of your burn rate (quantity of money a not-yet profitable business will be costing monthly), breakeven point (when cost and income cancel each other out and there is neither profit nor loss), estimate on first-year cost requirement, gross margin, its comparison to the average of your industry, a practical growth rate, and how costs will scale relative to sales. Also, be sure to cover your customers, how you will win them over, and the cost of acquiring them.
• What is your credit history? Lenders will want evidence that you can responsibly pay debts and manage money and will take a close look at your credit history. Take your credit score into account: 710 is ideal. Prepare to explain late payments and prove a healthy and steady income/cash flow.
• Can you generate enough cash flow? A lender’s biggest concern will be the ability of your daily operations to make enough profit to repay the loan. Cash flow will show how expenditures relate to money sources which can give the lender insight on the market demand and business competence of your company as well as flow via investments and financial activities.
And on the construction and designing portion of their questioning:
• Is the contract comprehensive? Practiced lenders will analyze the contractor-client contract to assure it is comprehensive and reliable. They will look over the permits, extent of work, and contingency before approving a loan.
• What is and isn’t included in the project build-out? Typically, landscaping, FF&E, and security systems are not included in contracts.
• What are the due dates for permits and zoning, and what fees need to be paid? Municipalities often require money up front for the review of drawings, planning process, and permits.
• What are the due dates for the closing the building or land? A lender will occasionally grant a “bridge” loan to keep the project going until a permit is provided.
• How many months will construction take? Lenders with experience will account for additional months in their fiscal plan in case of delays.
• And finally, who will be overseeing the project and how qualified are the inspectors? Owners should consider the quality of inspectors and GCs to monitor their construction. Inspections also provide punctual payment schedules for the contractor.
• How much retainage will be withheld? Retainage is a negotiable percent of the contract withheld by the lender on each request for payment with a maximum of 10%. It secures the lender and the owner from liability and ensures total completion. Once all final checklist items are finished to the owner’s satisfaction, retainage is paid to the contractor.
• How is the contractor paid and how is one insured from mechanics’ liens? Mechanic liens are filed by the sub or general contractor to protect them from project collateral. Experienced lenders arrange payment procedures to assure the contractor is paid on time and the contract is fulfilled. Commonly, contractors are paid once an unconditional lien release is accepted by the bank. This means a mechanic’s lien will not be filed because the contractor acknowledges that they will not file a lien and will be paid the amount due on time. If a mechanic’s lien does become a problem, a lender cannot disburse funds before it’s cleared and this issue can result in costly delays. (Paid upon progression of project)
• How will the bank approve a contractor? Lenders trained in construction will require a statement of the contractor’s references, qualifications, and financials to approve them. It is critical for an architect and contractor to have hotel building experience otherwise the building will be built to general code and specifications but may not provide total satisfaction for the owner. Issues in flooring, electrical, and plumbing can include additional costs.
• Lastly, what loan will best suit the owner? First and foremost, the lender will need to know the type of hotel project. Generally, a conventional loan is the primary loan requested by an owner. They are entirely directed by loan-to-value or LTV requirements. A loan to value ratio compares the total size of mortgage you take out to purchase property compared to the market price of the asset. Conventional loans on hotels are typically granted up to 85% LTV meaning that if a property is estimated at $10MM, the bank can lend a max of $7.5MM. The higher the LTV, the more profitable the investment. Essentially, the owner is required a down payment of 25% plus soft costs. If the estimation comes lower than $750,000, the owner is required to provide additional payment down for the difference. Also, the type of collateral used to secure a loan affects the bank’s LTV ratio. Conventional loans for construction are given a maximum LTV and may or may not encompass an interest reserve for loan payments over the duration of construction. Additionally, fees may not be included and these loans may or may not be amortizing and include a call feature for permanent funding. If possible, a permanent loan should be established before starting the project.
Different Types of Loans
• SBA 504 loan program: 504 loans grant long-term and fixed-rate finance to small businesses for real estate, machinery, and/or equipment via Certified Development Companies (CDCs) through lenders. Usually, 50% is financed by the bank, 40% by the CDC, and 10% by the business. It allows up to 80% advance rate for multi-use properties as well as a 85% advance rate for special-use properties. In exchange, the SBA (Small Business Association) expects small businesses to retain or create jobs. However, the 504 program is only for “hard” assets and won’t include inventory, working capital, or short term equipment. The appraisal requirement for it is for building-to-value with total costs except equipment and if appraisal is lower than expected, the difference of the costs against the appraisal will be at the expense of the owner as it would be in a conventional loan.
• 7a loan program: Also known as the 7a General Business Loan Guaranty Program, this loan is typically used for start-up businesses and meet short/long term needs. This program will cover construction costs but will additionally allow other uses to be requested like inventory, working capital, leasehold improvements, or real estate. Loans are generally up to $750,000 with a guaranty rate of 80% on loans of $100,000 or less and 75% on more than $100,000. In addition to the usual bank guidelines for loans, your business must qualify as a small business. Interest rate on SBA loans are based on prime rate. However, the SBA can only regulate the amount of interest a lender may charge. 7a loans automatically turn into permanent ones. It is not loan-to-value and there is no maximum on the LTV
Above all else, a successful hotel construction loan requires a qualified team. Get that, and the whole process will be far easier and less costly in the long run.