Overview
Capital City Bank (CCB) provides hotel financing loans to experienced hotel developers and owners who currently Bank with CCB. In addition, we will finance Hotel’s for prospective clients when the property is located within the Bank’s footprint. The Bank offers 2 loan product options:
- Construction/Perm Loan - where the Bank finances both the new construction and the permanent financing of a new or “to be renovated” hotel
- Permanent Financing Loan - where the Bank will finance an existing stabilized property
The 2 primary hotel types are full and limited service.
- Full-Service hotels offer a higher level of service and an increased amenity package including dining and room service, convenient retail, banquet and convention centers, recreational facilities, and business support services. Full-Service hotels derive a sizable portion of their income from non-room-related activities.
- Limited-Service hotels offer limited or no food service and limited meeting space. Limited Service hotels derive most of their income from room revenue and are the predominant hotel type that CCB finances.
Lenders are required to originate hotel loans on flagged properties with a reputable franchise and built as an inside-corridor facility. An outside corridor property may be considered on an exceptional basis, however, will be limited to a stabilized property, with a strong operating history, and strategically located within the Bank’s footprint. Lenders should expect that when an outside corridor property is approved, the loan will be decisioned using stricter underwriting standards (LTV, DCR, amortizations, reserve requirements).
Hotel financing loans are originated and managed by designated Commercial Real Estate (CRE) Lenders or Community Presidents approved by Credit Administration and trained and experienced in CRE project financing.
Evaluating Site Locations
Be sure to consider the following when evaluating a hotel financing site location:
Proximity
Evaluate the location of the property.
- Proximity to major highways, heavily traveled, in locations where the property can optimize revenues from multiple sources to include tourist travel, business travel, and destination travel is critical.
- Examples include: interstates, airports, universities, tourist attractions, medical facilities, beaches, and the central business district.
- When financing limited-service hotels, the proximity to eating establishments is especially important.
Visibility
Hotels that have site frontage and sign visibility on major highways enjoy higher revenues from overnight travel.
Ingress/Egress
A lender must evaluate the ease of getting to the site.
This is critically important especially in areas experiencing major growth. DOT and other public authorities are continuously upgrading the road systems. A major road expansion or detour can have a negative impact on a property’s occupancy for an extended period causing significant cash flow problems.
When evaluating the site, the lender is encouraged to review the permitting reports published by the county and city to determine if any new road construction has been permitted near the site. Inversely, road expansions can also enhance a property’s location. An example of this may be the addition of an interstate exit and/or a service road.
Legal Access
Verify legal access to the property through the following:
- Visual inspection
- Review of a survey
- Review of title work
Potential environmental constraints or contamination
Evaluate the site for potential environmental constraints or contamination.
- Lender’s on-site inspection should look for potential wetlands (for example: standing water, low areas, types of tree growth), dead vegetation, unidentifiable debris or abandoned equipment/ autos/tractors/fuel tank (operable or inoperable)/homes or buildings, endangered species (for example: gopher turtles), indications of past use related to farming, dry-cleaning, manufacturing, railroads and processing facilities, waste dump sites, defense or military operations, and mines.
- Review the Environmental Risk Management Policy for documentation requirements.
Phase I Site Assessment
Drive around to identify any off-site properties within a 1- mile radius that could have the potential to contaminate or could have already contaminated the site you are considering financing. It is quite common for a property to become contaminated through the migration of contaminants from offsite properties.
Obtaining a Phase I Site Assessment performed by a qualified engineer will identify any potential Recognizable Environmental Conditions (REC's).
Flood Status
If the property is located within a designated special flood area, evaluate the impacts that a weather event could have on your property’s cash flow, borrower, and collateral. Identify ways the Bank may mitigate its credit risk and decision the loan accordingly.
Within the state of Florida, our business clients are challenged by the constant turnover in insurance companies and rising insurance costs. A lender needs to understand what impacts there maybe be to the property’s cash flow if CCB were placed in the position of providing forced placed insurance.
Permitting
Confirm that your site has the appropriate zoning and future land use designation for the intended use. In addition, review Costar or the local permitting reports to determine if any new hotel construction has received permitting within your property’s defined market area which is typically a 3–5 mile radius. Costar is a particularly useful tool for evaluating the existing, incoming, and depleted number of rooms within a given market area.
Demographics
Review Costar or Wikipedia to determine if the population is growing in the subject’s market and where that growth is coming from (retires, young professionals, new business). If the market is stagnant and the STR report trends show deterioration, then, require a feasibility study or reconsider financing the project.
Evaluating Existing or Proposed Improvements
Assess the overall design and functional utility (new construction or existing):
- Parking Ratio
- Sufficient to support the room count and complies with approved plans and specs.
- Inside Corridor
- Amenities consistent with comp set
- Swimming Pool, fitness room, business center, breakfast area, vending machines, free wi-fi, and meeting rooms
- Acceptable brand recognition
- Research the flag, assess the reputation of the franchise and be aware of any changes being made to the overall design by the franchisor
Evaluate the condition of the property if existing:
- Age and condition of the roof system, parking area, signage, exterior building, painting, interior rooms, pool area, fitness room, case goods, flooring, bedding, equipment and major appliance items.
- Review the most recent annual audit report issued by franchisor to confirm compliance.
- Review the most recent Property Improvement Plan (PIP) to assess existing or future capital expenditure needs and planned changes to the design or utility of the hotel. PIP requirements should be taken into consideration when evaluating the requested loan amount, amortization, and reserve for replacement requirement. When financing an older property (15+ years), if any deferred maintenance is noted, obtaining a property inspection report is highly recommended.
- Go online and read the reviews provided by tenants.
Underwriting the Property
General underwriting policies for CCB for hotel financing:
- DCR - 1.15x – 15 yr. amort. or less; 1.35x- 20 year amort.; 1.45x – 25 yr. amort.
- LTV - 70% for 20 yr. amort.; 65% for 25 yr. amort.
- Minimum vacancy - 35% for full-service hotels; 25% for limited service
- Management Expense - 4% of EGI
- Reserves for replacements - 4% of EGI - Note that you have reserves for replacements associated with the building improvements and the Furniture, Fixtures,& Equipment (FF&E)
- Non-room revenue is limited to 20% of operating income
- Pricing guidelines are available on Net Interest under Bank Rates
The lender should obtain and review the following documentation once it has been determined that the site is acceptable along with the existing or proposed improvements.
Franchise Agreement
- If new construction, the franchise agreement should provide for a minimum term of 15 years.
- If existing construction, the franchise agreement should have a minimum term remaining of 10 years for loans with an amortization period of 20 years.
- Note: A limited number of hotel franchises require year to year renewal terms. (Best Western). CCB will consider loan approval in these situations if the financials show a stable operating history under the current flag and the most recent audit history reveals that the borrower is complying with the terms of the franchise agreement.
- The franchise agreement discloses the formula for the calculation of franchise fees or annual cost to the borrower for royalty, monthly program, and miscellaneous fees.
- When preparing your preliminary cash flow analysis on loans for new construction, utilize the operating expense percentage included in the franchise agreement for estimating the franchise fees.
- For existing properties, use the higher of the last 2 years historical operating expenses or the percentage required per the franchise agreement.
STR (Star) Report
- Whether new construction or an existing property, review the STR report to evaluate who the competition is and what the Average Daily Rate (ADR), Occupancy, and Revenue Available Per Room (Rev Par) trends look like for the borrower’s competitors.
- A lender and underwriter should review STR reports for multiple periods.
- A long-range view provides a clearer picture as to any seasonality related to the business, provides for better economic forecasting, and reveals any significant changes in operations. Your borrower will provide you these reports upon request.
- When financing new construction, lenders should compare the borrowers forecast for ADR, Occupancy, and Rev Par with the estimates included in the STR report to verify consistency.
- The STR report is the most valuable tool to utilize when projecting gross revenues, vacancy, and effective gross income (EGI).
- Successfully assessing supply and demand and projecting cash flow are critical to ensuring repayment of the loan.
- When reviewing the STR report, the running 12-month measurement provides the most insight into the seasonality associated with the property and what the primary sources are driving revenues.
STR Example
A STR report assists lenders with identifying who the borrower’s competition is and how the subject property is performing when compared to its Comp Set.
For example:
Comp Set:
Operating Expense Ration (OER)
On an existing property, the borrower’s financial statements and tax returns for the last two years will give a lender the most insight into the operating expenses associated with a hotel. For new construction, the bank will utilize industry standards in estimating operating expenses. The OER is the total operating expenses divided by EGI.
In 2021, the Global Hotel Profitability Review (HOST) reported typical operating expense ratios within the Hotel industry as follows:
A newer property likely scales toward the lower end of the range and an older property, the higher end.
Cash Flow Analysis
Lenders should perform a cash flow analysis prior to presenting a hotel financing request to Preflight or Credit Administration to confirm that the requested loan amount is supportable based on the Bank’s underwriting criteria. Templates for cash flow analysis are available in the Quick Reference Guide. Below is a detailed example of a cash flow analysis on a hotel property.
Management Expertise and Owner Experience
Management expertise and owner experience are critical in running a successful hotel operation. Considerable advancements have been made in software technology to improve efficiency in workflows to ensure the best experience for guests while maximizing profitability. The labor shortages experienced during the pandemic and post pandemic have awakened the industry to its need to automate as many front room and backroom operational activities as possible.
When evaluating hotel loan requests, lending personnel should obtain resumes from owners and fully understand their experience in ownership and management of hotel properties. In addition, review financial statements to determine the exposure a borrower or guarantor may have to the industry and any contingent financial liabilities related to that exposure.
If a third-party management company is overseeing the day-to-day operations, lending personnel should perform due diligence to assess the experience and reputation of the management company.
Underwrite the General Contractor (GC)
- Assess the contractor’s experience in building similar property types of the same scale
- Obtain active contractor’s license
- Determine if the contractor is bondable
- Obtain financial information if available or a condition of the loan
- Review contractor’s website and obtain a resume of projects
- Collect and review GC’s liability insurance policy
Interest Reserves
From time to time the lender or Credit Administration will require the borrower to fund an interest reserve at closing. Interest reserve accounts are a credit enhancement to a loan considering the construction project is non income producing while under construction.
Interest costs during construction are funded from the Bank controlled interest reserve account as the interest comes due. Interest Reserves are non-interest bearing accounts. Underwriting conditions that typically trigger an interest reserve requirement are:
- Low liquidity levels of the borrower
- An extended timeline for project completion
- Project size or type OR
- Volatile conditions within the economy
Closing and Monitoring the Construction Loan
The Construction Loan Administration (CLA) Department administers the construction loan and oversees the funding of the draws. CLA will determine the amount of the draw based on a review of the inspections performed by Bank approved inspectors. Draws will be funded utilizing an AIA Schedule of Values.
The key construction documentation required to be obtained by lenders from borrowers prior to closing is listed below (See Construction Loan Administration Requirements on netinterest):
- Collect the required permits prior to closing including:
- Development Order that shows approval from the local permitting authority
- Environmental Permit
- Obtain the necessary documents from the borrower to obtain contractor approval from CLA. (contact CLA for guidelines)
- Obtain all final plans and specs associated with the project. Confirm plans and specs are consistent with the appraisal.
- Obtain the bond if a materials, payment, and performance bond is required as a condition of loan approval.
- Obtain any contracts associated with the general contractor. The contract associated with the project must be a Guaranteed Maximum Price Contract (GMPC). The acceptance of a Cost-plus Contract is highly discouraged and will require approval from Credit Administration.
- Confirm that your Loans in Process (LIP) account is adequate. When originating a commercial construction loan, a LIP line item should be recorded on the closing statement, in an amount of money sufficient to fund the completion of the improvements (per your costs breakdown and construction contract). If the loan is approved with an interest reserve requirement, the closing statement must specifically disclose the amount in the LIP that will be allocated to the interest reserve.
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Equity Requirements
- When closing, if the borrower has an equity requirement per the loan approval, and the equity is being provided through other sources besides the equity in the land, the lender is responsible for documenting the sources of equity.
- The lender is required to:
- Obtain from the borrower a copy of previously paid invoices AND
- Bring to closing sufficient funds to ensure the equity requirements is met and the LIP is fully funded.
- The practice of borrowers providing equity post loan origination is prohibited per CCB credit policy.
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Title Commitments
- Issued title commitments and surveys on all commercial construction should be reviewed by Bank counsel pre- closing to confirm accuracy. The title endorsements at a minimum should include the following:
- Survey endorsement
- Variable rate endorsement AND
- Environmental endorsement. In Florida, a Florida Form 9 endorsement is required on all real estate loans closed.
- Issued title commitments and surveys on all commercial construction should be reviewed by Bank counsel pre- closing to confirm accuracy. The title endorsements at a minimum should include the following:
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Special Provisions
- Insure that the special provisions required per the loan approval are accurately disclosed in your promissory note.
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Credit Approval
- Prior to closing a loan, it is the lenders responsibility to ensure that the loan is closed in a manner consistent with the terms and conditions approved and outlined in the Credit Memorandum.
- Lending personnel are encouraged to make periodic visits to the site throughout the construction process, monitor any changes to the franchise agreement, stay informed on market conditions, stay in touch with your client, and coordinate with CLA in monitoring any changes made to the original plans, specs, or costs.