By Dave Kotter
After taking a hit in 2020, the hospitality industry is looking to make a comeback in 2021. With lockdowns ending and people on the move again, investors are looking to get back into the hospitality market. In addition, the growth of the industry has also attracted many first-time investors looking to build hotels. The high ratio of experienced leaders working in the hospitality industry can make it hard for newcomers to stand out and obtain the financing needed to break into the industry. Nevertheless, just because financing is difficult to obtain, doesn’t mean it’s impossible for these prospective hotel owners. Financing is available for those who are proactive and make the right moves. Here are a few tips to help first-timers break into the hospitality industry.
Find a partner or employee with experience
If you are green and want to get into the hospitality industry, it’s important that you partner or seek counsel with someone who has more experience than you. This can be an employee or a 50/50 partner, a property manager or a hotel developer. It’s important you have someone who can shepherd you through the realities of the industry. If 2020 proved anything, it’s that the hospitality industry is full of ups and downs, and having an expert guiding you will give you more clarity and credibility.
The bottom line here is, potential financiers will feel more comfortable offering you a loan if you have the right people working alongside you.
Understand what kind of hotel you want to build
It’s critically important that you nail down what space you want to fill in the market. Are you looking to create a full-service hotel or limited-service? Are you looking to start a new hotel brand or franchise with an existing brand? Figure out what space you want to occupy and then do your research on that space. How many similar hotels are in your area? How long have they been around? What is the focus of your hotel and hotels around you? Do they mostly service families, businessmen or long-term occupants?
You also need to do your geographic research. Know if you want your hotel to be in a major metro area or in a smaller market. There are pros and cons to each. Urban areas have more customers, but you are going to pay more for real estate. On the contrary, you’ll pay less for real estate in a rural area, but you have to know how to efficiently capture a smaller market share.
Incorporate all these details into your business plan in order to show potential financers that you are a good candidate for a loan. Let them know what you are going to bring into an area that your competitors are not. A unique space could be something as simple as bigger or cleaner rooms. Find that thing that will entice investors. It’s also important that you conduct a market study and learn all the factors that move the hospitality industry in your area.
Establish financial viability
You must prove to financial investors that your prospective hotel is viable before you are considered for a loan. Your prospective hotel will be financially viable if you have conducted your market study and have your financial house in order. This means you have a strong balance sheet and at least six months of cash reserves to ensure your hotel can deal with any sinkholes that could come up. Historically, financing hotels is a risky play for loan providers due to the nature of the industry; it’s highly operational and seasonal.
If you’re building a new hotel, it’s important that you prove your business is municipally viable. This means your local city or county government supports the construction of your hotel. You build your case for municipal viability by taking your project to the local city planner, and confirming your plans are following local building codes. To ensure your building is following all local codes, you can hire a qualified and local engineer, architect and zoning lawyer who can push for the approval of your project. Hiring a team that understands local code is key to getting your hotel off the ground.
Find the right loan
Find out what type of loan is best for your hotel. Does a conventional loan or SBA make more sense for your situation? A conventional loan requires you to put down 30-35% of the project upfront, while an SBA loan will only require you to put down around 15%. The SBA has two programs, the 504 loan and the 7a loan.
The 504 provides two loans: a first deed of trust, and a second deed of trust. The first loan is with a local bank, which will finance 50% of the project cost. Then the SBA, or the CDC, will offer the other 35% in the form of a second deed of trust. If the project is new construction, then the bank will fund the whole amount during construction. When you have the close of escrow, the ratios will go back to 50% to the bank, 35% to the CDC and your 15% equity. The benefits of this program include lower fees and long-term fixed rates.
The 7a is a single loan at a 25-year amortization and never balloons. They will finance up to 85% of the total project cost. Rates can be floating or fixed for up to 25 years. Fees range from 3-3.5% for this loan. These loans do have a 5,3,1 prepayment penalty. The benefits of this program are that it is just one loan, as well as the flexibility with the prepayment penalty.
Just because you’re new to the hospitality industry doesn’t mean you can’t obtain financing. If you create a solid financial plan and surround yourself with experienced people, you have a great shot at finding a lender who will help you get your hotel off the ground.
Dave Kotter is the principal of Integrity Capital LLC, a commercial mortgage brokerage in Scottsdale, AZ.
This is a contributed piece to Hotel Business, authored by an industry professional. The thoughts expressed are the perspective of the bylined individual.