The hospitality industry continues to be an attractive sector for developers. Hotels grew revenue per available room (RevPAR) by more than 3% in 2016, and that growth is expected to continue in 2017. However, funding for hospitality development is becoming harder to obtain, largely because many banks are concerned that the growth trend is nearing its peak.
That leaves hospitality developers in need of a simple strategy for funding their hospitality development projects. There are several different options for consideration if you know where to look for funds to supplement traditional bank loans.
Alternative Types of Financing
1. Mezzanine financing: is a hybrid of traditional debt and equity financing. It sits behind the debt but typically in an unsecured position. It can potentially act as junior debt, receive an ownership stake or convert that debt into an ownership stake in the business if the borrower defaults. There are several benefits of mezzanine financing:
- It typically requires little to no collateral,
- the interest is tax-deductible,
- and interest payments can be worked into the balance of the loan, which can be extremely beneficial in times of rapid growth and/or tight cash flow.
The downsides include:
- higher interest rates and
- a potential loss of control or ownership in the entity.
2. Subordinated debt: If a borrower defaults on a loan or declares bankruptcy, subordinated debt is repaid only after all other corporate debts and loans are settled. Depending on available assets, lenders of subordinated debt may not be repaid at all. Due to that higher risk, subordinated debt usually carries higher interest rates, but it is a legitimate option for developers looking for a way to supplement other types of funding.
3. Key money: is advance funding provided by a hotel brand to the owner or developer. Brands do this to secure a spot in a highly competitive market or to lock in an especially desirable property.
4. Property-assessed clean energy (PACE) funding: is a program legislated at the state level which creates a framework for private capital to finance specific items in the construction budget. The program allows funds to be delivered upfront and paid back over a period of 10-20 years through a line item on the borrower’s property taxes. PACE funding offers a number of benefits to borrowers:
- The capital is attached to the property itself, so it is non-recourse to the owners
- The cost of capital is substantially lower than some of the sources listed above
- It can provide financing for 10-20% of the total capital stack
- If a developer is considering EB-5, PACE should be considered given the similar (or less) cost of capital and faster timeframe
5. Foreign investments: Developers can also look outside of the United States for needed funding. EB-5 is a federal VISA classification designed to spur the American economy by offering incentives to foreign investors. While the future of the program is unclear, current legislation allows foreign investors who meet specific requirements to apply for green cards -- along with their spouses and unmarried children under the age of 21.
Learn more about PACE Funding:
Other Sources of Funding
1. TIF: stands for tax-increment financing.It’s a method by which governments can use anticipated revenue from future property taxes to encourage development in blighted or undeveloped areas. It allows public money to fund private developments that will benefit the community as a whole (through job creation, taxes, etc.).
2. New Market Tax Credits: Like TIF funding, New Market Tax Credits encourage investment in underdeveloped or blighted communities. However, rather than an upfront infusion of funds, the developer receives credits toward federal income taxes.
3. Clean energy incentives: There are a variety of programs -- most often grants or tax credits -- designed to encourage the construction of green buildings. There’s also a searchable database of state incentives as well as a separate database for available grants. In addition, a number of utility providers offer their own incentives.
Arranging Capital For Hospitality Properties
Putting together a capital stack for hospitality development might be more complicated than it used to be, but there are also more options to choose from. When arranging capital for hospitality properties, smart developers get creative and research all available sources of funding.