Financing_The_Hotel_ - Financing The Hotel Industry Financing A.J.Singh The analogy of physical leverage& financial leverage The A Physical

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Unformatted text preview: Financing The Hotel Industry Financing A.J.Singh The analogy of physical leverage & financial leverage... The A Physical Lever... 500 lbs 2 feet 5 feet 200 lbs LIFTS "Leverage Ratio" = 500/200 = 2.5 “Give me a place to stand, and I will move the earth.” and - Archimedes (287-212 BC) Financial Leverage... Financial $4,000,000 EQUITY INVESTMENT BUYS $10,000,000 PROPERTY "Leverage Ratio" = $10,000,000 / $4,000,000 = 2.5 Equity = $4,000,000 Debt = $6,000,000 FLOW OF FUNDS DIAGRAM FLOW Sources Households Business Net foreign investment Direct Real Investment Uses Households Consumer durable goods Residences Real estate development Business and equipment Inventory levels Other uses Direct Real Investment Deposits:Commercial banks Deposits:Thrifts Reserves:Life Insurance companies Reserves:Pension funds Shares:Investment companies Shares:REITS Shares:Mortgage companies Shares: Corporation Household: Business: Consumer loans Mortgage loans Mortgage loans Corporate stock Corporate bonds CMBS/CMO U.S. government obligation State and local obligation Financial Assets Government: Direct Financial Investment What are Financial Markets? What Arena where investors (suppliers of capital) Arena exchange capital for financial claims financial – Stocks – Bonds Advantage of Marketplace: – Buyers in one place – Sellers in one place – Creates liquidity Facilitators of Financial Markets are financial Facilitators intermediaries intermediaries – – – – Banks Investment Banks Life Insurance Companies Investment Companies (mutual funds) Operation of Financial Markets $$ Investors Financial market Intermediaries Financial market $$ Hotel Firms Dividends (stocks) Interest+Principal (bonds) What are The Funds Used For? What Construction Conversion Renovation and Upgrades Acquisition of Individual Properties Acquisition of Portfolio of Properties Acquisition of Business Expansion and Investment Overseas: – Foreign Direct Investments(construction or acquisition) – Management Contract with partial ownership Who Needs the Funds? Who Corporation – C-Corp – S Corp REIT (Real Estate Investment Trust) Partnership Individual Investor (domestic Partnership and foreign) and Individual Investor: Domestic/International Real Estate Fund Who Invests in the Lodging Industry? Who Method: Equity Investment in Real Estate Pension Funds Private Equity Firms Life Insurance Companies Investment Banks Conduits Individual Investors Who Invests in the Lodging Industry? Who Method:Equity Investment In Lodging Method:Equity Company Stocks Company Investment Company (Mutual Funds) Pension Funds Life Insurance Companies Individual Investors Who provides Debt Capital to the Lodging Industry? Who Method: Mortgages Commercial Banks Life Insurance Companies Conduits Investment Banks Thrift Institutions Finance Companies Pension Funds Who provides Debt Capital to the Lodging Industry? Who Method: Debt Securities Life Insurance Companies Investment Companies (Mutual Funds) Pension Funds Commercial Banks Investment Banks A Fundamental Relationship Fundamental Lodging Industry Structure and Capital Needs •Number of Lodging Supply •Types of Products •Purpose for which applied •Types of owners Availability of Capital Operating and Investment Performance Competing Assets Current Sources and Terms of Debt Financing (Hotels) (Hotels) Type of Lender Loan Size Millionixed Interest Loan To ValueDebt CoverageAmortization Loan Term F Regional and 1 minimum State Bank National Bank 1 minimum SBA Loan 2 to 5 MBSC Upto 5 Investment Bank Finance Company1 minimum Pension Fund 3-4 minimum Life Insurance Mortgage Brokers 1 minimum 200-400 basis Up to 85% over treasuries Prime +.25 to 2pts60 to 65% Prime+ 1 to 2.75 up to 90% Prime +3 pts 75-80% Treasury + Treasury + Up to 75% Up to 70% 1.25-1.5 1.4-1.5 1.3-1.4 1-1.3 1.3-1.5 1.6-1.7 1.25-1.6 up to 30 years 5 to 25 years 20 to 25 years 3 to 25 years 20-25 years 20 to 25 years up to 30 years up to 15 years up to 20 years 5 to 10 years up to 30 years 5 to 10 years 3 to 25 years 3 to 25 years 250-450 basis Up to 85% over treasuries Lodging Hospitality: HVS Lender Survey: Q4 2008 HVS Lender Survey: Q4 2008 HVS Lender Survey: Q4 2008 HVS Lender Survey: Q4 2008 HVS Lender Survey: Q4 2008 HVS Lender Survey: Q4 2008 Role of Construction Lenders Role Construction Lenders Generally Commercial Banks provide construction lending They mission is to ensure that their loan is paid off as soon as the They project is complete project They require that developers have a “take out” commitment from They a permanent lender permanent Construction loans are paid in installments called “Draw” Construction Each Draw is paid as a stage of the project is complete. Construction lenders have the fear (risk) that project will not be Construction complete on time and on budget complete If cost overruns occur lender has option of foreclosing on project If or giving developer more funds to complete project or Interest rates for construction loans is high due to risk. Developers over time develop a relationship with banks that Developers provide construction loans provide Primary Sources of Construction Loans Loans Community Banks Regional Banks Money Center Banks Thrift Institutions Finance Companies Mini-Perm and Term/Bullet Loans Loans Mini-Perm: Mini-Perm: – A loan with a fixed rate of interest that may be used in loan place of permanent financing place – Used when borrower may not be able to get permanent Used financing but needs to get construction started. financing Term/Bullet Loan – Intermediate loans (3-10 years) with a fixed rate with Intermediate minimum or no amortization. – If construction lender does not want to provide a miniperm loan after construction, the borrower can get a perm term/bullet loan till the property establishes a track record. Mezzanine Financing Mezzanine In many cases Mezzanine financing is provided by In a franchise company in return for its affiliation franchise It is supplemental debt which can act like a second It mortgage mortgage Provides high loan to value ratio (up to 90%) Usually 2-5 years loan term When is mezzanine financing used: – To bridge gap in low loan value and equity down To payment payment – When buyer does not have enough cash – Asset repositioning related to a renovation or upgrade – Used as a take out to pay off existing financing Role of Permanent Lenders Role Permanent Lenders Insurance Companies and Pension funds Insurance traditionally have been permanent lenders to the hotel industry to Permanent Loans are used to pay off the Permanent construction loan/bullet loans construction Permanent Lenders are interested in the Permanent income stream from the property. (Occ, ADR, Revenue, EBITDA) ADR, Sources of Permanent Financing Sources Pension Funds Life Insurance Companies Money Center Banks Conduits Commercial Banks Commercial Primary Source of Hotel Lending – Money Center Banks (CitiBank,Bank of America) – Regional Banks (CoAmerica, Old Kent) – Community Banks Community Approximately 58% of hotel lending from commercial banks Primary Source of Construction Lending Overbuilding in 1980s:Foreclosures and loan losses Early 1990s Banks withdrew from lending scene Started to re-enter lending market in 1995 with restrictive terms and higher Started underwriting standards underwriting Why did they return: – – – – Industry performance improved Fewer delinquent loans Banks became more profitable Increase in competition for loans Current Lending Climate Current (Hotel Loans 2007) Money Available for Owners with good track Money record, financial strength, management expertise and brand affiliation. and Lenders mainly interested in Lenders acquisition,renovating,repositioning and refinancing existing properties refinancing Some select project construction money is Some available such as timeshare,extended stay and resorts. Lenders prefer mid- to high end limited service Lenders hotels with strong brands: Marriott, Hilton and Starwood. Starwood. Current Hotel Lending Climate Current 2009 Construction Slowdown Transaction Slowdown Property Values Decline Demand Dip RevPar decline Business Environment Uncertain – Leading Economic Indicators negative Cost of Capital and Lending Terms Stringent Hospitality – Historical Loan Production Production 1996-8/31/2008 Millions $2,400 $2,200 $2,000 $1,800 $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 97 99 01 03 05 19 96 20 02 07 8 00 4 6 8/ 31 /2 00 19 9 20 0 20 0 19 19 20 20 20 20 20 8 $264 $372 $585 $376 $421 $573 $478 $726 $812 $1,354 $1,341 $1,290 $2,282 Conduit/Fixed Rate Loans Interim Loans Mezzanine Loans Construction Loans Lending Criteria: Ranking the Most Important Factors Influencing Hotel Loan Decision Factors Scale: 1= most important: 5 = unimportant (based on arithmetic mean) 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Location,Location,Location (1.72) Financial Projections based on internal analysis (1.78) Barriers to Entry into Market (1.83) Fit of project in the market (1.88) Financial strength of applicant (1.89) Experience of Applicant (1.94) Micro Economic Climate (2.06) Brand Affiliation (2.11) Profitability of Loan to financial institution (2.17) Management affiliation and performance of sponsor Management other businesses (2.22) other Credit Decision Making at Commercial Banks Commercial Sr. Management input Credit Committees Credit Policy Committee Credit Decision Key’s Credit Character: Integrity and Ability Character: Integrity Credit: Past and Future Potential Credit: Past Capacity: Brand, feasibility, mgt comp Capacity: Brand, Collateral: Real Estate and guarantees Collateral: Real Cash: LTV, Equity, subordinated debt Cash: LTV, Other Character Character Integrity and ability Owner/Manager Tenant Tenant Contractor Credit Credit Past Credit History Past Potential of Maintaining Credit Status Capacity Capacity Ability of the borrower to repay the debt Firm relationship is a strength Brand reservation and marketing Feasibility Study Collateral Collateral How do we get paid if source of repayment is not How available from operations? available The role of guarantees Cash Cash Equity provided by owners Can take the form of subordinated debt Cash vs. Collateral Typical range from 20% to 50% Other Considerations Other Industry and market outlook Hotel loans repaid from profits! Commercial Banks:Loan Documentation Commercial Description of Hotel and project Description of loan and requested terms Resumes and financial statement of owners Market Study and Appraisal Owners projection of income and expense Description of Management Company Description Operator’s projection of income and expense Renderings, schematics and photographs Architectural plans and specifications Estimate of all project costs Identification of project team (in new construction) Copies of all major contracts (management, franchise, Copies ground lease, tenant leases) ground Thrifts Thrift Include savings and loan institutions, credit unions and Include savings banks savings S&L’s entered commercial real estate market after S&L’s deregulation in 1982 deregulation Due to their initial inexperience (and in many cases greed Due and lack of monitoring by the government agencies) many failed failed The infamous “S&L Crisis” from 1987-1992 resulted in: – Foreclosures – Failed thrifts – Reregulation (FRREA Act 1989) Thrifts play a small role in hotel lending Generally involved in small loans in the $1 million to $3 Generally million range million Finance Companies Finance Due to negative lending experience of banks and thrifts (failed loans) Traditional lenders virtually stopped lending to the hotel industry in Traditional early 1990s early Resulted in emergence of new breed: Finance companies These included companies such as GE Capital, Money Store, GMAC, These Finova and Heller Capital Finova Generally finance companies either financial arm of large corporations Generally such as (GMAC,GE Capital) such Or independent companies such as Finova They borrow money in the “open market”, lend at a higher rate and They make money on the spread make Generally loan sizes from $5 Million to $25 Million Various types of loans: Construction, permanent, but usually Various considered lenders of last resort because of higher rates considered Many Finance Companies work with SBA in making SBA guaranteed Many loans (under $ 2 million) loans Life Insurance Companies Life While Commercial Banks focus on construction While lending lending Life Insurance Companies are primary source of Life permanent lending permanent Life insurance company generates its funding Life from insurance premiums which are long term in nature nature Not involved in small scale projects Usually make loans on single or portfolio loans Usually ranging from $10 million to $100 million ranging Life Insurance Company Commercial Mortgage Holdings (2001) General Account Commercial Mortgages 22,562,046,151 17,790,984,738 15,243,666,084 11,162,790,547 8,500,564,094 7,968,084,480 6,974,184,520 6,708,740,472 6,465,680,987 5,459,258,916 4,576,506,432 4,100,223,288 General Account Assets 125,424,554,067 135,415,189,505 86,594,094,090 120,889,016,376 31,901,290,247 42,732,880,324 74,317,226,448 51,790,475,691 23,515,818,636 52,319,095,840 36,291,876,671 35,299,590,913 Percent of General Account Assets in Comm. Mortgages 17.99% 13.14% 17.60% 9.23% 26.65% 18.65% 9.38% 12.95% 27.50% 10.43% 12.61% 11.62% COMPANY_NAME Teachers Ins & Ann Assoc Of Amer Metropolitan Life Ins Co Northwestern Mut Life Ins Co Prudential Ins Co Of Amer Connecticut General Life Ins Co Principal Life Ins Co New York Life Ins Co John Hancock Life Ins Co Nationwide Life Ins Co Massachusetts Mut Life Ins Co Allstate Life Ins Co Lincoln Natl Life Ins Co Total Assets 129,653,097,786 184,673,070,532 98,379,554,914 184,193,745,534 69,511,016,773 77,162,431,620 77,942,283,677 64,301,127,561 80,756,048,364 70,239,048,400 43,996,107,484 73,936,122,229 Pension Funds Pension Tax exempt capital funds held by corporations, labor Tax unions and state or local governments unions Fastest growing source of institutional capital. Fastest Long term lenders and investors and source of permanent Long financing financing Primarily equity investors As with life insurance companies 1987-1993 pension funds As lost a lot of money in hotel real estate. Many started to re-enter market in mid 1990’s as investors Many of REIT stocks of Pension funds active in hotel investing include: AT&T, Pension General Motors, Stanford University, employee retirement funds of Pennsylvania, and Ohio funds Pension Funds Pension How do pension funds finance hotels? – – – – – Stock investments Direct investment in hotels Joint ventures Equity funds that invest in hotels Investment in mutual funds Investment Banks Investment Investment banks increased role in hotel Investment financing in early 1990’s Resolution Trust Corporation had to sell Resolution defaulted bank portfolio of loans defaulted Investment banks created new debt Investment securities and sold them for RTC securities This was the genesis of the CMBS industry This for hotel loans for Similar role on Equity side with Similar underwriting REITs underwriting Investment Banks Investment Hotel Financing Role Issuing initial and secondary public offering Issuing for Hotel companies for Raising debt capital for hotel companies Advising on mergers and acquisitions Providing direct lending either as mortgage Providing or a revolving line of credit or Financing opportunity and acquisition funds Recent Transaction: Lehman Bros and Starwood Capital Capital Bricks and Brains Deal. 36 Owned and Leased Le- Meridian Hotels Bricks goes to Lehman Bros/Starwood Capital JV Brains (management contracts) goes to Starwood Hotels and Resorts. Brains Past two years Le-Meridian having trouble servicing the debt for its 36 owned Past and leased properties. Lehman Bros held debt $600 million and Lehman Bros needed an exit strategy to off-load this debt which was nonperforming Joint Venture formed with Starwood Capital (Lehman Bros/SWC JV) to Joint purchase these assets (36 Le-Meridian Hotels) purchase The New JV will fund this purchase by securing financing The New Le-Meridian: – 36 properties will now be owned by the JV – All 135 properties will be under contract with Starwood Hotels and Resorts – – – Lehman Bros was able to off load non performing debt Starwood Hotels and Resorts via JV able to expand in European Market 36 hotel portfolio saved from foreclosure and possible liquidation The Win-Win-Win? Investment Banking and Conduit Programs Investment Investment banks set up many “conduits” Investment with licensed lenders known as “correspondents” “correspondents” The purpose is to originate a loan and then The sell the loan to the investment bank. sell The investment bank then packages the The loans into a debt security known as CMBS. loans Investors buy these securities like they Investors would a stock or bond. Flow of $$$ Flow of $$$ Flow of $$$ CONDUIT BORROWER Hotel, Motels, Resorts, Corporations, Correspondent Arrangement with Investment bank. They originate loans and then sell the loans to the investment bank INVESTMENT BANK Sets up contractual Arrangement with Conduit. Buys loans, packages loans and sells securities CAPITAL MARKET Investment bank sells securities in the capital markets to Individuals and institutions such as , Insurance companies, Mutual Funds and Pension Funds. The funds generated then flow back to the in vestment bank, which use the funds to buy more loans for purposes of securitization. Issue Mortgage Sell Loans to I.Bank Sell Securities in Market Conduit Arrangement and Securitization Process The Credit Crisis Visualized The What are REITs Real Estate Investment Trusts A corporation set up to own or finance real estate Resembles a corporation and issues stock, Resembles commercial paper and borrow from banks commercial REITs use the financing to purchase real estate, REITs including hotels including REITs stocks became attractive to those who REITs wanted to invest in real estate but did not want the illiquidity of real estate investments illiquidity Became a major source of equity financing from Became 1994-1998 1994-1998 REIT Tests REIT (criteria to qualify for REIT status) Diverse ownership: More than 100 All income must be derived from real estate All held as a passive investment passive REITs must distribute 90 percent of its REITs income to the shareholders as dividends income REITs have tax advantage over REITs corporations as they can deduct these dividends Exhibit 1 Publicly Traded Hotel REITs Company Trading Symbol Owned Hotels Owned Rooms Equity Market Capitalization (in $ millions) Traditional (AKA "Generic") REITs Boykin Lodging Equity Inns FelCor Lodging Trust Hospitality Properties Trust Host Marriott Corporation Humphrey Hospitality Trust Innkeepers USA InnSuites Hospitality Trust Jameson Inns LaSalle Hotel Properties RFS Hotel Investors Winston Hotels Paper-Clip REITs MeriStar Hospitality Totals MHX 109 1,208 28,099 236,982 746 $9,259 BOY ENN FCH HPT HMT HUMP KPA IHT JAMS LHO RFS WXH 33 96 182 251 123 87 67 11 122 17 58 52 9,257 12,284 48,303 34,284 59,172 6,006 8,131 1,679 8,319 5,900 8,424 7,124 $198 314 1,132 2,273 3,285 28 339 18 50 291 418 166 Major Financial Markets Major Capital Markets – – Stocks Bonds Selling New Stock Selling First time a company issues stock is called “going public” By going public you make it possible for outsiders to By invest in your company invest As first step to taking company public you need to register As company with SEC and make an IPO company As small (private)company begins to grow, access to As capital may be limited. capital Investment Bankers facilitate the IPO process. Investment Investment banks “underwrite” IPO – Firm commitment vs. best efforts basis They help develop a prospectus. They advertise in financial papers (called tombstones) They go on a “road show”(with preferred client) Secondary offerings may be made if additional capital is Secondary needed. needed. Who are the Underwriters? Who Underwriter Merrill Lynch Salomon Smith Barney Morgan Stanley Dean Witter Goldman Sachs Lehman Brothers Credit Suisse First Boston J.P. Morgan Bear Sterns Chase Manhatten Donaldson Lufkin&Jenrette Value of Issue $304 Billion $ 225.00 $ 203.00 $ 192.00 $ 147.00 $ 127.00 $ 89.00 $ 83.00 $ 71.00 $ 61.00 $ 1,198.00 Source:securities data source 1999 Issuers of debt and equity securities The Private Placement The Sale of securities (stocks/bonds) to a limited Sale number of investors number Advantage: no need to register with SEC. General rule is to sell to about 12 knowledgeable General investors investors Typically private placements done with Typically institutions such as: institutions – Life insurance companies – Pension Funds – Mutual fund companies General Cash Offers: Public Companies General In order to Fuel further growth and In expansion… expansion… Firms may offer to issue additional shares Firms called: Seasoned offering Seasoned Seasoned offering may be for general Seasoned public or restricted to existing shareholders public Rights offering: If offer of sale of additional shares restricted to existing share holders shares Trading Process Stocks Trading •Broker Places order electronically •Order received by broker rep at NYSE Contact Stock Broker (100 shares Marriott stock) Ask: $32.50 (asking price if you want to buy) Bid: $32.00 (buyer will pay if you want to sell) Spread: Difference (specialist fee) Your cost = $32.50x100 + transaction fee •Order given by floor broker to specialist who specializes in stock/industry (market maker) •Specialist matches your order with a seller •If price agreeable transaction made •Completed order goes back to broker who will notify you •Owner of 100 shares Marriott stock $3,250 + broker fees. READING THE STOCK TABLES 52 WEEK HI-LO Name of Company and Stock symbol Div: Cash dividend :Dividends per share (last quarter) Yld:Percentage dividend of current stock price. Cam compare return to other investments P/E”: Price earning ratio Price of stock/EPS last 4 quarters Vol: number of shares traded previous day (X100) Hi-Lo Close: Highest, Lowest and closing price Net chg: change in closing price over previous period Bond Market Bond Bonds are loans made to corporations and Bonds governments. governments. Investor earns interest on the loan. At end of term Investor of bond (maturity) both principal and interest repaid. repaid. The interest rate is fixed at time of issuance. Par value of Bond is fixed at time of issuance. Par Amount repaid at maturity. Bond Certificate Par Value: Face value repaid at maturity. Example: $1000 Maturity Date: Date when Bond will be repaid Coupon is Interest Rate 6.5% on $1000 bond Yield of Bond: interest rate/price of bond READING THE BOND TABLES Name of company issuing bond First number is interest rate Last two digits show year of maturity Current yield is interest rate/current price of bond. Volume: Dollar volume in 000’s previous day Close: closing price of bond previous day. Quoted as $10. 110 means $1,100 Net chg: change from previous days closing price ...
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This note was uploaded on 09/10/2010 for the course IAH 001 taught by Professor Wang during the Spring '10 term at Michigan State University.

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