Using Government Guaranteed Loans to Finance Hotels

Nov 3, 2011
Jane Larkin

SBA loans can be used to refinance or acquire hotel properties. - Kirby Urner

Learn what is needed to secure debt for hospitality projects using loans from the Small Business Administration and U.S. Department of Agriculture.

In today’s economic environment, lenders are actively using the loan programs from the Small Business Administration (SBA) and U.S. Department of Agriculture (USDA) to provide debt to business owners and developers, especially in the hospitality arena. The good news for hotel owners and operators is that the increased availability of funds through these channels is enabling projects, often in under served communities, to move forward. The bad news is that hotels are still not a preferred asset class among lenders and not all generally advertised SBA or USDA products and terms are available to the lodging sector.

What that means for hoteliers considering government guaranteed loan products is that it is important to understand what it takes to get this type of funding for a hotel today. Generally, most of the characteristics lenders want to see for conventional hotel loans apply to both the SBA and USDA Business & Industry (B&I) programs – well-known flags from such brands as Marriott or Hilton, strong borrower financials, operators with good experience and proven results, the ability for sponsors to pledge additional cash or collateral, high traffic locations off major thoroughfares or interstates, and properties with interior corridors.

SBA Hotel Loan Characteristics

SBA guidelines state that loan amounts for 7a and 504 loans can go up to $5 and $5.5 million respectively, with loan-to-value (LTV) ratios of 90%. But in today’s financial climate, it is hard to secure debt for hotel properties with high leverage and larger loan amounts. On hospitality, some SBA lenders will not lend more than $2 million and want to see LTV’s no higher than 70%.

With a few exceptions, hotels that get SBA financing today have the following characteristics:

loan amounts between $1.5 and $3 million
LTV ratios from 50%-75%, with 65%-70% the target for most lenders
minimum debt service coverage ratios (DSCR) of 1.25X, with most lenders preferring 1.4X or higher. DSCR measures the borrower's ability to make the monthly mortgage payment from the property's cash flow.
personal guarantees from all sponsors

In the current capital marketplace borrower experience and property performance are key. First time hotel buyers considering an SBA mortgage should focus on properties with positive cash flow and should expect banks to require more equity. On 7a loans for the acquisition of non-performing assets, 25%-30% equity and qualified borrowers with experience are needed. The refinance of an under-performing property can be more difficult to close as the SBA can decline a loan for a hotel that does not have positive cash flow for a minimum of two of the last three years. Maturing loans and those with balloon payments automatically qualify for SBA funds but the properties need to show positive cash flow and a net operating income (NOI) greater than 1.1x the annual loan payments (DSCR above 1.1X).

In addition to the 7a program, the SBA is offering, until September 2012, a temporary initiative to help owners of owner-occupied commercial real estate with maturing mortgages or balloons to refinance. The short-term effort is executed using 504 loans.

USDA B&I Hotel Loan Traits

For owners and operators in rural markets, the USDA B&I program offers the ability to access the credit markets for mortgage refinance and acquisitions, as well as furniture, fixture and equipment (FF&E) financing. Capital for construction is covered under USDA guidelines but few banks are considering ground-up projects in these economically uncertain times.

The criteria most lenders look for in lodging projects applying for USDA funds are as follows:

loan amounts to $10 million, with many between $2 and $5 million
up to 70% LTV, with lower leverage (55%-65%) preferred
tangible balance sheet equity, which is cash, paid-in equity investments and retained earnings based on the type of loan; 10% required for the refinance of an existing property, 15% for an acquisition, and 20%-25% for new development
personal guarantees by all sponsors
properties in rural areas with populations of less than 50,000
on a refinance, more than half of the loan proceeds must be used to create or retain jobs

Hotel owners in small markets interested in accessing capital through this program should allow themselves plenty of time to secure funding, as it is a lengthy process and can take up to six months to close a loan.

The SBA 7a and USDA B&I programs are financing tools hotel owners and operators outside of major metropolitan markets can use to access debt in today’s financial marketplace. While money is available for hotels through these programs, hospitality projects outside of the above mentioned criteria are less likely to be considered. Borrowers need to be prepared for a process longer than 30 days and tight underwriting with the strongest deals getting done.