Hotel Financing With the SBA 504 Loan Program

March 28, 2019

The US hotel industry saw another record year in 2018, reaching absolute values that were the highest ever benchmarked. A 10th consecutive year of growth is predicted for 2019, according to CBRE Hotels Americas Research.

Borrowers who seek to acquire or refinance hotel properties are finding that some lenders today are cautious on hotel deals, as many see the sector at a peak.

There are still good deals out there. As experienced lenders, we are convinced that the best, most cost-effective solution is to finance your hotel is with an SBA 504 loan. In this article, we will walk you through today’s peak hotel market, as well as recent changes that affect SBA 504 loans.

The thriving hotel market

The demand for hotel accommodations continues its nine-year rise in line with the continuing strength of the US economy, with hotel occupancy seeing a 0.5 percent year-over-year increase to 66.2 percent in 2018, the fifth straight record level for the industry. The average daily rate (ADR) rose 2.4 percent to $129.83, and revenue per available room (RevPAR) increased 2.9 percent to $85.96. Group and corporate travel stays will be a consistent source of demand growth for hotel rooms in the U.S., according to STR. Additionally, weekday demand is very strong, indicating that corporate/ business guests are traveling more frequently.

CBRE even predicts that overall hotel returns over the next three years will be the highest of any commercial real-estate sector. According to CBRE’s R. Mark Woodworth, “The magnitude of profit growth may not be spectacular, but the probability for revenue growth is solid, and operating margins remain well above historical levels.” Growth will be slower for sure. STR & Tourism Economics forecasts demand growth year¬-over-¬year at 1.9 percent, compared to prior projections of 2 percent.

What does this mean for loan seekers?

Hotels have emerged as one of the commercial real estate sectors where owners can still make the returns compute. Bank financing on commercial real estate isn’t as readily available today as it was over the past few years, however, and owners may face challenges in finding affordable financing. Timing can make the difference between winning and losing for owners seeking to lock in a relatively low long-term interest rate on an asset. We believe the proven solution is to borrow from an experienced hotel lender with expertise in SBA 504 loans. Capital is there for reaching short- and long-term financing goals if you know where to find it.

SBA 504 loans and hotels

Hotel owners will find the SBA 504 loan has advantages that no other can equal. For facilities that are older than two years, borrowers can take advantage of all the many benefits that come with the SBA 504 program: 85 percent LTV (loan-to-value ratio) financing, a low fixed rate, and up to 25-year terms. The SBA guarantees a portion of the loan assuming the risk of default, allowing for a much higher LTV than any conventional commercial property mortgage alone. SBA 504 loans can be used solely to acquire existing hotels, acquire and renovate a hotel, and refinance an existing loan.

The SBA classifies some properties as “special purpose” properties. It defines a special purpose property as “a property that is appropriate for one use or limited use: a building that cannot be converted to another use without a large capital investment,” and requires a 15 percent down payment on 504 loans.

Also, borrowers cannot use the SBA 504 program to refinance an existing SBA or other government loan.

Close-up of an SBA 504 loan

Let’s demystify the nature of an SBA 504 loan. Imagine a borrower is seeking SBA 504 financing for acquiring a Best Western hotel for $4.2 million, including the PIP. Where will the funds come from? How much money does the borrower need to come up with out-of-pocket for the down payment?

We can calculate the financing structure of an SBA 504 loan simply as: 50 percent + 35 percent + 15 percent = 100 percent. That formula breaks down as follows:

• 50 percent: The first 50 percent takes the form of a conventional loan from a financial institution like a bank or specialty SBA lender. The first-lien loan is usually a fixed-rate loan amortized over 25 to 30 years. In our example, this means that the first-lien lender will commit $2.1 million toward the total financing of the deal.

• 35 percent: The next 35 percent of financing is a 20-year second-lien fixed-rate loan from an organization known as a Certified Development Company (CDC). A CDC is an SBA-regulated, nonprofit organization with a mission to promote community economic development through the SBA 504 loan program. Each of the more than 260 CDCs nationwide covers a specific geographic area of operations, usually the state in which the CDC is incorporated. The SBA assumes the risk on the CDC’s second-lien loan through its guarantee. If the borrower defaults, the SBA will pay off the loan. Our hypothetical hotel buyer will secure a second-lien loan in the amount of $1.47 million from the CDC, guaranteed by the SBA.

• 15 percent: The final 15 percent is the down payment from the borrower. Most conventional loans require a 25 percent minimum down payment, so the borrower realizes significant cost savings with an SBA 504 loan. For our imagined borrower, the down payment will be $630,000.

• When a borrower is acquiring a branded hotel, the franchise typically requires a property improvement plan (PIP) that will bring a hotel into compliance with the brand’s latest standards, from design to energy efficiency. The SBA 504 loan will finance up to 85 percent of the acquisition cost plus PIP.

Recent changes in SBA 504 regulations

The past few years have seen the SBA increase its scrutiny of borrowers’ qualifications for the 504 program. While it used to overlook borrowers who were minority (less that 20 percent) stake partners, the SBA is now looking closely at them and the type of hotel ownership they hold. Formerly, when minority owners had too much SBA debt to qualify, they could hold a five percent stake, while the majority owners were said to be running the business. Today, they are no longer tucked away from SBA scrutiny—every borrower on a deal must have no more than $5 million in total outstanding SBA debt. A good SBA 504 lender with hotel experience will understand this requirement, and help you structure your deal to help avert any future problems with your partner borrowers down the road.

A fairly new SBA requirement is for borrowers to submit a feasibility study to ensure that market conditions support the potential future success of the hotel investment. The feasibility study is a report by a qualified third party that examines the local market, demographics, and other factors that are expected to affect the hotel property’s performance, such as an already overbuilt market.

After reviewing an SBA 504 loan package, an experienced SBA lender will ask the right questions, anticipate problems, and help the borrower overcome any potential roadblocks. This is why it’s so important to find the right lender. The experts at Liberty SBF have an extensive network of finance industry contacts. We specialize in helping guide both borrower and CDC though the loan process efficiently to ensure their successful SBA 504 loan.

Smart financing

The hospitality industry may be at a peak, as some predict, but Liberty SBF also believes there are still good assets to be found and when a borrower has identified one we are here to help them secure the deal with a low, fixed rate.

Contact Liberty SBF today. Email info@i.libertysbf.com or call (213) 297-5747.