CMBS lenders make a cautious return to US hospitality

With recovery underway in the US hotel sector, securitisation activity is gradually picking up in select sub-sectors – albeit with more conservative underwriting.

The US hospitality and lodging sector is gradually crawling out of its pandemic-triggered distress, buoyed by the nationwide vaccination drive and uptick in domestic travel. An estimated $5.6 billion-worth of hotel transactions came out of the $96.7 billion in aggregate commercial real estate deals in Q1, according to data provider Real Capital Analytics.

In line with the investment rebound, new commercial mortgage-backed securities issuance, which had remained relatively muted during the peak months of the covid-19 outbreak, is slowly but steadily changing as sentiment surrounding certain sub-sectors within hospitality improves. According to an April report published by S&P Global Ratings, lodging accounted for 7 percent of all the US CMBS conduit new issuance transactions in Q1, down from 9 percent in Q4 2020, but up from 2 percent in Q2 2020. Blackstone and Starwood Capital Group’s approximately $6 billion transaction, agreed in March, to acquire Extended Stay America, the region’s largest owner and operator of extended stay hotels, is also to be partly financed with CMBS debt, according to a person involved in the transaction who did not provide further details.

“When you are issuing into the public market – like a standard CMBS deal – you are definite­ly subject to some broad-based assump­tions”

Toby Cobb
3650 REIT

“This will be the largest, most important test of hotel CMBS in a long time,” Rich Hightower, managing director and research analyst at Evercore ISI told affiliate title PERE at the time of the ESA transaction. “[Although] this is the way private equity firms typically finance such deals, this would not have been possible for a portfolio of full-service, luxury hotels or even the resort sector.

“The extended stay category was the top performer during covid and will have a reasonably good performance this year.”

An executive at a New York-based commercial real estate lender says he is also starting to see some requests for new loans, but most of this appetite is for sub-sectors such as extended stay, select service and limited-service hotels.

Convention hotels and other assets reliant on conferences and business travel would have a comparatively later recovery, and therefore less CMBS lending, he says.

Challenging market

Irrespective of the sub-sector, it is challenging to issue a CMBS loan for a hospitality asset, especially during uncertain times.

According to Wit Solberg, founder of Mission Peak Capital, a Kansas City, Missouri-based real estate investment and advisory firm dealing in both debt and equity markets, hotels and lodging are going through a transitional period, which means CMBS is not a very good financing option. “For any property type that requires flexibility, entering into a 10-year locked-out relationship with a party is something a lender cannot administer, and a borrower is not going to want to do,” he says.

Toby Cobb, managing partner and co-founder of 3650 REIT, a Florida-based commercial real estate lending firm, agrees: “When you are issuing into the public market – like a standard CMBS deal – you are definitely subject to some broad-based assumptions. The hospitality sector is assumed to be challenged.”

Cobb adds that, if a debt provider opts to underwrite a stable, income-producing limited service or extended stay hotel, it needs to consider that CMBS investors will take a defensive view of notes backed by hospitality assets: “The fact that the ultimate bond buyer is going to see the label of a hotel will create a level of conservatism on the buy side, and therefore on the origination and underwriting side. It is unavoidable.”

In a February report on the impact of the pandemic on US CMBS transactions across all sectors, Fitch noted that it had applied more conservative adjustments within its property cashflow analysis to factor in market risk. The ratings agency has applied a 15-20 percent reduction to RevPAR (revenue per available room) relative to the performance immediately prior to the pandemic. This implies, as Fitch noted, “an additional decline in RevPAR of 10 percent beyond the 5 percent to 10 percent RevPAR stresses used pre-pandemic”.

It added that property volatility scores are generally increased to five – the most punitive score – which adds another 2.5 percent to a loan’s probability of default in the base case.

Conservative underwriting

CMBS lenders are also applying a more conservative underwriting approach to hospitality loans. To estimate projected stabilised cashflows of a hospitality asset, underwriters typically do an average of the previous years.

Solberg believes current investors would underwrite future cashflows based on the average performance of a hotel between 2017 and 2019, and project that to 2024, which is the projected recovery timeline for the sector. The shortfall would be filled in by high interest reserves.

Lenders who spoke to Real Estate Capital say they would layer such debt service reserves or some other component of recourse as added structures on to the CMBS loan to have better downside protection during these transitional times.

3650 REIT recently made an approximately $40 million participation in a large-scale CMBS financing for the $4.6 billion purchase of the MGM Grand and Mandalay Bay hotel casinos in Las Vegas to a joint venture between Blackstone Real Estate Income Trust and MGM Growth Properties. Real Estate Capital understands the LTV ratio for 3650 REIT’s loan was 45 percent.

“We will be far more conservative in total proceeds,” says Cobb, when asked about the underwriting approach for such deals in a post-pandemic world. “We will be insistent on a greater level of reserves and a high debt yield.”