The American hotel industry is on a clear upward trajectory, and this article will discuss the financing options available to help business owners take part in that growth. According to Statista, the United States is currently leading the world in several metrics of hotel industry growth, including construction of new hotels (4,814). On top of that, revenue in the US hotel industry is projected to hit nearly $280 billion for 2022. In fact, before the pandemic, travel spending and total hotel occupancy had both grown year after year for nearly a decade. By nearly any measure, it’s an opportune time to get into hotel management and ownership.
Hotel loans, which are available for owners of hotels, motels, resorts, RV parks, bed and breakfasts, and other lodging businesses, can help you start or grow within the industry. Read on to learn about the costs of the hotel business, and how you can fund your hotel project.
Why You Need Hotel Loans
The hospitality industry can be very lucrative, but it’s important to remember that there are considerable start-up costs and ongoing expenses. Here are just a few possible areas where a hotel loan might be necessary.
Real Estate & Construction
If you’re starting up a brand new hotel, you’re going to need to build. That’s no small expense. Hotel construction can cost millions and will likely be your largest up-front cost. Real estate is particularly important in the hotel industry. Hotels need to be located in prime locations, and that land can be extremely expensive. If you’re erecting a building on top of buying real estate, your loan amounts will be considerably large.
Operating a hotel requires a ton of people, from customer-facing employees getting your guests checked in and comfortable to the custodial staff making sure that rooms are ready for the next group of guests. You’ll also need to consider property management, food, management, and possibly even security. Finding a hotel loan can help you make sure that all these staff members are paid.
Buying an Existing Hotel
Building a hotel property is incredibly expensive. So many entrepreneurs hoping to make it big in the hotel industry choose to purchase an existing facility. Doing so means buying into an established market, and, if you’re wise about where you’re spending your money, you’re probably buying into a hotel which has already proven to be successful. Regardless, buying a hotel can cost in the hundreds of thousands up front, and you’ll likely need a loan to help with the purchase.
It should also be noted that financing the purchase of an existing hotel is much more attractive for lenders when business owners are able to present a the lowest possible loan-to-value ratio, or LTV ratio. A loan to value ratio measures the amount that the financial institution is financing against the total cost of the real estate. So if you’re looking to finance a $500,000 motel with a $100,000 down payment, your LTV ratio is $400,000 divided by $500,000 – or 80%. Lowering that percentage by either purchasing a less expensive property or increasing the size of the down payment will make it more likely that your business loan will feature favorable terms.
Renovation and Remodeling
If you’re buying an existing hotel, you’ll want to make it your own. Even if you’re a long-time owner, you’ll want to periodically update the aesthetics in your space to make sure guests feel comfortable, luxurious, and satisfied with their stay. That means renovation and remodeling. These can be extremely simple – a fresh coat of paint can take your rooms from outdated to modern, while adding a simple microwave to each room is a massive amenity for your guests. Regardless, hotels are made up of dozens, even hundreds of rooms. Small upgrades get expensive quickly at scale.
One massive expense for hotel owners is equipment. Laundry machines, pool equipment, even luggage carts all qualify. If you serve food, you’ll need kitchen equipment. Plus there’s your POS system (where you’re able to accept credit cards), fixtures and furniture, even the TVs in your rooms. No matter what equipment you need, lending can help make it happen for your hotel.
Because of all the different expenses found in the hotel business, cash flow can get tight. Sometimes, you’re going to need a bit of extra working capital. That extra money will help your hotel’s day to day operation in leaner times.
Finally, there’s refinancing. If you’ve built up some debt while starting up your hotel or making a hotel purchase, you might find that you’re a much better-qualified borrower now than you were when the debt was originated. That’s where you might consider refinancing or even consolidating your debts. If your credit score has improved enough, you’ll likely find that you’ll save thousands of dollars over the course of a loan due to lower interest rates from a simple refinance.
Types of Hotel Loans
There are nearly as many types of hotel loans as there are ways to use them. After all, a hotel is many things at once: you’ll operate like a restaurant, a retail store, and a homeowner all at the same time. Consider the intended purpose of your new loan money as you think about how to build a loan program that fits your needs, your budget, and your credit.
Traditional lending is simple. Also known as a term loan, these are loans given out by a financial institution. You’ll get a certain amount of money and, in turn, you’ll repay that money plus an agreed-upon interest rate. Money received in a traditional loan can be used for a variety of purposes, from basic operating expenses to renovation.
SBA loans are similar to traditional loans, with one vital difference. SBA loans are guaranteed by the United States Small Business Administration, or SBA. That means that they’re less risky for private lenders, as the government will guarantee a large percentage of the principle in case the borrower is unable to repay the loan.
That’s a positive and a negative for borrowers. Because the loan is guaranteed by taxpayer dollars, these loans can be extremely difficult to qualify for. But in exchange for these stringent underwriting guidelines, SBA loans tend to have lower interest rates than your normal bank loans. You’ve got to be more qualified to get one, but getting one means you’re more likely to repay it, so the bank can charge a lower interest rate.
There are two main forms of SBA loans that hotel owners should be aware of. First, there are SBA 7(a) loans. The most common form of SBA loans, they can be for up to $5 million and have a repayment term of 10 years or 25 years, depending on the purpose of the loan. They’re also variable rate loans, which means that your interest rate will change depending on your creditworthiness. There’s also SBA 504 loans, which are fixed-rate loans of up to $5 million. The big difference is that 504 loans must be used to finance assets that are intended to grow business or create jobs. 7(a) loans can be used to purchase inventory or as working capital loans; 504 loans must be used for things like landscaping, building new facilities, or modernizing roads and typically have longer repayment terms.
Both forms of SBA loans are appealing for hotel owners, so consider your eligibility and creditworthiness. If you’re able to get approval on an SBA loan, it can be a massive boon for your company.
As we’ve said before, there’s a ton of equipment needed in any hospitality property. Equipment loans are designed specifically to help finance that equipment, as their name implies. They work by holding the newly-purchased equipment as collateral. That means that if the borrower is for some reason unable to repay the loan, the lender can simply repossess and sell the equipment, leading to reduced risk on their end. These loans don’t bring the same freedom to operate as a traditional or SBA loan, but holding the equipment as collateral means that interest tends to stay relatively low.
Lines of Credit
Lines of credit are appealing types of financing for hotel owners because they’re uniquely helpful when dealing with the unexpected. Lines of credit don’t work like a traditional loan. Instead, lines of credit work more like credit cards. A financial institution approves the borrower up to a particular credit limit. The borrower only pays interest on what is spent under that limit.
Lines of credit are fantastic for dealing with emergencies. You don’t need to pay back a dime until you’ve used your line of credit. So when the plumbing gives way during a cold winter night, you can finance an expensive repair immediately, keeping your company on the tracks.
Hotel Bridge Loans
Hotel bridge loans are particularly helpful when purchasing an existing hotel. Bridge loans are short-term loans used to cover the time period between acquiring a new asset (like a hotel) and the finalization of its financing. These loans are shorter term, which means they’re risky for lenders, and thus carry a higher interest rate than other forms of lending.
How To Get a Hotel Loan
Once you’ve determined which form of hotel financing you’re aiming to acquire, you’ll need to make sure that you and your company are in the best possible position to be approved for affordable financing. Getting a loan isn’t necessarily a good thing if the loan terms will cripple your business’s ability to operate.
Regardless of the form of debt you’re looking to take on, you’ll want to consider your debt service coverage ratio, or DSCR. This is a metric used by lenders to determine your company’s ability to repay a new loan. The calculation is simple – you’ll divide your annual net operating income by your annual debt obligations. If your company makes $1 million this year in net operating income and has a debt obligation of $250,000, your DSCR is 4.0. You make 4x as much money as you’ll need to repay your debt this year, meaning that you’re likely able to take on additional debt (or weather a downturn in income).
DSCR is just one form of creditworthiness for you to consider. You’ll want to look over your business plan, your company’s credit history, assess your accounts and financial statements, and consider whether your company is in a position to take on additional debt. But if it is, you’ve got a wealth of opportunities for funding, and ways to make that funding build your company even further.