Financing the Purchase of a Bed & Breakfast Inn

Rick Newman, Managing Partner of Commercial Capital Network, LLC

All Bed & Breakfasts and Inns are unique by design. In fact, it is that unique quality that separates one Bed & Breakfast Inn (B & B Inn) from the next. Innkeepers invest their energy and capital over time to create a welcoming and hospitable environment that is unique to their community and valued guests. While the charm and ambiance of an Inn add to a patron’s experience, such intangibles have only an indirect effect on the actual value. An Inn’s market value will ultimately be determined by combining the values of the real estate, good will and sometimes furniture, fixtures and equipment (FF&E).

It is important that you are comfortable with the value assigned to the real estate component of a transaction before making an Offer to Purchase or a Contract of Sale. Realtors who specialize in marketing and selling Bed & Breakfasts Inns have access to comparable sales data and financial information that should support the asking price. An accountant should be consulted to analyze the financial data to be sure that the property can support the debt service relative to the down payment and your investment objectives.

The Contract of Sale is the controlling document in a purchase and should reflect terms that are practical relative to the down payment and the financing terms for which you are best qualified. The value of the business’s “Good Will” and FF&E may be assigned separate values from the real estate in the Contract of Sale. Try to avoid this if possible as loan programs that accommodate financing anything other than real estate are less flexible and sometimes difficult or expensive to obtain. It is always a good idea to consult your lender before entering into a Contract of Sale, since a lender who is familiar with bed & breakfast inn properties can pre-qualify you and the property.

Most Contracts of Sale contain a mortgage contingency clause of 30 to 45 days, the exception being cash transactions, 1031 exchanges of equal value or sales where the seller has agreed to be the primary lender. The contract will also contain inspection clauses for items such as insect infestation, plumbing, HVAC, electrical and the structural integrity of the building(s). During this ‘due-diligence period,’ it is also common to incur attorney fees, survey fees and title fees. It is therefore important to note, that should the appraised value be determined to be less than the contract sale price, the appraised value will be used to determine the actual loan-to-value, rather than the contract price. If this should occur and the parties cannot agree on a revised value or contract terms, the buyer risks loosing all or a portion of his/her due-diligence expenses.

The lender will require and order an appraisal of the property; appraisal fees range from $2,800 to $5,000 depending on the nature of the property and customary charges in a given geographical area.

Down Payments may be as little as 10% for qualified buyers, although interest rates typically increase proportionately for higher risks to the lender.

Funds from 401ks or IRAs can be used as a down payment on a B & B Inn. The programs are quite complicated but can be managed professionally by a qualified plan facilitator. Go to http://www.commercialcapitalnetwork.com and select IRA/401k for details.

Resumes will be necessary on purchases for all partners with an interest greater than 10%. A resume containing experience in the hospitality and/or restaurant industry will be extremely beneficial, as the lender must determine that the borrower’s work history is sufficient to maintain and/or improve the cash flow of the business.

Credit Scores are extremely important to a lender in evaluating the merits of a loan. Your credit (or FICO) scores have a direct impact on the rate, term and loan program you for which you qualify.

Note: Individual lender guidelines may vary. The credit tier examples listed above are only for general information purposes. For a copy of our Credit Guide, please visit our web site at: http://www.commercialcapitalnetwork.com

Financing Overview

Each transaction is unique in some way, so it would be advisable for a lender to pre-qualify you relative to the credit of all parties to the purchase, discuss which financing programs are available in your state and what financing options you will have for the property you desire to purchase.

A Conventional/Full Doc loan application package will contain such information as the Contract of Sale, 2 to 3 years business tax returns, an interim financial statement, bank statements and in some cases a business plan. In addition, for all partners with an interest greater than 10%, a credit profile, 2 years personal tax returns and resumes will be required. The following is a brief overview on the various aspects of commercial financing:

Seller Financing has long been common to the Bed & Breakfast industry for the following reasons:

  1. The business has income, but the Bed & Breakfast Inn’s financials show a modest profit, or even a loss, and will not support the debt service.

  2. Banks local to the property may not understand the industry because they lack the experience with the business itself or the non-conforming property type.

  3. The concentration of Bed & Breakfasts Inns in a particular area may be insufficient to develop the comparable sales data, which is an important criterion to establish value.

  4. The borrower’s resume does not contain the skill sets that would give a lender confidence that the borrower has the ability to manage and maintain the business going forward.

  5. The combination of the buyer’s down payment and the loan amount of the first mortgage falls short of the asking price or appraised value.

Before non-bank lenders, if a local bank would not lend on a B&B Inn, seller financing was the only way to facilitate a transaction. Seller financing still has its place in some transactions, as it broadens the pool of potential buyers and, in fact, may be the last and only way to consummate the sale. The good news is that there may be a tax advantage for the seller to hold a 1st or 2nd mortgage because the income/gain from the sale is not realized until the income is actually received.

Banks commonly take an interest in business ventures within their defined trade area, provided the financials support the debt service. A bank’s ability to lend on properties that do not cash flow the debt service on their own is often restricted. The FDIC, which insures bank deposits, regulates lending policies and generally requires the entity borrowing the money to repay the debit based on the cash flow from the primary asset. To strengthen a loan request, the bank may seek additional collateral. They generally require that the borrower provide updated financials each year so they can monitor the ongoing financial health of the business. This requirement becomes an issue only when the required Debt Service Coverage Ratio falls below an acceptable pre-determined level. Failure to maintain this ratio may cause the bank to call the loan.

Banks often like to re-set rates from 3 to 5 years—and sometimes even annually. Depending on the direction interest rates are heading at the time, this may or may not be an advantage for the borrower. More often than not, amortizations are limited to 20 years or less.

Non-Bank Lenders like Commercial Capital Network (CCN) offer a wide variety of loan solutions to owners and purchasers who were considered previously to be un-bankable. Conventional/Full Doc Programs are available with fixed rates from 2 to 30 years. All sources of income may be considered to offset shortfalls in the business’s cash flow including: W2 or 1099 income from any partner, investment income, Social Security, Disability, etc. Annual financial statements are NOT required and loans are often assumable, which depending on interest rates at the time you decide to market your Bed & Breakfast Inn, may be a big benefit to both you and your buyer.

“No Doc” Loan Programs are also available for refinance or for purchase. These programs are quick and well suited for Innkeepers or Aspiring Innkeepers who are unable to fully document their income, or where income from all sources is inadequate to qualify for the loan. Please note these loans are real estate-based loans, which means the sale of the business and FF&E listed in the Contract of Sale cannot be financed and must be covered by the down payment.

Non-Bank Loan Programs Highlights

  • Income from all sources considered to qualify
  • Tax returns may not be required
  • Unrestricted refinances
  • Pre-Approvals in 48 Hours
  • Closings in as few as 45 days
  • Loan terms up to 30 years
  • Purchase with as little as 10% down payment
  • Yearly Financials are not required

Small Business Administration (SBA) is a guarantee or an insurance (of sorts), which offers a layer of protection to a bank or investor. A guaranteed fee, which adds to the cost of originating the loan by 2% to 3.5% of the loan amount, is charged to the borrower. The 7A program rate ranges from 1.5% to 2.75% over prime and adjusts monthly. The 7A loan terms are:

  • Real Estate may be purchased with as little as 10% down and a 25-year term
  • FF&E may be financed with 100% with 10-year term
  • Working Capital may be financed 100% financing, up to a 7-year term

The SBA 504 program is often a combination of a bank 1st lien loan at market rate and a SBA 2nd loan similar to the 7A example above. Both programs involve significant documentation and lead-time to commit and close. The borrower’s resume is very important in underwriting the loan request.

Copyright ©2008 Rick Newman, Managing Partner of Commercial Capital Network, LLC
©2008 Eliot Dalton