Inn Financing - Prepare for Success in 2010
The national banking system appears to have stabilized. Yet shock waves are still rippling through the economy. The future promises to bring banking consolidations and tighter federal regulations. What will the impact be on the Innkeeping industry in the coming months?
There is good news for Inn owners intending to sell their properties and for buyers intending to purchase an Inn. Interest rates are at historic lows and local and regional banks have money to lend, although they are more cautious. As always, the better prepared both buyer and seller are entering into a transaction, the higher the probability of obtaining the favorable financing and completing the sale.
Confidence
Lenders want to limit risk and return to banking activities that require tighter credit terms. Lenders are returning to practices that were typical 20 years ago, when buyers were expected to make large capital investments. At that time, when my wife and I bought our Inn, our banker said, “If you aren’t willing to risk your capital, why should the bank?”
As economic growth slows, mortgage capital is harder to get. The new imperative is for seller and buyer together to project stability and risk management to lenders. How can you improve your position with lenders, as either buyer or seller, in the sale of a hospitality property? Understanding the fundamentals of Cash Flow, Collateral and Credit as either a buyer or seller is essential. Proper disclosure and preparation will promote lender confidence and qualify both the Inn being sold and the individuals purchasing it.
Sellers need to assist buyers and lenders in seeing the value of their properties. Clean balance sheets, realistic pro-forma projections and complete disclosure is essential.
Cash Flow
Lenders are now requiring that borrowers share more of the lender’s risk. Buyers who are looking for conventional financing, using the Inn’s income to cover the debt service (mortgage payment), can expect to make a minimum capital investment of 25% - 35% of the purchase price. This is dependent on Cash Flow. Today’s reality calls for Cash Flow to be 120% - 130% of the projected debt service. If the Cash Flow falls short, lenders will require more capital or Collateral. For those (smaller) properties that generate modest Cash Flow, other sources of buyers’ income are required.
Collateral
Smaller local community or regional banks (especially the current mortgage holder) are still the first place to go for financing. Local banks are already invested in their communities and understand the local economy. However, all banks are subject to closer regulatory scrutiny of their cash reserves and loan underwriting practices, so buyers and sellers should be prepared for lower loan-to-value ratios. If additional Collateral is needed, other real estate or portfolio assets may be required. Alternatives exist if traditional Collateral is unavailable. Two-tier debt is becoming more common. SBA 504 and 7(A) loan programs, installment sales and seller financing (where the seller holds a second-position note) are typical components of Inn financing packages.
Credit and Creditworthiness
Today’s buyers are faced with higher credit score requirements to qualify for competitive rates. The long-standing minimum score of 700 has moved higher. The creditworthiness of a Bed and Breakfast or Country Inn is linked to its quality. Established properties with strong ADR, Occupancy Rates and Cash Flow are looked upon more favorably by lenders in contrast to “value added” or “upside potential” properties. These properties are now seen as higher risks than before. Inn buyers and Inn sellers should understand their credit scores and creditworthiness thoroughly.
Inns and Bed and Breakfasts are continuing to sell to new owners. Sellers are realizing their investment of years of effort and good management. Buyers are realizing their dreams of hospitality business ownership. Just as “the race goes to the swiftest”, the financing goes to the best prepared! By adjusting to the current economic reality and understanding its new requirements, both buyers and sellers will be in the best possible position for a successful sale.
Ask Eliot how he can help you with your Inn purchase or sale!
