What does AVANA Look for in a Project Before Extending Hotel Construction Loans?
The Federal Reserve (Fed) initiated the rate cut cycle with a 50-bps interest rate cut in September 2024. It is a step in the right direction, and more rate cuts will meaningfully stimulate commercial real estate (CRE) lending, including hospitality financing. The rate-cut cycle creates opportunities for nonbank institutes and private lenders to expand their debt portfolio by financing and refinancing more hotel construction projects.
However, experienced hotel financing companies like AVANA Capital do. Before granting hotel construction loans, they evaluate the hotel construction projects by considering several factors. In this article, we discuss essential project details AVANA Companies consider and scrutinize while processing hotel construction loan applications.
11 Project Details AVANA Companies Check When Granting Hotel Construction Loans
1. Project Feasibility
We evaluate the viability of the hotel construction project based on a comprehensive feasibility analysis. The feasibility report prepared by a third-party entity helps us evaluate critical components like demand, supply, and competition. We expect entrepreneurs to submit elaborate feasibility reports that cover site, market, design, financial, and risk analysis.
2. Regulatory Approvals
Delays in regulatory approval always impact the costs and timeline of the hotel construction project. We eliminate the risk of delays by checking the status of essential regulatory requirements like zoning approval, building permits, Environmental and Safety Permits, police licenses, and FSSAI licenses. Borrowers can get funding quickly when the required regulatory approvals are in place.
3. Previous Tax Returns
We evaluate the project’s revenue and profit by reviewing the borrower’s previous tax returns, expecting them to provide personal tax returns for the past three years. Our loan officers use this information to prepare revenue forecasts, ensuring we accurately assess the borrower’s eligibility for the requested loan amount. These tax returns also give us insights into financial stability, enhancing our ability to tailor the loan offer.
4. Cash Flow
As an important CRE industry metric, cash flow helps us in determining two crucial factors – the financial health of the borrower and the ability to pay back. Our credit team calculates cash flow by deducting the money leaving the business from the money entering the company over a certain period. They ensure that the entrepreneur maintains a positive cash flow before considering other metrics.
5. Debt Service Coverage Ratio
Entrepreneurs applying for hotel construction loans often have prior debt obligations. We determine their potential debt obligations based on their debt service coverage ratio (DSCR). Our credit team calculates DSCR by dividing the project’s annual net operating income by their potential annual debt payments. We prioritize applicants with higher DSCRs, as they demonstrate stronger financial health.
6. Loan-To-Value Ratio
The amount of risk associated with a hotel construction project impacts interest rates and down payments. We measure the potential risk associated with the hotel construction loan by calculating the loan-to-value (LTV) ratio. Our credit team measures LTV as a percentage of the loan amount to the appraised value of the commercial real estate property.
7. External Credit Rating
We prioritize entrepreneurs with a good business credit score. Our credit team evaluates a borrower's creditworthiness primarily through their FICO score, which reflects a comprehensive overview of credit history, duration, and financial management. Borrowers can increase the chance of approval and get more favorable terms for the hotel construction financing by building higher business credit scores.
8. Hotel Construction Loan Structure
The structure of the hotel construction loan influences the success of the project directly. Our credit team mitigates critical risks like project delays, budget overruns, and loan default by reviewing the loan structure in detail. When evaluating the loan structure, they focus on crucial factors like loan type, loan tenure, interest rates, and exit strategy.
9. Exit Strategy
CRE entrepreneurs usually pay off hotel construction loans by generating cash flow from operations. However, some entrepreneurs pay off the loan by selling the CRE property or refinancing CRE loans. Our loan officers check the borrower’s exit strategy to understand how he plans to repay the hotel construction loan on schedule.
10. Security and Collateral
Like other private CRE lenders, AVANA secures house construction loans by asking for security. We usually ask the entrepreneur to mortgage the entire CRE project as primary collateral. Hence, the primary collateral includes the land and building along with equipment, furniture, fixtures, and electrical installations. However, we require entrepreneurs, in certain cases, to provide additional security or collateral in the form of stocks, equities, and similar valuable assets.
11. Borrower’s Capabilities
Variables in the CRE sector change frequently. We assess the borrower’s capability and psychology to weather storms based on his experience. While interviewing the borrower, our loan officers understand how he weathered storms by gathering good and bad details.
The information helps us understand if the entrepreneur can overcome emerging challenges in the future. At the same time, it makes it easier for us to predict the financial outcome of the CRE transaction based on the entrepreneur’s behavior and experience.
Conclusion
The rate cut cycle initiated by the Fed will lead to a surge in commercial real estate (CRE) lending transactions. Our $250MM private credit partnership with Oaktree Capital Management enables AVANA Companies to stimulate local economies and support job creation by funding new hospitality projects in the USA.
However, we focus on mitigating financial risks through prudent risk management. We look for several crucial factors in a hotel construction project before granting loans. Borrowers can expedite their CRE project funding process by understanding and meeting these essential criteria in our underwriting process.
