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Hotel financing provides the capital necessary to build, renovate, furnish and purchase hotels. Because running, growing and improving most hotels will require a lot of capital, most hotel businesses will need to access financing at some point, whether through an outside investor, small business loans or some combination of both.
In fact, it’s hard to overstate the importance of financing in the hospitality industry. Sure, hotels, motels, and bed and breakfasts can take in a lot of cash, but not without huge investments first. Plus, even a highly profitable hotel will need large amounts of capital to renovate or expand.
How Much Do You Need?
How to fund your hospitality business
Luckily, a major change in hotel financing has been afoot over the past years: More and more private sources of hotel financing have become available to hotel developers. As a result, hotel financing doesn’t necessarily have to come from a bank loan these days. This shift is especially good news for business owners who can’t meet the rigid criteria that traditional business bank loans require of borrowers.
We’ve compiled a guide to the top eight hotel financing options on the market now, as well as guidelines for the hotel loan underwriting process.
Top hotel financing loans:
SBA 504/CDC Loan.
SBA 7(a) Loan.
Business Line of Credit.
Commercial Real Estate Loan.
Hotel Bridge Loan.
Top 8 hotel financing options
There are many different forms of hotel loans, and the best hotel financing structure for your business will mostly depend on what you need the funding for.
Before you try to decide which of these top eight forms of hotel financing you should go with, make sure you’ve solidified your intended use for the loan.
Do you want to renovate, grow, buy furniture, access equipment, or purchase real estate? Or, do you simply need hotel financing to meet operational costs or access an advance for an outstanding invoice? Or, do you have bigger plans, such as purchasing another hotel?
Once you’ve pinpointed what you need hotel financing for, consider all eight of your top hotel loan options:
1. SBA 504/CDC loans
If you’re a highly qualified business owner looking for affordable hotel financing, then SBA loans should be your first stop. The SBA partially guarantees loans (between 50% and 85%) that banks and other direct lenders extend to qualifying small businesses. Since the SBA guarantee provides some safety in the event of borrower default, lenders are more likely to approve small business owners for a loan and to provide attractive terms.
For most hotel financing needs, the SBA 504/CDC loan program will be your best bet. Business owners that need to access hotel construction loans, commercial real estate financing, or financing for a large piece of equipment should consider this their top option.
The SBA 504/CDC loan program offers hotel financing for:
Purchasing existing buildings.
Constructing new facilities.
Refinancing similar debt.
What's more, SBA 504 hotel loans will offer some of the best terms on the market. Like all SBA loans, repayment terms can be 10, 20, or 25 years long, and loan amounts can reach up to $20 million.
Qualifying for SBA 504/CDC loans
In order to qualify for this type of financing, you’ll need to meet the following SBA 504 loan program requirements:
Meet the SBA’s size standards for small business, which differ based on industry.
Have a net worth of no more than $15 million and an average net income of $5 million or less after federal income taxes for the two years prior to application.
Meet owner-occupancy requirements.
Create or retain jobs or promote other public policy goals with the project in question.
Operate for profit and not be in a passive industry, such as real estate investing.
2. SBA 7(a) loans
On the other hand, if you’re looking for SBA hotel financing for more general costs, then the SBA 7(a) program will be a better option for your needs. SBA 7(a) loans are the most popular form of SBA funding because they’re working capital loans, so they can be put toward a wide variety of business expenses.
You can use this type of SBA hotel loan for operational expenses, acquiring a pre-existing business, commercial real estate, construction and more. The repayment terms for these hotel loans can be up to seven years for operational costs, 10 years for equipment purchases and 25 years for commercial real estate purchases. Loan amounts go up to $5 million.
Qualifying for SBA 7(a) loans
Like SBA 504 loans, this type of SBA hotel financing also has rigorous qualification standards. Specific requirements vary based on the lender; but in general, you'll need to meet the following requirements:
A personal credit score of at least 650.
Minimum business revenues of $100,000 per year as well as profitability.
A debt service coverage ratio of at least 1.15 for loans over $350,000 (more on this later).
Assets available to be put up as collateral.
3. Business lines of credit
Alternatively, if you want to set your hotel up with more sustained access to capital, then you should definitely consider a business line of credit for your hotel financing. Business lines of credit offer revolving credit from which your business can draw funds as needed. Once you draw funds from your credit line, you’ll repay your borrowed amount, plus interest, over an agreed-upon repayment term. After you repay in full, your credit limit will bounce back to its original amount.
This repayment term can be short- or long-term, depending on which line of credit product you fund with. And the hotel financing rates you access through a business line of credit will depend mostly on how long or short your repayment term is. Loan amounts typically range from $10,000 to $1 million on terms between six months and five years.
If you need sustained access to hotel financing, definitely consider a business line of credit over a loan for your hotel business.
Qualifying for business lines of credit
If you're a younger, less established hotel business, you'll likely have an easier time qualifying for a business line of credit than you would an SBA loan. Typically, you'll need to meet the following qualification standards:
Annual revenue over $180,000.
Minimum credit score of 630.
At least one year of business history.
4. Commercial real estate loans
Though SBA commercial real estate loans often offer the best hotel construction loan terms, they’re not necessarily the easiest to qualify for. Luckily for hotel owners who don't have perfect financials, they’re not the only hotel construction loan option out there. Consider traditional commercial real estate loans from banks, hard money loans, or commercial real estate crowdfunding for alternative hotel construction financing. Many hotel lenders will also call construction loans CapEx loans—or capital expenditure loans—so keep an eye out for those, too.
Depending on the loan product you go with, you're looking at anywhere from a 25-year term (for a bank loan) to a one-year term (for hard money or crowdfunded loans). Loan amounts can be very small or go up to seven figures and interest rates can range from 5% for bank loans to 30% for short-term lenders.
Qualifying for commercial real estate loans
Again, commercial real estate loan qualification standards vary depending on whether you're getting a bank loan or a short-term loan. Since commercial real estate is such a large, capital-intensive investment, lenders look closely not just at you, but at the property you want to purchase as well.
Here’s what lenders will consider when you submit an application for a commercial real estate loan:
Your personal credit score (hard money lenders will want to see a minimum personal credit score of 550, while banks will want to see a credit score around 700).
The collateral value of the real estate your purchasing.
Your time in business (the longer you've been in business, the less risky you appear to the lender).
A debt service coverage ratio greater than 1.2.
5. Hotel bridge loans
If you need hotel financing immediately, then you’ll most likely have to access funding through a hotel bridge loan. These commercial bridge loans are short-term financing solutions that business owners take on to seize time-sensitive opportunities—all with the intention of refinancing the bridge loan later. Hotel bridge loans are quick-to-fund hotel loans that, for the most part, allow borrowers to access funds for purchasing a hotel quickly. Remember, though, by definition, hotel bridge loans will need to be refinanced by other, more affordable hotel loans in the future. Luckily, SBA hotel loans can be used to refinance short-term hotel bridge loans.
6. Equipment financing
If you’re looking to finance the construction of a hotel, and you’re not able to access hotel construction loans—SBA or otherwise—look into equipment financing. Through this form of funding, you’ll be able to access capital to purchase equipment and the funding will be secured by the very equipment you purchase.
Because of the self-collateralized nature of this kind of hotel financing, you’ll be able to access pretty solid terms, even if you’re not getting the all-encompassing hotel construction loan you initially wanted. Equipment financing can also go toward large fixtures and furniture, which tend to be referred to as FF&E financing, or furniture, fixtures and equipment financing.
Qualifying for equipment financing
Qualification requirements for equipment financing vary depending on the lender you choose to work with, but generally speaking, you'll need to meet the following standards:
Annual revenue over $130,000.
A minimum credit score of 630.
Two years of business history.
7. Invoice financing
Searching for small hotel financing? Consider invoice financing as a go-to option. Invoice financing allows your business to access advances on your outstanding invoices. The hotel financing you receive through invoice financing will be secured by the invoices themselves, so this is yet another form of self-collateralized hotel loan.
Say you’ve landed a huge project to host a massive party at your boutique hotel, but you don’t have the liquid cash necessary to start preparing for it. Through invoice financing, you can access an advance for the invoice you send your clients. This form of boutique hotel financing is perfect for fulfilling events and conferences, especially if you’re not handling massive revenues like larger hotels do.
Invoice financing can cover up to 100% of the invoice's value, and you can get funded in as little as 24 hours.
Qualifying for invoice financing
The best thing about invoice financing is that pretty much anyone can qualify, as long as they currently have outstanding receivables. Since your invoices will act as the loan’s collateral, lenders just want to make sure the invoices make sense for them to finance.
The maximum you can qualify for depends on the total amount and quality of your invoices. Lenders also look for a minimum credit score of 600 and at least one year of business history.
8. Owner financing
If you’re trying to figure out how to finance a hotel purchase, then you might have the option of accessing hotel financing from the owner you’re purchasing from. Owner financing—also known as seller financing—is when a business’s original owner offers an interest-bearing discount on the price of the business to the buyer.
First, the buyer makes a down payment in cash as soon as the deal closes. The seller’s loan covers the remaining amount of the sale price, plus interest, according to the terms set by the lender. Seller financing rarely covers the entire price of a business, so buyers usually use another form of financing in tandem with their seller’s loan.
If you’re able to find a hotel for sale with owner financing, you’re lucky. This type of hotel financing is pretty rare and you’ll still have to prove that you’re a reliable borrower to access it. So, unless hotel owner financing presents itself as a possibility, we suggest you look into your other hotel loan options.
Hotel loan underwriting: What hotel lenders look for
Hotel lenders will consider many business credentials as they underwrite your loan. While some hotel loan underwriting guidelines will look much like generic business loan underwriting guidelines, others will be very specific to hotel loans.
We've already talked about business credit, time in business and annual revenue, but what additional numbers will hotel loan underwriting entail?
Let’s take a look at the credentials that hotel lenders will look for as they underwrite this specific type of financing:
1. Cash flow
Like any commercial lender, hotel lenders will look at your business’s cash flow. Cash flow is the amount of money you have entering your business, minus the amount of money you have leaving your business at any given moment.
2. Debt service coverage ratio (DSCR)
Again, most business lenders will consider the debt service coverage ratio of any loan they’re underwriting—and hotel lenders are no exception. The debt service coverage ratio, DSCR, compares a business’s cash flow to its potential debt obligations. To calculate DSCR, you’ll need to divide your annual net operating income (which we’ll explain in a bit) by the potential annual debt payments you’d make for the hotel loan in question.
3. Loan-to-value ratio
Now, let’s get more specific: While not all business lenders will look at the loan-to-value (LTV) ratio, almost all commercial real estate lenders will. So, if you’re looking for a hotel loan to finance a purchase or construction project, get ready to calculate the LTV. This ratio is simply the loan amount divided by the appraised value of the given property.
Another version of LTV is ARV, or after repair value. If you’re applying for hotel financing to improve or renovate your hotel, then potential hotel lenders will consider the amount of a hotel construction loan, divided by the estimated value of your post-project property.
4. Net operating income
Net operating income is a stat that hotel lenders will use to see how efficiently your hotel runs. This is your hotel’s revenues minus all necessary operating expenses. These numbers are pre-tax and don’t take into account any debt payments, capital expenditures, or depreciation.
5. Revenue per available room
A stat that’s extremely specific to hotel loan underwriting? Revenue per available room, or RevPar. RevPar is exactly what it sounds like, and it gives hotel lenders an idea of how efficiently a potential hotel borrower runs their business. To get even more context during hotel loan underwriting, a hotel lender might even consider both RevPar index and RevPar growth.
6. Debt yield
Hotel lenders might also look at debt yield as they underwrite. Debt yield is simply your hotel’s net operating income divided by the potential loan amount and it indicates the return a lender would see if they were to have to foreclose on your hotel from day one. Debt yield is a worse-case-scenario underwriting credential that allows hotel lenders to breathe easier.
Finally, some hotel lenders will consider the name of your hotel as they underwrite hotel loans. If you’re operating under a huge, well-respected brand, then this will be a play in your favor. However, this might make small and boutique hotel financing tougher to score. If you’re running a small hotel, then be sure to seek out hotel lenders that specialize in working with businesses like yours, rather than huge commercial lenders that aim to work with the Marriotts and Hiltons of the world.
The bottom line
There you have it—all the ins and outs of hotel financing. Because the costs of starting, running and growing hotels will often be huge expenses, hotel financing can take many different forms. Whether you’re looking for a hotel loan to purchase a hotel, or you’re looking for a hotel construction loan to build one from the ground up, there’s a form of hotel financing out there for you.
This article originally appeared on Fundera, a subsidiary of NerdWallet.