In commercial real estate, few property types have vexed bankers more than hotels. Weak sponsorship, lax underwriting, and intermittent slowdowns in corporate and leisure travel have in recent years forced foreign and domestic banks to swallow unthinkable losses.

One "fantasy" hotel in Hawaii, for example, fetched 5 cents on the dollar, despite costing more than $400 million to build. Last summer, New York's Four Seasons Hotel traded at a 50% discount. Banks were liable in both cases.

Given such chronic angina, it might therefore seem incongruous that so many banks are once again busy financing hotels. Until, of course, you see the changes afoot.

Bankers Trust estimates that more than $12 billion of debt and equity was raised in 1996 for the U.S. hospitality industry. More money was raised for lodging in the last two years than in the entire 1980s. While not all the money today is coming from banks (Wall Street and insurers are still prominent financiers), many money-center banks and superregionals are syndicating loans anew, typically to refinance or acquire existing hotels but sometimes to build new ones.

Once thought extinct, the national bird of the commercial real estate industry (the construction crane) is now spotted regularly in Orlando and Las Vegas, where giant hotel-casino projects are under way, with banks often as backers.

Coopers & Lybrand reported 102,000 room starts in 1996, below record highs yet above the 20-year average of 82,000. Most of the new construction, however, is in limited service. Among full-service hotels, barriers remain in in-fill locations.

The surge in building tracks a general increase in commercial real estate lending by banks. A recent survey by KPMG Peat Marwick, reported in American Banker, noted that 78% of the national-superregional banks had seen a rise in construction loans in the past 12 months.

Data from federal banking regulators show a similar rise in commercial mortgages on the books of banks.

So who called the reverse on hotel financing?

Essentially, the economy did, with a push from underwriters and credit officers who base financing today on historical operating performance and cash flow.

During the last two years, robust economic growth has fueled recoveries in business and pleasure travel. A strong U.S. dollar has also made it easier for foreigners to visit the United States and more difficult for Americans to go abroad.

But the biggest change involves the industry itself. A fundamental realignment of owner and operator interest in lodging and a marked shift toward public, institutional ownership of U.S. hotels have occurred.

Sponsors in the 1980s were typically private developers who raised debt for hotels on room rate projections, tax breaks, and little if any equity. Lenders today expect owners to put up 50% or more of their own equity and manage the properties themselves.

At last count, there were 27 publicly traded lodging C-Corps (e.g., Bristol Hotel Co., HFS, Host Marriott) and 13 publicly traded hotel real estate investment trusts (e.g., Patriot American, Capstar, Felcor Suite Hotels), up from just 12 C-Corps and three hotel REITs at the end of 1993.

The result of this rush to the public equity markets has been a massive deleveraging of the lodging industry. Total capitalization has risen to almost $50 billion, up from a mere $7 billion in 1991.

Among public lodging companies, total debt-to-market capitalization has shrunk from near 50% in 1993 to around 40% today, including the larger investment-grade lodging companies.

From a lender's perspective, this shift toward public ownership has meant better reporting and financing now based on trailing operating performance, revenue per average room, and EBITDA, a cash-flow multiple.

Many banks today also structure senior debt financing with sophisticated mark-to-market mechanisms, enabling the size of a loan to decrease if the value of the property falls.

At the moment, the fundamentals in hospitality, especially among full- service hotels, are strong: Profits, demand, occupancy, and daily rates are up, while new construction is historically low. Worker productivity has risen, while operating expenses (payroll, management fees, etc.) have fallen. Debt service as a percentage of revenues is at its lowest level in nearly 15 years.

The question of course is, will the good times roll? Probably not. The lodging industry is very susceptible to mood swings in the national economy, which many economists believe is slowing. Moreover, hoteliers generally build too much in good times, thereby strangling profitability when conditions sour.

But in the near term, the industry is sound: Profitability is at record highs, and room rates are predicted to rise again this year.

The key to sustained growth in hospitality is for lenders to acknowledge their mistakes, recognize the industry has changed, and renew financing based on today's more conservative underwriting criteria. If they do so, lenders will be better prepared for tough times.

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