Looking for funding for your hotel or hospitality business? Traditional bank loans are just one option when it comes to financing hotels and hotel operations. Whether you need cash to cover a new washing machine or a loan to finance the purchase of an entire resort, the plethora of financial instruments to choose from can be overwhelming. In this article, we’ll break down several popular funding sources for hotel businesses, including pros, cons, and specific situations in which they are most advantageous. The right financing option can unlock tremendous value to your business without compromising your equity, your working capital, or your business’s long-term financial health.
SBA Loans for Hotels
The Small Business Administration (SBA) is a government program designed to help small businesses find funding, and some of its loans are especially relevant for hospitality entrepreneurs. The SBA 7(a) loan provides up to $5 million in funding which can be used toward hotel acquisitions, renovations, equipment purchases, refinancing existing debt, and more. These loans have terms between 10 and 25 years.
Another option is the SBA’s 504 loan program, which provides up to $5.5 million in funding which can be used toward construction expenses, land purchases, and renovations. This type of loan cannot cover real estate transactions, refinancing existing debt, or working capital. Both types of SBA loans come with a few requirements: your business must qualify as a “small business” and you must have previously been denied private financing options.
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Loans for Small Hospitality Businesses
While the term “small business loans” might make you think hotels don’t qualify, think again. Small business loans generally offer up to $10 million in funding, and they can be applied to anything from capex projects to payroll.
One small business loan option is called a working capital loan: this type of loan is intended to cover short-term operating expenses, such as payroll or marketing. A working capital loan can fill the gap if your hotel’s cash inflow doesn’t quite cover your expenses. It can be a good option if your hotel is in a very seasonal market or if your property experiences some type of disruption in demand. You can secure a working capital loan quickly, and unlike other forms of financing you don’t need to give up any equity in your business, but interest rates on these loans can be quite high and excellent credit is needed to qualify for one.
Small businesses can also take advantage of a business line of credit, which lets you draw as much money as you need (up to your approval limit) while only paying interest on what you have used, and business credit cards, which offer quick cash with minimal downside if you can pay your statements in full each month. Credit cards can be an excellent solution for covering day-to-day expenses, while also earning rewards or points.
Hotel Equipment Loans
Rather than taking out a small business loan or using a business credit card to purchase new equipment, it’s possible to lease equipment or take out a special hotel equipment loan. Large, expensive purchases like washers, dryers, luggage carts, and kitchen appliances can be good candidates for equipment loans or leases. Like an auto lease, this program allows you to receive a new appliance or furniture item and pay a fixed monthly amount during the duration of the lease term, which is usually between two and six years. At the end of the term, you can start a new lease for a brand-new model. This option is great for operators who are in a time crunch, because these loans can be arranged quickly, and for owners who don’t want to tie up other types of capital in costly physical goods.
Bridge Loans for Hotels
Bridge loans serve a unique need: they provide short-term financing before you secure permanent financing. These loans can help you avoid missing opportunities just because financing hasn’t come through yet. For example, if you purchase a hotel, but there is a period of time before you acquire loans to pay for it, you might need a bridge loan to cover this gap to avoid tying up all of your capital in the purchase. Your hotel needs to remain operational, so you need some working capital during the transition period. Because time is of the essence in these situations, bridge loans can be secured quickly, but they come with high interest rates (up to 10.5%) and short repayment periods (usually 1 year).
CMBS Hotel Loans
For entrepreneurs seeking significant capital to purchase a hotel or remodel an existing one, commercial mortgage-backed securities offer a lot of value. After you purchase a property, you package your mortgage into bonds, and you sell those bonds to investors. CMBS loans are intended for big purchases; they generally start around $2 million. They also don’t require excellent credit, so they can be a solution for entrepreneurs looking for a fresh start.
Hard Money Hotel Loans
If you have physical assets that can be used as collateral and need funding fast, then a hard money loan can be a good financing vehicle. Hard money loans are usually issued by private investors, and the investor offers funding with a relatively high interest rate and some sort of physical collateral, often in the form of real estate. The investor expects to recoup their investment, plus interest, within about five years. These loans can be secured quickly, making them attractive for a business that needs a capital injection immediately, but because of the high interest rates and short repayment period, they aren’t often a business owner’s first choice.
Traditional Bank Loans for Hotels
Of course, we can’t forget about traditional bank loans, which can also be a great option for hotel businesses. These loans usually come with lower interest rates than some other funding options, but keep in mind that the approval process is likely to be stricter and longer than other types of loans. If you want a loan with the best interest rate and you have time on your side, then a traditional bank loan can be the perfect fit.
What is the best financing option for hotels?
Trick question! There is no one-size-fits-all funding option for hotel businesses. What’s best for your unique business depends on your needs and your financial goals. Is your business new, or does it already carry good credit? Do you need capital ASAP, or can you afford to wait a little to secure the lowest interest rates? Are you comfortable giving up a stake in your business in exchange for capital? And how much money do you need? These questions will help guide you toward the financing option that’s best for you and best for your business in the long run.
Why Are Loans So Important to the Profitability of Hotels?
Hotel loans are crucial to the profitability of hotels and are essential for various reasons within the hospitality industry. Hoteliers, whether they are hotel owners looking to expand or new entrepreneurs seeking to enter the market, rely on hotel financing to meet their objectives and enhance cash flow.
Financing Options: Hotel financing options are diverse, catering to different property types and needs. These include bank loans, SBA loans (such as SBA 7(a) and SBA 504), commercial mortgage-backed securities (CMBS), mezzanine loans, and bridge financing. Each option serves specific purposes, allowing borrowers to tailor their financial strategies to their unique situations.
Loan Amount and Down Payment: The loan amount is a pivotal factor for hoteliers, as it determines their ability to acquire, renovate, or expand hotel properties. A higher loan-to-value (LTV) ratio may reduce the down payment requirement, making it easier for borrowers to access funding.
Construction Loans: For those looking to build new hotels, construction loans are indispensable. These short-term loans help finance the development of a hotel project from the ground up, covering costs such as land acquisition, construction, and initial operating expenses.
Refinancing: Hotel owners can benefit from refinancing their existing loans to obtain more favorable loan terms, lower interest rates, or access equity tied up in their properties. This process enhances cash flow and overall profitability.
Interest Rates: Interest rates play a critical role in determining the cost of borrowing. Hotel lenders and borrowers closely monitor interest rate movements, as lower rates can lead to reduced debt service and increased profitability for hotel businesses.
Debt Service Coverage Ratio (DSCR): Lenders often evaluate the DSCR to assess the hotel's ability to cover its debt obligations. A healthy DSCR is crucial for underwriting hotel loans, ensuring that cash flow remains sufficient to repay the debt.
Cash Flow and RevPAR: Positive cash flow, driven by strong revenue per available room (RevPAR), is essential for the financial health of hotel businesses. Hotel financing supports the improvement of operations and services, ultimately increasing RevPAR and profitability.
Non-Recourse Loans: Some hotel loans, particularly CMBS loans, offer non-recourse terms, meaning that the borrower's personal assets are not at risk if the hotel business faces financial challenges. This can be a significant advantage for hotel owners.
SBA Loans: The Small Business Administration (SBA) offers hoteliers access to SBA 7(a) and SBA 504 loan programs, providing government-backed financing options with favorable terms and lower down payment requirements.
Underwriting and Loan Terms: Lenders carefully underwrite hotel loans, considering factors such as the hotel's location, brand, and market conditions. Favorable loan terms are essential to ensure that hotel owners can manage debt effectively while maximizing profitability.
In summary, hotel loans and financing options are instrumental in the profitability of hotels and hospitality properties. They provide essential capital for hotel construction, expansion, and renovation, helping hoteliers navigate the unique challenges of the hospitality industry and ultimately contribute to the success of their businesses.