Understand Hotel Loan to Value Options

Taking out a loan for a hotel or other commercial property operates on much the same principles as taking out any other kind of loan. Any time a lender loans money, they are taking a risk that they will get their initial investment back, let alone turn a profit on the venture. As a result, they need to be sure that the amount they are lending is equal to or greater than the value of the property being purchased, minus the cost of liquidating the asset and turning it back into cash if the borrower should renege on the loan agreement in any way.

Any time you are trying to secure a loan, lenders look at four key factors to determine how much money they are willing to lend you and at what interest rate. Generally, these factors are:

  • the value of the object or property you wish to purchase
  • your projected ability to pay the loan back
  • your history of paying back other loans
  • the amount of your personal investment

Taking all of these factors into account allows lenders to determine what percentage of the purchase price they are willing to lend and at what interest rate. If you want to purchase a $30,000 car and make a $10,000 down payment, you will most likely get a very low interest rate, even if you have less than stellar credit because of the amount of your personal investment. Conversely, if you have a well-established history of paying back loans then you can generally get a low interest rate even if you don’t put down a large down payment. In either of these cases, the loan is considered to be low risk and low risk equals low interest.

In commercial lending, there is generally very little difference in the interest rate being offered, but there can be a vast difference in the amount that is offered. Just like any other type of lending, lenders will look at essentially the same factors: the value of the item being purchased, the ability of the business to generate income to pay the loan back, the borrower’s personal track record of paying back loans and the size of the borrower’s investment. The more “risky” they consider the investment to be, the more they will want the borrower to invest – or the lower the loan amount, the lower the offer will be. Lenders generally base their loan amounts on two ratios, although recently some lenders have begun using a third ratio known as a Debt-Yield Ratio. Here are the three ratios and how they are calculated.

  • Loan-to-Value Ratio (LTVR): The loan to value ratio is simply the value of the property divided by the amount of the loan being requested. If you are looking to purchase a property with a value of $100,000 and asking for $70,000 loan, then the LTVR is 70%.
  • Debt-Service Coverage Ratio (DSCR): The DSCR measures the business’ ability to cover mortgage payments by dividing the annual Net Operating Income (NOI) by the annual debt obligations. A business with a $200,000 NOI and a debt of $140,000 has a DSCR of 1.43, indicating that it has 43% revenue surplus. A business with a $200,000 NOI and $220,000 of debt has a DSCR of .91, meaning that it is has a negative cash flow and can only cover 91% of its annual debt obligations.
  • Debt Yield Ratio (DYR): The DYR is calculated by taking the Net Operating Income (NOI) divided by the loan amount, times 100%. Notice this ratio does not take the value of the property into account, only the Net Operating Income (NOI). An “acceptable” Debt Yield Ratio is generally considered to be 10%, so if you were looking to purchase a property worth $6M but the business has a NOI of $400,000, then the maximum loan amount based on the DYR would be $4M.

Just like with any other loan, a high or low score in one area will adjust the other areas up or down. For instance, if you want to purchase a hotel that doesn’t have a very high property value but has a consistent track record of generating enormous profits, then the bank will likely offer you more than they would based on just the LTVR alone. Conversely, if the business doesn’t generate a huge profit but the land that the business sits on has a high value, they may offer you a higher loan than what the DSCR might dictate.

For more information on how these ratios work or for any other lending questions you might have, give The Passport Group a call today! We can help you through every step of the buying process; from scouting to financing to managing your hotel all the way to selling on the other side.

By |2017-06-05T16:00:30-07:00January 9th, 2017|Hotel Buying, Hotel Owner's Tool Kit|Comments Off on Understand Hotel Loan to Value Options

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