Business owners seeking financing for a hotel construction project have several options they can pursue, but not all are equally attractive. Loan requirements can vary greatly in regard to terms, down payments and other aspects. The Small Business Administration (SBA) is an important funding source in the hotel construction arena, and the SBA 504 loan provides borrowers access to up to $5.5 million with convenient conditions.
Where to Get a Hotel Construction Loan
A conventional lender. Banks or credit unions can provide commercial mortgages, but will be highly selective of the projects they choose to fund. Hotel financing, and construction projects in particular, are considered high risk loans and many lenders are reluctant to accept such a project. Under typical conditions, the borrower will have to make a down payment of at least 25% of the project cost, and possibly up to 40%. The interest rate may be fixed or variable, which means it fluctuates with the market. A typical conventional loan for hotel construction could reach 8%.
The loan’s amortization period is likely to be significantly longer than the term of the loan, meaning that the borrower will face a balloon payment at the end of the life of the loan. If the term of the loan is 7 years, and the amortization is 20 years, the borrower will be liable for 13 years worth of payments at one time when the 7-year term is up. For example:
The borrower has the option of paying the balloon payment or refinancing it at a new rate. Changing rates and fees can add several percentage points to the cost of the loan.
An alternative lender. There are a variety of nonbank lenders that finance hotel construction. These lenders include web-based finance companies as well as “banking firms,” many of which specialize in hotel financing, with large offices and representatives ready to meet with borrowers face-to-face. There are even specialized loan brokers for hotels. Often these lenders are more willing to finance projects than conventional lenders are, but their conditions are likely to be even less favorable than a conventional lender’s. Alternative lenders base their lending decisions less on a borrower’s personal credit than banks do, but they will insist on seeing a solid business plan.
Alternative lenders tend to be tight-lipped about the conditions they will offer until they see a loan application. A strategy that is often seen online is to feature down payments of 25-40% and quite competitive interest rates (starting below 5% in January 2018) with short terms and large balloon payments. These terms can be shorter than a year on a 25-year amortization period, which makes refinancing the loan extremely likely. It should be noted that the fees from frequent refinancing can add up to a considerable expense by themselves.
Thus, while the conditions of the refinancing loan can vary, a typical loan from an alternative lender might look like this:
When making their decision, both conventional and alternative lenders will take into consideration the hotel’s franchise—often referred to as its “flag”—if there is one.
The SBA 504 Loan for Hotel Construction
If going to a conventional or alternative lender would put you in a tight financial situation, there is always the Small Business Administration’s 504 loan to consider. The 504 loan is designed to encourage small business growth. It is administered by a Certified Development Company (CDC), which is a nonprofit organization set up specifically for that task. A 504 loan can be used to:
- purchase land or buildings
- construct buildings
- purchase equipment with a service life of ten years or more
- improve, upgrade or renovate buildings
- refinance conventional debt
In conjunction with a conventional lender, the 504 loan can provide long-term (10- or 20-year) financing for hotel construction
- at a fixed, below-market rate
- with a 15% down payment
- with no balloon payment
A 504 loan will finance up to 35% of a hotel project, or $5 million, with the conventional lender providing 50% or more of the total. The conventional lender receives the first mortgage. The borrower contributes a 15% down payment instead of 10%, because a hotel is considered a single-purpose property by the SBA. Both franchisees and independent hoteliers are eligible for the 504 loan.
Projects financed with a 504 loan can be quite large. TMC Financing’s largest project, for example, is the Rush Creek resort hotel, which came in at over $40 million. Since this project exceeded the typical size standards, the borrower had a difficult time finding a conventional lender. TMC stepped in and found a credit union that specialized in hotel financing of that scale and was willing to partner with TMC to complete the 504 loan.
The SBA Green Energy Program gives a hotel owner the opportunity to increase the amount of SBA funding for a project to $5.5 million and to exceed the traditional limit on the number of projects that can be financed. To qualify for the Green Energy Program, a borrower should
- Buy or construct a building that consumes 10% less energy than their current location
- Buy the building they currently lease and make upgrades to consume 10% less energy
- Buy or construct a building that produces 10% of the energy it consumes or produces fuel to reduce fossil fuel consumption, using equipment financed through the loan
Besides giving the borrower access to the SBA financial incentives, participating in the Green Energy Program will save the borrower money, since the greater energy efficiency it promotes reduces utility bills. “Greenness” is also becoming an increasingly valuable marketing asset, and could make your hotel a more attractive option for potential customers.
TMC Financing is a leading CDC in California and Nevada and the national leader in hotel financing using the 504 loan. TMC is a Premier Certified Lender with the SBA, enabling us to provide faster loan approval times. To find out more about using a 504 loan to finance your hotel project, please contact a TMC 504 loan expert today.
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