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Debt funds emerge as hotel financing source

Debt funds are emerging as a major source of financing for hotels in the U.S.

The sector is taking prominence as other lenders with significant existing exposure to hospitality, such as banks, become more risk averse late into the cycle.

Debt fund investment into global hotels hit US$49 billion in 2017, an increase of more than 200 percent from US$16 billion in 2009. The pace is not expected to ebb.

The most active lenders for hotels have traditionally been banks and commercial mortgage-backed securities (CMBS).

But debt funds are generally more flexible, willing to lend up to 75 percent of the value of the real estate, according to Kevin Davis, managing director from JLL’s New York Hotels & Hospitality team.

“Over the course of 2018, the hospitality debt markets have been exceptionally strong, which is a trend we expect to continue,” he says.

Debt funds are leading the charge in financing deals that are riskier than typical bank transactions and offer more flexibility than CMBS. They are more willing to finance hotels with no cash flow as they are opening or coming out of a renovation, said Davis.

“Debt funds’ willingness to finance these deals is notable because very few lenders were willing to finance such deals even one year ago.”

Debt investing can be a good strategy for investors that are concerned about lofty valuations and the longevity of the current cycle. Lenders sit lower in the capital stack to equity investors, which allows them to avoid the potential losses that could be incurred by equity investors if property valuations come under pressure. This has become an important consideration amid caution around rising interest rates and the overall strength of economic growth.

In Europe, while banks still finance most hotel deals, Brookfield and GreenOak have closed their first European property debt fund, and French fund manager, Amundi, is slated to launch a European real estate debt fund mid-year.

Debt funds have also been active in mezzanine debt, a trend expected to continue into 2018 as the market becomes more liquid and competitive.

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