As promised for the next series of newsletters we will continue to be examining each individual investment type of real estate; from what it is, to lenders underwriting requirements to getting your loan approved.

The key to any piece of commercial real estate as you know from my previous articles is cash flow. If there is no positive cash flow without a significant down payment it is not a "good" investment today. You may elect to hold an investment and hope for appreciation upon a future sale, but that is not going to give you cash today.

The investment types that will be covered in this series of articles are all known as "cash cows". They typically return an investor a consistent cash flow and therefore a good cash on cash return. Today's topic will be the exciting area of Hospitality Ownership.

Hotel Loans come under the same underwriting guidelines as other commercial properties, except that there are usually additional service income that is part of the net operations.

To properly underwrite a hotel loan, the lender must first categorize the hotel based on product type, amenities and location. After further analysis of the financial statements the true profitability will become clear, allowing the underwriter to compare similar products to determine the proper pricing structure.

For example a franchise or flag property will underwrite more aggressively, than a non-flagged property. Aggressive underwriting translates into lower rates, fees, and longer terms.

HOTEL LOANS ARE A REFLECTION OF ALL THE INDIVIDUAL DEPARTMENTS TRUE PROFITABILITY.

Therefore, it all comes down to the consolidated operating statement of all the various departments of the hotel.

Each individual department will demonstrate their profitability by taking all revenue for that department, applying all allowable expenses; including cost of goods or services sold, yielding true net operating income for that department.

Market and Location
The property should be easily accessible and visible from the highway or major roadway. Business- oriented hotels will provide ready access to downtown business areas,corporate parks and airports. Vacation-oriented hotels will be highly visible from major roadways and be in close proximity to recreational amenities.

Property Condition and Characteristics
The property should exhibit sufficient parking capacity to adequately accommodate its range of services and location. A stable historical operation is critical. A property with a history fo four or less years should be reviewed carefully.
The property should have established an ongoing refurbishment program for both hard and soft goods.
Franchise affiliated hotels or Flagged Properties are preferable, with franchise agreements extending beyond the term of the proposed loan.
Minimum acceptable occupancy (annualized for properties with seasonal fluctuations) is typically 60%; the average occupancy over the last 3 years should be at least 60%.

Full Service, Limited Service Hotels & Extended Stays
Caters primarily to business, government and vacation travelers.

Underwriting Requirements

Maximum LOAN TO VALUE - 65% to 70%
Maximum Amortization - 20 to 25 years
Minimum DSCR - 1.40x for full service & 1.45% for limited service
Minimum Occupancy - 60% over the past three years
Maximum Occupancy when calculating Room Revenue - 75% Minimum Furniture, Fixtures and Equipment (FF&E) - the greater of actual or 5% of Total Revenue
Minimum Franchise Fee - the greater of actual or 5% of Total Revenue
Minimum Maintenance Fee - the greater of actual or 4.5% of Total Revenue
Capitalization Rate - use market-driven capitalization rate; typically 10% to 13%
Food & Beverage (F&B) contribution should be less than 40%

Key Commercial Loan Indexes

Fed Prime Rate 8.250%

10-Year CMT 4.670%

30-Year CMT 4.840%

USD 6 MOS LIBOR 5.360%

As of April 30, 2007

We've all heard the term CAP Rate, but how many of us truly understand what they are and more importantly their significance to financing a conventional commercial property.

Capitalization Rates or as they are affectionately known as Cap Rates, reveal the true value of an investment piece of real estate. These market rates of returns are a function of the general real estate market that you are buying into. For example the exact same property located in a different area with the same net operating income can have a different rate of capitalization due to the location factor.

BY KNOWING COMPARABLE CAPITALIZATION RATES FOR A PROPERTY THE APPROPRIATE PURCHASE PRICE CAN BE ASCERTAINED

Cap Rates are an indication of the market demand for a particular commercial investment.

The lower the cap rate the higher the value of the property, and conversely the higher the capitalization interest rate the lower the value of the property. Therefore rates of capitalization have an inverse relationship to value.

This is because typically speaking a higher rate of return of an investment would yield a lower investment, or in the case of commercial real estate a corresponding lower sales price.

To perform any of the three cap rate calculations you would need to know two of the following three variables. Either...

1. Net Operating Income
2. Expected Market Rate of Return
3. Purchase Price of Property


Knowing any of the above two will yield the third.

Some examples are in order; let's assume a building is for sale at $5,000,000, the net income for the building is $425,000,
What is the Required Rate of Return of the investment?

(Calculation) $425,000 divided by $5,000,000 or 8.50 %

Now let's assume that we know the investor want a market return of 8.50% what is the purchase price for a building with an NOI of $425,000?

(Calculation)$425,000 divided by 8.50% or $5,000,000.

Now let's assume that we know the market rate of return we need, and we know the price we want to spend but we want to make sure that the property will cash flow according to our investment needs. What NOI do we need?

(Calculation) $5,000,000 multiplied by 8.50% or $425,000.

Since the NOI of the property is constant, the variable for any project is the Cap Rate.

A full understanding of the mathematical relationships of the three variables is absolutely necessary for the investor.

Only by understanding the relationship between NOI, Expected Market Rate of Return and the Purchase Price of the Property can you the investor determine if the property is a good value.

I'm thinking about buying a franchise with a base franchise fee in excess of $100,000.00 and was wondering are there any business loans available to help me, or do I have to take the in-house financing that the franchisor is offering me.

Jeff, San Diego

Jeff,
There are many ways for a future franchisee to get money for his or her purchase. The one you mention is probably the most costly but probably the easiest to procure providing you have a strong net worth. I have to assume that your net worth is strong enough or you would not qualify for the purchase of the more expensive franchises.

The terms of the franchisor's financing will most likely be a short term loan with a balloon payment all due and payable in less than five years.

An SBA loan on the other hand would offer you at least seven to ten years to pay off the loan. Also, the loan payment would be based on both principal and interest payments making the loan a fully amortized payment.

Jeff, if you can qualify and have the time I would certainly look into the SBA Business loans offered by companies like ours.

Please email your questions to "Ask Your Financial Broker" at Askthebroker@loanforbiz.com.

P.S. If you are interested in joining our company please contact either Harlan or David directly. We will be expanding this year and would like to have you join us. For those financially astute individuals we offer a proven system to build your commercial finance business along with comprehensive training.

email: harlan@loanforbiz.com

phone: 858-592-0659

web: http://www.loanforbiz.com