Lending to Hotels and Motels

By Kendrick, Peter N. | The Journal of Lending & Credit Risk Management, April 1996 | Go to article overview

Lending to Hotels and Motels


Kendrick, Peter N., The Journal of Lending & Credit Risk Management


Lending to hotels, motels, and motor inns presents numerous challenges to lenders of all levels of experience, and many lending institutions have policies to limit or curtail exposure to this segment of the hospitality industry. Loan officers, their credit officers, and bank risk managers need to know the tools required to understand industry trends, to evaluate risk in loan structuring, and to monitor loan compliance.

The following areas should be looked at when considering lending to a hotel or motel borrower:

* Industry and business risk.

* Financial statement analysis.

* Valuation of the securing asset.

* Loan structure.

* Ongoing monitoring.

Industry and Business Risk

The hospitality industry depends primarily on trends in leisure or vacation spending together with business travel. The industry is highly cyclical with earnings that rise and fall faster than changes in economic activity. Lending to this industry is dissimilar to lending against other real estate assets such as apartments, retail mails, leased warehouses, and other revenue properties that have income stability. Income reported in the latest hotel or motel financial statements may not be representative of future earnings.

The state of the industry within the local economy as well as the potential impact of a slowdown in business or recreational travel must be evaluated. Such a slowdown would particularly damage a destination resort solely dependent on conventions or vacationers. Sensitivity to economic changes may be minimized if the customer or prospect caters to commercial travelers, is located close to a major hospital serving out-of-town patients with family members that stay on during surgery and convalescence, or is adjacent to a known attraction that is not likely to go out of fashion. The mix of revenue should be evaluated. Most larger hotels generate substantially all their revenue from room operations, but some depend on beverage or lounge operations. These businesses are also subject to risks of fluctuating demand trends.

If the local hotel industry depends on travel from foreign countries, then revenue may be subject to changes in other economies or exchange rates. It is important to understand how sensitive the client may be to changes in the dollar compared with, for example, the yen.

Management

Another key factor to fully evaluate is management. It takes many years of experience, starting in junior positions, sometimes coupled with college training, for a manager to acquire the skills to run a hotel operation. Hotel operations may be managed by the owner or a hired general manager; in either case, their credentials should be reviewed. Most hotel managers have a detailed resume that outlines their past experience, and background checks should be done when new managers are hired. If the hotel is part of a small, independent chain, the track record of the other hotels in the system should be reviewed.

Labor

The state of labor relations must be investigated. Lodging is a people business, and management's approach in leading and motivating employees is very important. Determine if there is a history of acrimony or if a harmonious relationship exists. Hotel policies in the event of employee theft should be reviewed. Also determine if there is a good pool of experienced labor in the community to meet vacancies arising from turnover. If the operation is unionized, learn the expiration date of the collective agreement. It may be necessary to determine if local labor laws allow for replacement workers during a strike. If not, the operation will need to be run by management or, even worse, shut down during a strike or lockout.

Chain Affiliation

An additional set of concerns need to be reviewed if the hotel or motel is licensed as part of a major chain. The requirements to maintain the franchise or "flag" should be known, and the hotel's ability to meet them assessed.

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