Hotel project funding: construction lending

As the pandemic draws to a close, the hospitality industry is looking to the future.

The basis for the recovery and prosperity of this industry is the project financing of hotels and affordable long-term loans for the construction of new facilities or the reconstruction of existing ones.

By 2020, hotel construction around the world was at a high level, requiring multi-billion dollar funding for nearly 15,000 new projects with more than 2.4 million new hotel rooms.

Today, financial institutions and other providers of capital are extremely cautious about funding new projects, which requires more comprehensive research and analysis, as well as increasing the demand for professional support and management of investment projects.

Costex Corporation DBA, a company with an international presence, is ready to offer your business long-term financing for the construction and modernization of hotels in Europe, the USA, Canada, Latin America, the Middle East and South and East Asia.

We specialize in long-term loans, organization of project finance (PF) schemes, investment engineering, consulting and management of large projects.

To find out more about our services and opportunities, contact an LBFL representative and schedule a free consultation at a convenient time.

Funding the construction of hotels: general information

Companies taking their first steps in the hotel business often experience difficulties in financing projects.

Sometimes they don't have experience in the industry, they don't have a credit history, and they don't even have adequate collateral.

Obviously, before starting any capital-intensive project, it is critical to conduct a comprehensive study of the company and consult with the top management who plans to invest in the hotel. This work should address the possibility of obtaining funds to finance the project and analyze the most effective ways to attract them.

Table: Classification of funding sources for hotel projects.

Internal sources	External sources
	Traditional	Alternative	Support
Profit from the current activities of the company	Long-term investment loan for development	Leasing	Loan subsidies
Retained earnings	Short-term loan for working capital replenishment	Factoring	Grants and subventions
Depreciation deductions	Bond issue	Venture capital	Credit guarantees
Sale of surplus assets	Issue of other debt securities	Crowdfunding
Owner contributions
Issue of new shares

Financing of large projects in the hotel business can be carried out using a wide range of internal and external resources.

Equity capital can be generated as a result of current operating activities (for example, current income from other hotels, retained earnings, depreciation, sale of assets), as well as by increasing the company's authorized capital. An increase in the authorized capital can be carried out through contributions of the owners or by attracting new partners (issue of new shares).

An important way to raise capital is the cooperation of the hotel business with venture capital funds. Venture capital funds are involved in high-risk projects with above-average potential returns. As a rule, such projects are not accepted by large banks due to an excessively high level of risk.

The most common debt securities that serve as an instrument for funding the hotel business are bonds.

Other securities that are used relatively rarely include bills of exchange and warrants.

Bonds are securities issued in series, in which the issuer confirms the debt to the creditor and undertakes to perform a specific action in relation to him. Bonds come in different types depending on the type of issuer, maturity, face value, interest rate, additional options and ways to minimize the investment risk of a particular project.

We will discuss the role of project bonds in the next section of this article.

Long-term loans for hotel construction

Until recently, bank loans have been the most common external source of financing for hotel projects.

When choosing loans, experts recommend that companies carefully read the policy of a particular bank regarding commissions and additional fees charged to customers.

The offers of banks are as diverse as the terms of financing.

Since banks strive to ensure a high return on capital, the cost of a loan consists of several elements, such as a fee for processing a loan application, a commission for providing funds, interest, and more.

As part of a credit relationship, the bank provides the company with funds, and the borrower is obliged to repay them with interest due in accordance with the loan agreement. Investment loans for the construction of hotels are often provided for a period of 7-10 years or more.

Together with an investment loan, a loan for replenishment of working capital can be issued, which provides additional benefits to project participants. The procedure for applying for a loan requires submitting to the bank the results of studies related to the funding of hotel investments. These include a business plan, financial plan, estimate, project documentation and other documents.

In the hotel industry, important indicators for lenders are, among others, the RevPAR index (profitability of an available room), NOI (net operating income), LTV (loan-to-value ratio), NCF (net project cash flow) and others.



During the negotiation process, the main provisions of the future loan agreement are formulated, such as the accrual of a penalty for early repayment of the loan, the possibility of recourse and requirements for additional borrowing.

The results of the analysis of the loan application and the response of the bank will largely depend on the existing credit risks and the creditworthiness of the company. The level of risk is significantly affected by the availability of liquid collateral. Such collateral can be a land plot, as well as a financed hotel complex, movable property of the borrowing company, financial assets, etc. The collateral provided, its value and liquidity affect the final cost of borrowed funds.

To increase the chance of obtaining a loan for the construction of a hotel, experts recommend using such auxiliary tools as guarantees.

In many cases, additional mechanisms are being developed to ensure debt repayment, such as a guarantor's application to enforce financial obligations (restrictions on the payment of dividends to shareholders, etc.).

An important point that is taken into account by banks when considering a loan application is the borrower's financial participation in the project.

The more significant the initiator's participation in the financing of the hotel, the higher the chance of obtaining a loan on favorable terms.

Most often, credit institutions require the financial participation of the project initiator at the level of 30-60% of the total cost of the hotel.

However, some financial mechanisms make it possible to implement a project with the participation of the initiator at the level of 10% or even lower.

In the case of granting loans to the hotel business in foreign currency, the currency and interest rate risk is additionally increased. The bank can reduce the interest rate risk by obliging the borrower to enter into an IRS (interest rate swap). This means replacing fixed interest rates with floating interest rates.

Currency risks are also minimized through hedging (futures contracts).

The IRS refers to an agreement between two counterparties to exchange a fixed interest rate for a floating interest rate. The floating interest rate is set for a partial period based on the base rate (eg EURIBOR or LIBOR). This tool serves as a hedge against adverse changes in interest rates. The agreement is concluded for a certain period of time.

The key document on which hotel business lending is based is the loan agreement. The loan agreement specifies the specific purpose of the loan, the terms of its repayment, the currency of the loan, the collateral and the repayment schedule. The preparation of this document requires a professional approach and repeated consultations between representatives of the bank, the borrower and other interested parties.

Due to the high social significance of certain investment projects, the state, as a regulator, can pursue a policy of economic stimulation of priority sectors. In particular, the government may support environmental, infrastructure, high-tech projects or projects aimed at improving the situation of certain social groups.

Private hotel projects can rarely rely on government support, but in some cases support is provided in the form of loan subsidies and guarantees. Ultimately, these solutions reduce the need for equity capital and reduce the value of the collateral provided.

Leasing as a tool for funding the purchase of hotels

Leasing or factoring can be alternative instruments for project financing of hotels.

These instruments can be used, for example, to finance the purchase of hotels. In practice, there are two types of leasing: operating leasing and financial leasing, which have certain limitations.

Operating lease actually refers to obtaining the right to use property for periodic lease payments and without the obligation to buy the property at the end of the term of the agreement. The asset remains the property of the lessor and is recorded on the lessor's balance sheet. The lessee's expenses represent the cost of the monthly lease payments and part of the down payment, determined depending on the planned length of the lease period.

Financial leasing essentially means "leasing" financial resources (funds).

The lessee becomes the owner of the asset, which is recorded on his balance sheet. This fact is of great importance for calculating depreciation and tax liabilities of the company.

Attention should be paid to leaseback, when the owner of an asset sells it to a leasing company and becomes its lessee on the basis of a separate agreement. Through such a transaction, the company receives an immediate cash inflow and continues to use this asset (hotel complex).

Factoring is a type of commercial transaction in which a specialized financial institution (factor) acquires claims for payment of money that a client owes to another party as a result of its current activities.

The conclusion of a factoring agreement can significantly speed up the implementation of current investment projects and increase liquidity.

If you need professional advice on the financing of hotels and tourism projects, contact Costex Corporation DBA and make an appointment at any convenient time. We will answer any of your questions and offer the best financial solutions for a specific investment project.

Modern trends in hotel project finance

Financing the construction and modernization of hotels in different parts of the world has developed its own way for a long time, so the share of long-term loans, project finance and other instruments varies significantly in different countries.

This should be taken into account when planning large projects and seeking funding sources.

The developed countries of Europe are traditionally characterized by an orientation towards bank lending to the hotel business, as in other sectors. Until the mid-2010s, about 80% of European business finance came from banks and other lenders, according to the OECD, in stark contrast to the modest 30% of lending in business finance in the United States.

The tightening of standards in the banking sector and the growth of the capital needs of the hotel business have been driving the evolution of the European model of hotel funding for a long time. Many companies are actively seeking alternative sources of funds by turning to the bond market and project finance (PF) instruments.

Below we discuss these instruments in more detail, summarizing the available information on bonds and PF schemes for the hospitality sector.

Growth of hotel finance project schemes

In recent years, the concept of "project finance" has become increasingly popular in the context of finding sources of funds for large business projects in many industries.

This method is mainly used in structured finance schemes, as well as for large projects that require complex contractual structures and are carried out in complex environments with many stakeholders.

Experts identify certain features of project finance, although there is no generally accepted definition of PF.



Some of the most typical features of PF are listed below:

• A special legal entity is created for the implementation of the project, called a special purpose vehicle (SPV), which takes part in the implementation of the project, for example, as a contractor or subcontractor.

• Project participants, including contractors, lenders, suppliers and government agencies, create a system of contractual relations aimed at identifying possible project risks and assigning them to individual parties.

• The company responsible for the implementation of the project uses high financial leverage, but at the same time, lenders have limited recourse to sponsors in the event of a project failure (this is the so-called financing with limited or no recourse).

Since many large projects are in areas of the economy that are of great importance to the state, obtaining a license from the state authorities (for example, licensing of the hotel business) may be mandatory in order to attract funding.

In rare cases, when it comes to the development of strategic infrastructure, the state is directly involved in the construction, operation and financing.

The PF scheme differs from other hotel funding instruments in that the only guarantee of debt repayment is the cash flow that the project will have to generate after its launch.

With proper organization and implementation of project finance schemes, this cash flow should be sufficient to repay the debt. The strategic goal of the PF is to limit or completely eliminate recourse to the project initiators on the part of funding organizations.

Traditionally, the Middle East, East Asia, North America and Latin America remain the focus of the global project finance market. This trend is supported mainly due to state participation in the financing of infrastructure and tourism facilities at the national level. After the global financial crisis that shook the world economy in 2007, there was a boom in project finance in the Asia-Pacific region and a proportional decline in the rest of the world, a trend that continued until the mid-2010s.

In recent years, prior to the pandemic, many large hotel and tourist resort projects around the world were implemented under project finance.

Subsequent events have greatly complicated the implementation of new projects due to unpredictability and the increased cost of capital.

As more stringent regulations are introduced, the ability of financial institutions to engage in capital-intensive projects is shrinking, and companies have to dedicate a significant portion of their resources to comply with financial requirements imposed by regulators. The role of professional services of investment and financial consulting is increasing, and these services are urgently needed by companies today to arrange project funding for hotels.

In 2022, it is not easy to imagine that a bank could be involved in the financing of a large hotel without the participation of a reputable company with extensive experience in building hotels or running a hospitality business.

Project bonds for the hotel business

Project bonds are an alternative instrument for financing large investment projects in the hospitality industry or other sectors.

It is mainly about fixed income bonds, the interest and principal of which must be repaid by the cash flows generated by the hotel.

This instrument experienced the greatest growth after the 2007 crisis.

In the past, most projects were financed through lending institutions, but today project bonds offer institutional investors a greater opportunity to participate in hotel project financing through listed assets with more attractive returns at higher risks. The use of project bonds as a financing mechanism may be less attractive to low-risk investors, as a sector such as the hospitality or tourism industry in the post-pandemic era offers potentially high risks and restrictions.

In 2012, the EU launched an initiative to promote public-private partnerships (PPPs) through the issuance of more attractive project bonds for institutional investors to promote large projects.

This is achieved through strong European credit enhancement levers such as liquidity guarantees or subordinated debt schemes provided by the European Investment Bank and other major institutions.

This gave a boost to project financing through bonds, helping participants avoid potential liquidity problems that commercial banks in Europe often face when funding large projects.

Capital markets are accustomed to playing a leading role in financing large-scale projects through the issuance of bonds. However, since the credit crunch, they have become much less motivated and less willing to take on risk. Along with increased pressure on the financial balance sheet of many banks, this has led to a decrease in the number of adequate loan offers.

If we compare project bonds with syndicated loans (another common way to finance large hotel projects), they have a number of features that make them more attractive to institutional investors than to banks.

These benefits include:

• Bonds are "standardized" instruments that usually offer the best liquidity if the issue size is large enough to get the required resources in the market.

• The largest bond issues can become well-known indices, increasing the interest of a wide range of potential investors.

• Finally, project bonds can be issued with much longer maturities than syndicated loans.

Although project bonds in the hotel industry look like a financial product with great potential, there are also a number of limitations that make this tool unsuitable in some cases.

First, investors will only be interested in project bonds if the risk of construction has passed (for example, investments in existing hotel complexes). This limits the range of potentially suitable projects.

Secondly, investors are traditionally sensitive to independent ratings, which are compiled by external expert agencies. Although it is not necessary to have a rating, in the case of a bond issue, it is advisable to take care of good ratings.

The role of a business plan in hotel financing: investment consulting services

As we said above, the role of professional investment consulting services in hotel project financing is steadily growing.

This can be easily explained by the tightening of requirements in the financial sector, which is looking for reliable and well-prepared investment projects in order to avoid losses. An important role in attracting funding belongs to a solid business plan, which should reflect the potential opportunities, risks and limitations of the project.

Whether it's a bank or an investment fund, the hotel's business and financial plan will be key when deciding whether to provide large funds.



Potential lenders or investors want to know more about the history of the company, its current results, owners, services, the position of the hotel in the tourism market, its development strategy and competitors.

The business plan describes the history of the company and its development plan for the future.

It defines the mission and strategy of the company, its goals, resources, market, target group of customers and direct competition. Essentially, a hotel business plan is a plan of action, according to which investments will be realized and results will be achieved in the future. It should present a realistic picture of the future based on previous analyzes and studies, contracts and plans.

The project partners look to the business plan for answers to the questions listed in the table below.

Partner questions	Answers that a business plan should give
What are the chances of winning the market?	This question requires a clear description of the offer, information channels, analysis of the competitive environment, mechanisms for creating competitive advantage, and so on.
What are the operating principles of the hotel?	It is important to answer questions about the format of the hotel, its brand, type, organization, management method and other aspects.
What is the best way to implement the project?	Description of the company's plan for the implementation of the investment, including concept development, architectural plans, licensing, financing, professional management, and so on.
What is the knowledge and experience of the project team?	Large banks and institutional investors are willing to work with professionals, so they are more willing to provide funds to companies that have brought together teams with relevant organizational, financial and commercial experience.

A detailed financial plan for a hotel project is designed to answer any questions about the expected financial results in a certain period.

This plan is drawn up on the basis of reports, balance sheets, analysis of financial flows and changes in the company's capital structure. The finance team should pay particular attention to standard project financial performance indicators, sensitivity analyses, loan maturities, schedule of financial needs, etc.

A very important element of the financial and economic plan is the operational forecast, compiled in accordance with USALI (The Uniform System of Accounts for the Lodging Industry). This generally accepted system requires taking into account hotel services, organizational structure, staff motivation, hotel occupancy levels, service profitability, fixed costs, and much more.

The success of the project will largely depend on whether your company can obtain the necessary funding on adequate terms.

In general, the more effort a team puts into a hotel's business plan and financial planning, the more detailed, substantiated and persuasive documents a company can provide to potential investors and lenders.

A company that specializes in this type of consulting and has the knowledge, practice and ability to raise capital can help achieve this goal.

If you are interested in investment consulting and project finance services, the international team of Costex Corporation DBA is at your service at any time.