TOUGH TALK: Refinancing hotels in today's market

Seven Tides Hospitality managing director Mike Scully reviews the banking dilemma and points owners in the direction of third party investors

As owners who are looking at refinancing their properties, I believe we have to go back and look at the fundamentals as to where we are today and what is going to drive tomorrow. This will lead to a more comprehensive business plan, which is what all refinance will be about; in other words, how well we will be able to service the debt that we are about to take on in the future?

We all know that many developers bought their land at high prices and built their properties during the boom time, and the dilemma now is how to service these debts on old terms. It is believed that in the UK — whose banks are prominent lenders in the UAE market — almost all commercial loans granted on properties after 2004 are now under water, where their value of asset to valuation drops below the stated figure in the loan documents. Here we have seen banks requesting waiver fees for the covenant breach or in some cases looking for additional guarantors to step in, however, most banks will not necessarily seek additional security or foreclosure on these loans as long as they are being serviced.

BUBBLE TROUBLES

If you look at the “bubble troubles” of the last three decades we note that in most cases these were western government led policy mistakes and in almost all cases they have resulted in, or were caused by, over availability of easy credit. This applies to the share crash of ’87, the dot-com crash and post 9/11, and the same applies to the latest property crash that we are experiencing at present.

Although western governments are now pumping cash into the market to stabilise their economies, this will not continue for long and in many cases the cash that has been pumped in is being used to push the profitability of the banks themselves through charging high interest rates even though they are borrowing at very low rates. We also note a conflict of interest whereby they are able to trade on the for-ex and commodities markets or run hedge funds for their own profitability. If they do decide to lend, very often they are at exorbitant rates requiring anything up to 200% security.

Many of the western world’s banks have loans on their books equivalent to up to 150% of the GDP of their sovereign nations. In many cases they have NPLs (non-performing loans) of between 10-15% of their overall loan book.

This indicates just what a dilemma the finance and lending houses of today are in and that is why we are finding that very little capital is going into creating new real wealth through productivity as opposed to paper wealth on the back of real estate or shares. We even know that expenditure in green industries, where there is enormous investment, is still geared more to efficiency than production.

PLAN FOR PRODUCTIVITY

It is, therefore, absolutely essential that anyone going for refinance, additional funds or even looking for start-up capital will need to show a plan for productivity as opposed to showing growth on the back of a boom. A business plan will need to show how they will create new markets, who their strategic partners will be and where their innovation is coming from. They will have to explain who their operator is, and the operator will in turn be required to justify how they will ensure that this business will remain profitable, take market share from competitor hotels and generate new business. In some cases if they cannot do this, operators must be prepared to stand aside for owners to bring in new operators who are able to adapt to the new business environment.

I believe that ultimately the banks, as they are at present, are not necessarily the answer as it will be a while before they can realistically understand the extent of their bilateral bank loans and other liabilities. We therefore need to look at funding or refinancing through third party investors, in many cases using the likes of private equity, venture capitalists and fund managers. I believe that there is enough individual wealth out there to finance tourism projects and hotels which have good business plans, have a diversity of product and will ensure sustainable growth and development in a new business environment.

PLAY BY THE RULES

It is imperative when seeking finance and refinance that several rules are adhered to:

Present worst-case scenarios

A well laid out business plan taking into account many of the above points. We have seen business plans that set out the various “alternative” scenarios, including worse case scenario of liquidations. The aim has been to show the financiers that not supporting a refinancing would, in the long-term, be the worst possible solution for all stakeholders in terms of asset destruction.

The key to some business plans is to show that as unpalatable as it may seem today, “hanging in” for the long term will result in the best return for the financier and owner alike. Refusing to assist in a refinancing could result in a fire sale, however, you must always remember that a solid business plan is still needed.

Research types of deals

Understanding of what type of deal you would like, for example; well researched between different lenders, banks and VCs — in many cases this could involve a change in equity shareholding which owners and shareholders may have to accept.

Best lawyers

Appoint the very best property lawyers available both to protect you and give advice particularly if they have previously been involved in similar situations.

Balance sheet

Have an understanding of your balance sheet and an awareness of cash flow requirements in order to maintain business. This also means you need a clear understanding of future business trends which not all owners are aware of and should also be included in the business plan as financiers are looking closely at business plans to see that all scenarios have been considered.

Timelines

A clear idea of timelines and where the additional funds, if that is what is required, will be spent.

Familiar lenders

It is generally accepted that best terms will probably still come from familiar lenders or partners as very often they have a vested interest to make it work.

Documentation

Make sure that all documentation and paper work is readily available and in place.

Security

In some cases you must be ready for additional security requirements or requests for a cash injection in order to show commitment to the project you are undertaking.

Covenants

Ensure that financial covenants are realistic to make sure that technical breaches of loan documentation are not infringed.

Mike Scully has worked for some of the leading hotel management companies worldwide — Sun International, Holiday Inn, Accor and Starwood — as well as developing and managing properties for the Dubai Government. He is currently managing director of Seven Tides — Hospitality, which will be opening four luxury properties in Dubai within the next 12 months and which also owns Dukes Hotel in London.