How are interest rates impacting lending in the hotel industry?

In August 2023, the Bank of England raised interest rates for the 14th time in a row to 5.25% - the highest they have been in 15 years. The interest rate rise to 5.25% is likely to have a significant impact on lending in the hotel sector in 2024, according to Greg Moreton, debt advisory partner at RSM UK. He claims that high street lenders are now more cautious when lending to hotels since it is now more difficult for hotel owners to pay that level of interest on the same amount of debt with the same EBITDA. He says: “Leverage in the hotel sector is measured by most lenders as a multiple of EBITDA (an indicator of overall profitability of a business) – as with interest cover, there is greater divergence in the market today than previously. Some high street lenders are now restricted to the 5-6x range, whereas others are looking to stretch towards 7x and even double digits in London.” Additionally, he added that hotel owners have discovered that while turnover has not decreased, EBITDA has due to cost pressures. As a result, lenders can now lend the corporation less because of the squeeze on the companies’ ability to pay interest. Moreton also stated that rise in interest rates mainly puts constraints on the capex side of things for the hotel industry. He explains that he was talking to a client who was interested in developing their properties and expanding the number of rooms, but with the existing borrowing constraints they have to might have to “put a hold on that” because they're okay with the debt they've already got, but it's going to be harder for them to raise additional debt to back their their plans for expansion. In such instances Moreton believes that larger portfolios are typically able to command higher leverage than smaller ones. He says: “When we talk about lending in any sector, bigger is better; that's how lenders think. And to be fair to them, it has been proven over many years that large businesses are typically more robust than smaller ones. And the reason for that is clearly diversification. If you own 10 properties, of which seven are doing well and three are not doing so well, that's fine. But if you only own three properties, and all three of those are doing not so well, you've got much more of a problem. So lenders tend to prefer those larger groups because of the diversification that offers them in terms of their risk.” However, Moreton suggests that smaller portfolios of single property hotels should potentially look wider than they otherwise might. He says: “We're going to advise them to start considering alternative lenders if they didn't think high street banks or more traditional banks could provide the leverage they would need to raise further capital. So there are a fair number of less well known banks who are called challenger banks. If the high street bank were to demand interest cover as high as 2x, in response, a challenger bank may offer interest cover assumptions as low as 1.2x, which would allow them to lend more money against the same asset. These challenger banks are willing to take higher risk, that would typically come at a slightly higher price. For instance high street lenders would lend between 2 and 3%, over base rates, but challenger lenders might lend 3 or 4% over base rates, or even 5%. So you might pay more, if you like, but you might have greater optionality, and greater variability to borrow a bit more.” Additionally, Morton notes lenders are also favouring leisure at present, believing the staycation trend will run further than business travel if a recession sets in. He stated that years back before COVID, business travel was often preferred because people believed that business travel would be constant unlike leisure that goes up and down with the market. He says: “Interestingly, now, business travel is less favourable by many lenders, but just because there is less of it and in business travel there's worry about corporate spend, whereas actually, leisure spending clearly, although that is cyclical, there's a feeling that UK hotels, may benefit, even as sort of spending on holidays, overall, perhaps comes down to staycations. If you've got the right sort of properties, you potentially are going to benefit from that.” But again, Moreton underlines that different lenders hold varying opinions and have different preferences. He has observed other hotel chains that are more concerned with the type of location than with sub-segments such as leisure versus business.While rapidly rising interest rates are currently the biggest challenge for the UK’s hospitality industry, Moreton explains how advisers can help hotels manage their finances better. He says: “We would advise them to do two things: go a bit wider than you otherwise would have done, and be smart and prepared. Make sure you work with an advisor to get the right package of information together that clearly explains your business and present your business case as well as you can. He concludes: “In the same preparation category, I'd say to make sure you leave plenty of time to go to the markets, because the full debt refinancing process might take three or four months or possibly longer in the current market. So, if you've got the maturity of your debt a year ahead, start thinking about going into the market to get that refinancing done now, so you leave yourself a good amount of time to run a proper process and explore all the options before you get timed out, basically.”