Hotel term sheets lead with debt yield now, and that's the whole conversation

Question

Been reading hospitality term sheets from the credit side rather than the equity side and something has hardened. Nobody sizes off cap rate or even off DSCR as the binding test anymore, it's debt yield, and the numbers I'm seeing sit around 10.5 to 12 percent depending on segment and market. Full-service and resort quotes come in wider than extended-stay.

Stack it up on a real case. 1.9m of trailing NOI at an 11% debt yield gets you 17.3m of proceeds. Seller wants 23m. That's a 5.7m equity check on a 75-ish percent LTC deal that used to be a 3m check, and if there's a PIP the lender wants escrowed on top of that, the equity is closer to 7m before working capital.

So the equity has to accept a lower levered return or the price has to come down, and sellers of decent hotels are not in a hurry. My question for the room, is the debt yield floor the real constraint on institutional hotel deployment right now, or is it just the number lenders point at while the actual hesitation is that they don't want cyclical operating businesses on the book at all?

Rena Expert · Accepted Answer

The debt yield floor and the hesitation are the same thing expressed once as a covenant. Debt yield is NOI over loan amount with no interest rate and no amortization in it, which is exactly what a lender reaches for when it doesn't trust the durability of the income. On a hotel that income reprices nightly, so a lender sizing to 11% is saying it wants the loan to survive a RevPAR decline it can't forecast. Wider quotes on full-service and resort follow from the same logic, because those P&Ls lose more NOI per point of RevPAR decline than extended-stay does.

Your arithmetic is the live problem in the sector. When proceeds are set by trailing NOI rather than by a forward projection, the seller's asking price has to be met by equity, and equity in a cycle-sensitive asset wants a wider return, so the bid and the ask separate and volume thins. That shows up as fewer transactions rather than as visible repricing, especially in the dozen or so states where sale prices are not public and you can't verify what actually traded.

Where it breaks is your trailing NOI. If that 1.9m includes a strong leisure year that isn't repeating, the lender's 11% test is being run on a number that's already the peak, and your real debt yield in year two is lower than the term sheet implies. The lender knows this and prices for it. Ask which twelve months they're using and whether they haircut ancillary revenue.

The piece your framing leaves out is who runs the building. Lenders underwrite the operating agreement as much as the asset, and a franchisor comfort letter plus an operator the lender has seen perform can move proceeds more than a quarter point of debt yield argument will. Get the sizing basis in writing, since these terms move.

tylerbrooks9 · Answer

So the loan is small because nobody can promise next year's room rate. That actually makes sense to me for the first time.

omar_haddad · Answer

The PIP escrow on top is what gets underestimated. If the lender holds 125% of a 3m scope, that's 3.75m of your equity sitting in a controlled account being released on inspection draws, and draws on hotel renovations move slowly because the inspector wants rooms complete and returned to inventory. Your equity is funding a construction job and a hotel's operating losses at the same time.

tashaford30 · Answer

Does the debt yield get tested again during the loan, or only at closing?

chriswalton8 · Answer

quill, in what I've read it usually reappears as a cash management or springing lockbox trigger, so if debt yield falls below some level the lender sweeps cash flow. Which is the part equity should care about most, because that's the mechanism that turns a soft travel year into zero distributions while the sponsor is still charging asset management fees.

marcus_hale41 · Answer

I don't fully buy the framing that the constraint is credit. The gap I keep seeing is that sellers who bought before the rate move have low fixed-rate debt and no reason to transact, so the assets available at 23m are the ones with a problem. Debt yield isn't stopping good deals, it's revealing that the deal flow is adversely selected. tender, of the term sheets you've read, how many were on assets that had already been marketed twice?

dmitri_v6 · Answer

canton's point and the credit point aren't in conflict. Both show up in the loan documents as tighter covenants, more recourse carve-outs and a longer list of events that trip cash management. If you want to know what a lender actually thinks of the segment, read the definition of "excess cash flow" and count how many things get paid before the borrower does.

Hotel term sheets lead with debt yield now, and that's the whole conversation

7 replies