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Demand rising for hotel construction: CFO Capital

Many new players entering the hospitality sector across Canada, president Mark Kay notes

Hampton Inn & Suites by Hilton Toronto Markham. (Courtesy CFO Capital)
Hampton Inn & Suites by Hilton Toronto Markham. (Courtesy CFO Capital)

Demand for hotel construction has returned and, with financing being made available to the sector, CFO Capital president and principal broker Mark Kay said there are more projects underway now than prior to the pandemic in 2019. 

Somewhat surprisingly, Kay noted at least 50 per cent of those looking to develop hotels have never previously built or managed these types of properties. 

“Mostly all the new entrants are focusing on secondary markets across Canada,” Kay told RENX. “These are well-heeled entrepreneurs with other successful businesses, or in other successful real estate sectors, that want to diversify into hotels. And because there's a lack of product, they were looking at the construction side just to get in as an entrant.” 

Even though hotel construction costs are at historical highs on a cost-per-key basis, according to Kay, there’s now a proven 12-to-18-month track record of stability in the sector from a revenue per available room (RevPAR) perspective, and pro formas are pencilling out favourably.

“If your cost of construction is equal to or less than your completion value, the lenders will participate in the construction financing,” Kay noted. 

Financing is available for hotels

Markham-headquartered CFO has provided capital to all commercial real estate sectors since 2004, raising billions of dollars for its clients. 

Its team members have 150 years of combined commercial banking experience and relationships with more than 100 industry partners, enabling it to create customized financing structures for developers, investors and owner-operators.

The majority of institutional lenders have a moratorium on office properties at the moment. Land also has a challenged debt market, unless it can be proven construction can take place within 12 months and that a lender can participate on the construction side, according to Kay.

“We're seeing a lot more land coming to the market through either receivership or forced sale, with a reduction in values compared to 2019,” Kay observed. “Banks will not finance the investor anymore if it’s not a developer.”

This has been going on for the past year and Kay expects to see more of it during the next 12 months. 

Institutional lenders are involved

CFO works with institutional lenders and Kay said it’s been trying to educate them on the health of the hotel market. It’s apparently been working and institutional lenders are viewing hotels as operating businesses as opposed to just a piece of real estate.

“I would say 95 per cent of the institutions are back lending in this market compared to pre-COVID,” Kay said. “The debt is liquid but it comes with new underwriting requirements.

“New entrants, for example, need third-party management. New entrants that have never built before would also have to have a fair amount of liquidity for cost overruns.”

Kay said lenders are going as high as 75 per cent on a loan-to-cost basis for hotels, typically for a three-year term.

“There’s 18 months to two years for construction and 12 months as an interest-only ramp-up period, which is pretty healthy,” he said.

In addition to diversifying commercial real estate portfolios, hotels act as a natural hedge against inflation as average daily rates generally increase during inflationary times as well and maintain healthy margins.

A success story example

CFO previously arranged construction financing in 2018 for the 110-key Holiday Inn Express & Suites in Aurora, Ont., for an industrial developer that owned land visible from Highway 404 and was looking to enter the hotel space. 

“There was no new product in that area so he ventured into construction,” said Kay. 

The six-storey hotel’s performance after the COVID-19 pandemic has exceeded expectations and CFO is now arranging construction financing for the developer’s new 125-key Staybridge Suites hotel next door.

Hotel interest is across Canada

In addition to its Markham headquarters, CFO also has offices in Halifax, Montreal and Vancouver involved with financing for acquisitions, construction and refinancing of hotels and resorts as well as projects involving land and retail, industrial, office, multiresidential and special-use properties.

Kay said CFO has seen a recent surge in hotel and resort activity and is currently engaged with financing full-service, focused service and lifestyle/boutique hotels in and around Montreal, Ottawa, Toronto and Calgary as well as limited and focused service acquisitions in secondary and tertiary markets across Canada.

“It’s all attractive now because every brand has their niche and there’s a demand for all of the brands,” Kay noted. “We have quite a bit in the pipeline right now for acquisitions where there’s a significant requirement of CapEx.”

In addition to the two Aurora properties, hotel projects CFO has arranged financing for over the past six months are:

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