FINANCING OF HOSPITALITY PROJECTS
The financing of hospitality projects is a specialised lending and not all lenders are geared up to do the same.
CA ASHWIN MEHTA, MANAGING DIRECTOR PANKTI MANAGEMENT CONSULTANCY PVT LTD.
While the outlook for the hospitality sector is very positive, the lenders have shied away from funding new projects. Unless a promoter is already a hotelier with long standing experience and established brand name, the bankers insist on a tie up with reputed local or international brand for running the hotel.
Public & Private sector Banks are the major source of debt (loans) for hotel projects, but currently, they are not very active and private banks are very cautious. Private Equity/ Venture Funds are also hardly active in this sector. On the other hand, NBFCs have a lending horizon of 3- 4 years, whereas hotels require debt for 10 to 15 years.
One of the prime considerations is the financial strength of the borrower and conduct of his existing accounts with the banking system. The borrower should not be a defaulter in any of his existing or past borrowing. Also bankers will call for Credit Report from existing bankers, title search report of the land on which the project is to be constructed and Registrar of Companies search report to cross verify all the charges / encumbrances created by the Company till date and for other compliances. Bankers study the hotel operating agreements to ensure that they do not hamper their security creation or collection of dues from the project.
The bankers have various experts to carry out a feasibility study for the project that generally covers information and analysis of location / city specific demand supply assessment for the hotel project, expected Average Room Rate (ARR), occupancy levels, product type which is likely to succeed at a particular location, revenues from food & beverages, banqueting and other services, statistics of the visitors inflows in the past, justification for absorption of new rooms of the project, projections for next 10 to 15 years, estimates of project cost, etc.
In the current scenario many lenders are insisting on an External Credit Rating (ERA) at the time of processing the loan application. The ERA is done by credit rating agencies. Most of the lenders have norms that Investment grade rating (BBB) is a must for funding.
Normally for a hotel project the lenders will appoint a Valuer to do the valuation of the project including land at the time of initial processing and thereafter they monitor 64 the project through Lenders’ engineer who prepares the report of physical work done, cost estimates of the work done, etc.
The entire project consisting of land, building, equipment, plant & machinery, furniture & fixtures, electrical installations, etc. is mortgaged by banks as primary security. In a case where the land is not mortgeagable or the value of the land is very low or lenders perceive higher risk, then they ask for additional security (collateral) which can be any other real estate, shares and stocks, any other valuable assets.
Also bankers will insist for a personal guarantee of all the promoters and corporate guarantee of the holding company or a group company where the project is put up in a SPV. The lenders want to be doubly sure of the resources of the borrower.
This is one project where debt: equity ratio is preferred at 1 as most of the hotel projects are able to generate revenues only in the long term and higher interest burden can make the unit sick unless the promoters are resourceful.
Most of the lenders will insist that at least a sum equivalent to soft costs (consultant fees, interest during construction, preoperative expenses, contingent expenses, etc.) and land cost is brought in by promoters. Bankers will put a condition that unsecured loans from promoter group, though treated as quasi capital, cannot be withdrawn till the loan is fully repaid.
There is no formula to arrive at a prudent debt equity ratio, but I suggest that one must work out a figure that project can bear over the tenor of the loan and arrive at the debt component.
Many promoters wrongly perceive hotels as a steady income yielding asset with huge valuation in just a few years down the line but, a hotel project is highly cyclical and the revenue generation may not happen as per the projections. It is pertinent to note that the hotel project even if it is a runaway success will still take at least 12 to 15 years to pay back assuming all other external factors are favourable.
In case of cost overrun, it is to be funded by the promoters as banks are very hesitant in funding extra amount. Also lenders calculate debt per room to assess whether the project is viable or not.
Moreover, a promoter needs to declare COD (commercial operation date) which is recorded by the lenders. The project needs to achieve this date or the grace period of 24/12 months, otherwise banks will have to declare the project as a technical NPA, in spite of the fact that there is no financial default at all. This is as per the RBI guidelines.
An upfront equity infusion may look harsh on the promoters but it helps in complying with lenders sanction terms of bringing a particular portion of promoters’ contribution upfront and increases confidence level of the lenders.
This facility is availed as a sub limit from the main term loan when there is an import component in the project.
This is the main type of financial facility availed by all the projects and is mainly availed for 10 to 15 years.
WORKING CAPITAL FACILITIES:
On the hotel becoming operative it may require working capital limits against its stocks and debtors and these are sanctioned by banks either at the time of initial sanction or at a later stage.
It reduces the interest expenses during construction and also helps in indirectly increasing door to door tenor of the loan as one can always get a sanction for the tenor from the date of first disbursement. Upfront equity infusion helps in case of delays as COD can be tied up stating so many months from the date of first disbursement.
It is important to understand that banks are reluctant to sanction longer tenor loans not only because of lack of willingness but also because of the non-availability of long term funds to them resulting in asset liability mismatch (ALM) at their end.
One has to be very careful in drawing up repayment schedule for the loan over the loan tenor. One must first of all attempt to get a moratorium period of at least 18 to 24 months after the hotel becomes operative, so during this period only interest is to be serviced.
The repayments should be planned taking into seasonality of the hotel business. For e.g. higher amount can be repaid during peak tourist season. Similarly one can plan for stepped up (ballooning) repayment. That is the instalment amount will increase in progressive manner.
Promoters must start the construction only after obtaining all possible permissions because there is no relief from RBI for COD not achieved because of nonreceipt of timely approvals.