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Hotel Real Estate Investment Terminology

Amortization Period – the timeframe during which the loan amount will be paid down to a 0 balance; most hotel loans have a 25-yr amortization period, but some may be 20-yr or 30-yr

Bankruptcy – the legal process by which an owner files to liquidate, reorganize, and/or rework debt terms; typically done in order to maintain a level of investment interest and have some debt forgiven

Cap Rate/Capitalization Rate – the ratio of annual NOI to value; NOI may refer to trailing 12-month NOI or projected NOI; a 10% cap rate is a quick method of valuing a hotel, although full-service hotels are generally have lower cap rates and limited service hotels generally have higher cap rates; = NOI ÷ value; in underwriting, the Going-In Cap Rate refers to the cap rate upon acquisition; the Terminal Cap Rate/Residual Cap Rate refers to the cap rate used by an owner to calculate the value of the hotel at the end of the hold period; = NOI ÷ value

Cash-on-Cash Return – ratio of annual NOI after debt service to the total cash invested in the hotel; the cash investment includes the equity investment in the hotel plus any additional cash invested in capital improvements by the owner; = (NOI – debt service) ÷ cash investment

CMBS – Commercial Mortgage-Backed Securities – an investment vehicle whereby a bank will package together loans of multiple assets (it may be a group of hotel loans, or it may be various types of real estate loans) and resell them as securities (similar to buying a stock) to other investors and/or lenders; for example, Goldman Sachs may package together $100 million for a hotel portfolio and sell $20 million to Wells Fargo, $20 million to Merrill Lynch, etc.; CMBS investments are often seen as less risky because even if a few properties underperform, other properties tend to outperform expectations and are still able to pay the overall debt on the portfolio  

CAGR – Compounded Annual Growth Rate – the annual growth rate for a data point assuming it grew at the same pace year over year; = (Current Value ÷ Original Investment )^(1 ÷ # of yrs) - 1; for example, if you invested $10.00 and it grew to $13.31 over 3 years, the CAGR would be 10% ($13.31 ÷ $10.00)^(1 ÷ 3 yrs) - 1; the RATE function in Excel is much easier

Construction Loan – financing for a development project; typically these loans are short-term, covering the construction timeframe (1 to 3 yrs); after construction is completed, the developer usually pays off the construction loan by refinancing with a Permanent Loan – a standard loan for existing hotels

Debt – money owed by a property to entities other than the owner; typically, this is the mortgage, but may include other obligations (mezzanine loan, taxes, etc.)

DCR - Debt Coverage Ratio/DSCR - Debt Service Coverage Ratio – the ratio of net operating income to annual debt payments; obviously, lenders want the property cash flow to be higher than the debt payments; generally lenders require DCR/DSCR to be 1.2 or higher; = NOI ÷ debt payment

Default – the failure of a property to meets the obligations of its loan agreement; typically, this means that the hotel cannot pay its debt service; however, it could be numerous other items (e.g. inability to fund the required capital reserve or its DSCR falls below the required ratio; it is often referred to as Technical Default when the property is able to pay its debt service but other loan provisions are not being met

DCF - Discounted Cash Flow – a method of valuing a hotel by discounting the projected cash flows by the expected return % (i.e. see Discount Rate) 

Discount Rate– the combined return % on an investment for both the equity and debt investors; essentially, the IRR on a hotel assuming there is no debt; sometimes referred to as Yield Rate; the Discount Rate/Yield Rate will always be at a level between the interest rate (the lender’s return rate) and the IRR (the investor’s return rate)

Due Diligence – the investigation into a potential investment

EB-5 – an immigration program that provides a method of obtaining a U.S. visa by investing in the U.S. and creating new jobs within specified Regional Centers defined by the government; if a foreign investor develops a hotel and creates new jobs in these areas of the U.S., their family members have an easier process of obtaining visas; essentially, they’re buying their way into the U.S.

EBITDA – Earnings Before Interest, Taxes, Depreciation, and Amortization – similar to NOI, but excludes deductions for reserve for replacement; = NOI + Reserve for Replacement

Equity – the property value attributed to the owner; often this is the cash invested in the property; 
= Value - Debt

Foreclosure – the legal process by which a lender forces the sale (typically via auction) of a hotel that is in default in order to recover its investment; the lender is often the buyer when the property is auctioned

FFO – Funds From Operation – used by REITs to define cash flow from overall operations; includes deductions for depreciation and amortization

Hold Period – the timeframe that an investor owns a hotel; in underwriting, owners typically assume a 5-yr or 10-yr hold period

Interest Rate – the rate of return paid to the lender; the interest rate on a Fixed Rate loan remains the same throughout the lifetime of the loan; the interest rate for a Floating Rate loan varies with a variable base rate; LIBOR (London Interbank Offered Rate – the average interest rate for lending among banks) is typically the base rate for floating rate commercial real estate loans; such loans may be LIBOR + 150 bps (Basis Points); 100 basis points = 1.00%

Loan Term – the timeframe during which the loan will be paid off; the loan matures at the end of the term, forcing the owner to pay the remaining balance; this is different from the amortization period; a loan can be amortized over 25 yrs, but may have only a 5-yr term in which case the balance on the loan needs to be paid at the end of 5 yrs (typically paid by refinancing the loan)

LTV – Loan-to-Value – the percentage of the loan to the overall property value; the value may be the purchase price, the development cost, the appraised value, or the current value + renovation costs; typically between 60% and 70%; = loan ÷ value

Mezzanine Debt – a form of secondary financing (similar to a 2nd mortgage); this is a higher risk to a lender and generally has a much higher interest rate

IRR – Internal Rate of Return – the annual rate of return on the equity investment; sometimes referred to as Return on Equity; the formula for IRR would prevent you to reading the remainder of this document; Excel has an IRR function that makes this calculation easy

NOI – Net Operating Income – annual cash flow from the hotel prior to paying debt service

Non-Recourse – a provision in a loan that prohibits the lender from seeking debt payments from the owner of the property (i.e. if Marriott International owns a hotel that cannot pay its debt, the lender cannot go to Marriott International to satisfy the debt) 

PIP – Property Improvement Plan –  a list of required improvements/upgrades necessary for a hotel to adhere to brand standards; typically PIPs are performed when a hotel is sold and the new owner has the burden of investing additional capital in order to maintain the franchise

Receiver – an impartial entity appointed by the court to oversee a property’s operation; typically done when a property is in the bankruptcy or foreclosure process

REIT – Real Estate Investment Trust – an special type of corporate entity that invests in real estate (on the debt or equity side); this type of company has special tax benefits (i.e. a lower tax rate), but has certain restrictions and is required to distribute 90% of its profits to shareholders

Recourse – a provision in a loan that allows the lender to seek compensation from the borrower when the property is in default; (i.e. if Marriott International owns a hotel that cannot pay its debt, Marriott International is obligated to pay the debt themselves); in such a case, the loan terms are often better than a non-recourse loan because there is less risk of the lender losing money on the loan

Refinancing – to pay off an existing loan with a new loan, ideally with better terms (e.g. lower interest rate, higher LTV, etc.); this may occur because the market has improved and the owner is able to obtain better loan terms or the asset gained value, allowing the owner to increase cash flow to investors and improve the overall IRR on the investment; or this may occur when the loan term of the current loan matures, forcing the owner to obtain a new loan; this is the problem that arose during the recent downturn: many loans matured at a point where values had declined and loan terms were difficult, resulting in numerous bankruptcies, foreclosures, and loan extensions/modifications

ROI – Return On Investment – the percentage gained (or lost) on an investment; = investment gain ÷ initial investment; for example, if you buy a hotel for $10 million and sell it for $12 million, the ROI is 20% ($2 million gain ÷ $10 million initial investment)

RRM - Room Revenue Multiplier – the ratio of value to room revenue; = value ÷ room revenue

Servicer – the entity that oversees that the borrower adheres to the loan agreement, including up-to-date payments; if a CMBS loan goes into default, a Special Servicer is hired to deal with the borrower and determine how to handle the loan which can include a foreclosure, modification of loan agreement, or a sale of the asset

Stabilization  – the theoretical point when a hotel’s performance has “normalized”; this period doesn’t really exist, but typically hotel projections are created for a 3- to 5-yr period until stabilized and then simply increased by inflation (usually 2.5% to 3.5% annually) thereafter 

Subordinate – refers to the fact that one entity’s position is inferior to another; for example, the mezzanine lender is subordinate to the primary lender, meaning that the primary lender is paid first and the mezz lender is paid next; thus, the mezz lender is in a riskier position if there is not enough NOI to pay them; the investor is paid last, and is in the riskiest position if NOI declines

Underwriting – the process of evaluating an investment, including its potential value, risk, future cash flow, probable return, and ability to fund debt; performed by both investors and lenders

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