Return to our Home page Search
Click here for the hotel and hospitality news from around the globe Hotel, Travel and Hospitality Articles Videos and in-depth Interviews
Read more now
Read more now
Read more now
Filling the Cap Stack Gap.
By William G Sipple
Saturday, 25th January 2014

Even with great availability of low cost senior debt today, we still see a lot of projects suffering from a gap in their capital stack.

Most of these deals are new construction projects, but there are plenty of acquisitions that have the same issue. Many of the owners are seeking some type of “passive” equity to get their projects off the ground. They are hoping to identify groups that will take a non-controlling interest in a project and settle for lighter equity returns.

They often prefer to see these investors come in through the riskiest phases of the project and want to exit them from the deal at or prior to stabilization. While there are certain groups out there that will invest in deals on this basis, they are few and far between. Owners and developers would be better off seeking a structure that appeals to a wider range of the capital sources.

The options available to owners to fill the gap will vary based on a project’s, size, quality level, geographic market, product type and sponsor experience. It is generally the case that good quality assets in strong markets with experienced sponsors will have a much higher probability of attracting capital. Potential sources of gap capital include:

  • New Market Tax Credits
  • Historic Tax Credits
  • Special Tax Districts
  • Tax Increment Financing/Tax Sharing
  • Key Money from brands and/or management companies
  • Subordinate Debt
  • Preferred Equity
Each of the first four areas above could fill a column on its own. They all require significant work to assemble, and often the timing requirements are so lengthy as to make them impractical. Putting together a hotel capital stack can be like assembling a puzzle with moving parts that must come together simultaneously. The latter three options, on the other hand, can be effective tools that are negotiated in a reasonable amount of time.

KEY MONEY: Key money from the brand or management company can be an excellent way to bring additional capital to a deal. It is often structured as a loan that burns off over the term of the agreement. The term can sometimes be negotiated down to a shorter period. There is generally no interest paid unless the “loan” goes into default.

Companies usually do not want to be the first capital into the deal, so they time the payment to occur once the property opens or is substantially complete. It is sometimes earmarked for specific project costs like FF&E, working capital, or project operating shortfalls.

The corresponding negative for the owner is that there is less flexibility in negotiating many of the management or franchise terms, including fee structure, contract term, termination provisions, and performance outs. Just remember, key money is not “free” by any means.

SUBORDINATE DEBT: Subordinate debt, usually structured as Mezzanine Debt, can be an effective tool to get more leverage into the transaction. It is priced higher than senior debt, but below equity return rates, and is secured by an assignment of the ownership interest of the borrower.

Owners can often layer mezzanine debt on top of the 65% to 70% loan-to-value senior loan to get to an overall loan-to-value in the 80% to 85% range. The cost of this capital can be from the high single digits to high teens, depending upon the project specifics. It is generally co-terminus with the senior loan and may be interest- only at a lower rate to allow for the property’s cash flow to cover the debt service payments.

In this case, payments are then trued-up to the lender upon a sale or refinancing of the hotel. Mezzanine lenders are very concerned with seeing a viable exit for their position. They also consider what their basis in the asset will be if the borrower defaults. They adjust their cost of capital to reflect the perceived risk associated with the loan.

Potential negatives are the increased risk associated with higher overall leverage, the difficulties in negotiating an inter-creditor agreement, and the potential tax liability in the event of a default where there is forgiveness of debt.

PREFERRED EQUITY: A third option for some projects is preferred equity. Owners should be realistic about how this capital will be structured and need to be prepared to share the project returns. Preferred equity may be structured as a direct ownership interest in the hotel with a stated return that may or may not include a “kicker” in the event of a capital event like a sale or refinancing.

Alternatively, the deal may also be structured with a Promote position with Cash Waterfall feature. In this instance, the owner/developer has a “promote” position in its participation in the hotel’s cash flow. The preferred equity may have a “pay rate” during the term of the arrangement, with a true-up rate upon a future capital event.

For instance, the preferred equity will capture the first cash flow produced by the hotel until a base level of return is achieved. Cash flow over that amount would be split according to a negotiated formula, or “cash waterfall.” There may be multiple thresholds above the base level.

Upon a sale or refinancing of the asset, the preferred equity would typically receive the first cash flow taking it to a higher return, say 20 percent. The negotiated cash waterfall formula would then dictate splits over the higher return to the preferred equity.

Advantages to preferred equity include lower overall leverage, which may result in better debt terms; no need for an inter- creditor agreement; no personal guarantees; and in the event the project returns are lower than expected, you usually won’t get wiped out if the cash flow doesn’t cover the preferred equity minimums.

The bottom line is there are numerous options for filling a capital gap, but owners should be realistic about structuring terms that are capital friendly and the compromises that will be needed. There is very limited availability of truly passive equity that is content with mediocre returns and narrow control provisions. Owners should focus on the structure that works best for all parties.

About William G Sipple

William (Bill) Sipple is executive managing director of HVS Capital Corp (HVSCC), where he leads a team of professionals that provide a wide range of real estate investment services on an international level. HVSCC is the investment banking arm for HVS, and has extensive experience in debt and equity raises, asset sales, and capital structuring. You can contact Bill at (303) 512-1226 or or His “Inside Financing” column will appear regularly on

Advertise with ...[Click for More]

~ Important Notice ~
Articles appearing here contain copyright material. They are meant for your personal use and may not be reproduced or redistributed. While 4Hoteliers makes every effort to ensure accuracy, we can not be held responsible for the content nor the views expressed, which may not necessarily be those of either the original author or 4Hoteliers or its agents.

Learn more about DigiJames - in room technology
 Related Articles  (Click title to read)
Underwriting Your PIP.
Competing For Deals - How to Get Your Offer Accepted.
Hotel Financing Obstacles And How to Get Around Them.
The Fine Art of Hotel Sale Adjustment.
 Latest News  (Click title to read article)
Using science fiction to innovate
Wednesday, 20th August 2014

5% increase in passenger traffic in first half of 2014 recorded
Wednesday, 20th August 2014

3 things hoteliers must budget for in 2015
Wednesday, 20th August 2014

US resorts spark investor interest
Wednesday, 20th August 2014

Hospitality2015: game changers or spectators?
Wednesday, 20th August 2014
 Latest Articles  (Click title to read)
Ritz-Carlton Brings Brand Insights To LinkedIn
Wednesday, 20th August 2014

Global Update: Who's Where and Doing What - July 2014
Wednesday, 20th August 2014

SEO is a Journey, Not a Destination
Wednesday, 20th August 2014

Smartphone Check-Ins: Not Quite an Aladin's Lamp
Tuesday, 19th August 2014

How Hotels Can Engage Gen X and Millennial Guests
Tuesday, 19th August 2014
 Most Read Articles  (Click title to read)
Global Update: Who's Where and Doing What - June 2014
5 Social Media Trends to Embrace this Year
Global Update: Who's Where and Doing What - May 2014
Marriott Offering Rewards Points for Social Media Posts
New HR Study: Candid Recruitment Experiences with LinkedIn
 Useful Links  (Click company to visit)
A-Listings - Exclusive Links Section @ 4Hoteliers

AETHOS Consulting Group ~ Overview and Articles

Book Hotels & Travel

Connect with us at LinkedIn

Customized Hotel & Restaurant Equipment

Digital Innovation Asia

Follow us on Twitter!

Hospitality Consultants ~ Lifestyle Concepts

Hospitality IT & Technology

Hotel Opening Processes: Exploring better ways to open new hotels.

ITB 2015 Marketing

Private, luxurious holiday villa in Valbonne

Sayang - For True Wine Lovers

TravelDaily China Travel Distribution Summit - Live Interviews

Wynamics ~ Working the Dynamics of Wine

ZIXI - Your Asian Partner: Advisory - Sourcing - Project Management - Market Entry

© Copyright 4Hoteliers 2001-2014 ~ unless stated otherwise, all rights reserved.
You can read more about 4Hoteliers and our company here

Use of this web site is subject to our
terms & conditions of service and privacy policy