That big 400-room, full-service Marriott Hotel is going to be a tough deal to finance this year. The 300-room Ritz-Carlton won't be any easier. But hotels will still get started in coming months.

They're likely to be the 100-room roadside inns where the closest dining room is the Denny's down the street and the manager doubles as housekeeper. To keep this species of lodging alive, the U.S. Small Business Administration (SBA) will be playing a central financing role.

It's no secret that hotel lenders have turned cautious, but with the SBA willing to guarantee 30% to 40% of the loans on smaller assets, banks and other institutions will be emboldened to stay in the game.

Entrepreneurs considering new construction or acquisition of an older property are likely to view the SBA as a critical lifeline in coming months. The numbers are compelling: Whereas conventional lenders right now are asking developers to put at least 35% to 40% of their own money toward a new hotel property, the SBA's relaxed standards require just 20% owner equity. The gap between the two often makes the difference between a deal getting completed or sinking into oblivion.

“I'm a huge supporter of the SBA right now,” says Reginald Heard, president and CEO of Bankers One Capital in Danbury, Conn., a mortgage broker and lender. “A lot of lenders have put a moratorium on hotel development. But the SBA is still making loans even to first-time hotel operators. I did eight SBA hotel deals last year, and I expect to double that in 2009. The agency will be very important to the marketplace.”

It's become a rock of support for aspiring innkeepers like Rick Bessie, president and owner of investment firm Winslow Group Inc. in Dallas. At 65, Bessie has been a hotel broker much of his life. But with brokerage volume slowed to a crawl, he now hopes to build his first hotel from the ground up. He's applying for an SBA loan and admits that without government money his vision would turn dark.

Bessie has a 2.2-acre site in a small town in east Texas that he declines to name, and plans to put up an 83-room Fairfield Inn & Suites. The cost will come to $6.7 million, typical for such a hotel in a small town. Bessie has enough for a 20% down payment, but not enough for the 40% that his Texas bank would require in a conventional loan arrangement.

“My personal financial statement isn't strong enough to get a conventional loan,” Bessie says. In his scenario, the bank expects to lend half the cost of construction conventionally. Another 30% will be guaranteed by the SBA. Bessie will kick in his 20%. “The bank's exposure is just 50% on a deal like this,” Bessie observes. “So its risk is quite limited. The SBA participation gives the bank great confidence to move ahead.”

The SBA also will lower Bessie's costs. His first loan will be priced close to a 7% interest rate, he figures. But the SBA-guaranteed loan for the other 30% will be priced at 4.5%. Bessie's pro forma calls for 60% occupancy of his new hotel in the first year after it opens in 2010. With the discounted SBA loan's help, his break-even point will be just 52% occupancy. Without the loan discount, break-even would rise to around 57% occupancy, he says, leaving little margin for error in the first year.

“The SBA is absolutely essential in this deal,” Bessie says. “Without it, the project wouldn't get done.”

Big plans for Boise

Hement Khatri has owned an SBA-financed Comfort Inn of 80 rooms in Modesto, Calif. since 2001 together with his brother Suresh Chandra. Recently they acquired a three-acre site in Boise, Idaho, with plans to erect a La Quinta Inn & Suites there for about $8 million.

The SBA caps its loans at $2 million to any individual or partnership, and Khatri and his brother still owe the agency $700,000 on their Comfort Inn. They are close to a deal to borrow a crucial $1.3 million to help complete the La Quinta financing. Mountain West Bank will provide the conventional financing, and the brothers will invest $2.5 million of their own money.

“Hotel financing gets held up for all sorts of reasons these days,” says Khatri, age 50. “In our case the bank asked us for an additional $500,000 in an escrow account in case our construction costs go over budget. That would be a deal-killer without the SBA help.”

Is there much downside risk? Khatri's hotel site is across the street from the Boise regional airport. There are other hotels in the area, but no other La Quintas. “It's one of the very fastest growing chains anywhere right now,” says Khatri. “Its popularity is what gives us confidence.”

Loan volume shrinks

Confidence is in short supply in the hotel industry of late. Even with its important role in the absence of regular bank lending, SBA hotel loan volume has dropped. In the fiscal year ended last Sept. 30, the SBA guaranteed 1,830 loans, down 15% from the 2,163 issued in fiscal 2007. The dollar volume was down 11% to $1.9 billion (see chart).

In the current fiscal year, SBA hotel loan volume so far is down 40% from levels a year ago. “People think our lending ought to be up because so many banks have stopped making loans,” says Grady Hedgespeth, director of the SBA office of financial assistance in Washington, D.C.

“But we can't overcome the broader dynamics in the economy. Demand from borrowers of all kinds has fallen a lot recently.” He adds that the applicants he does see are often less creditworthy than they were 12 months ago. The chief reason: the equity in their own homes has declined. “A person's ability to borrow is tied pretty closely to the equity in their home in many cases,” according to Hedgespeth.

Although the number of SBA loans dropped from 2007 to 2008, the value of the agency's loans has risen from $540 million in 2000 to $1.9 billion last year.

SBA lending has a checkered past, but Hedgespeth insists that most of the hotel program's old failings have been fixed. In some years, the SBA simply ran out of money and stopped lending. About five years ago Congress made the programs self-supporting, with various fees providing needed capital and no direct subsidy from government coffers necessary. So there is now plenty of money to lend.

Like a speeding bullet

The biggest complaint for a long time was the SBA's slow pace in loan review. Underwriting was spread across 68 district offices and maddeningly inconsistent, too. Beginning two years ago under Hedgespeth, new computer technology was added to make applications paperless, and much of the loan process was consolidated to a central office near Sacramento, Calif.

The results are positive. “We do 90% of our approvals in five days or less now,” Hedgespeth says. “When I travel around the country lenders invariably want to thank me for the huge improvement we've made in the approval process.”

Still, not every hotel broker is sold on the SBA. Joseph Epstein, president and owner of First American Realty Associates LLC in Fairfield, N.J., believes that banks' retreat from the hotel market has been oversold by the media.

Banks are still lending, he asserts, and in fact the market remains stronger than it was in the depths of the savings-and-loan crisis of 1990. “In 1990, there were 747 banks that had gone under. Today only 25 have failed and another 200 are on the watch list,” Epstein says. “Lenders today are still listening to borrowers and they're still making loans.”

Epstein observes that the SBA's central role today is in bootstrapping first-time borrowers in the hotel industry. “A conventional loan to a first-time developer is almost impossible to arrange right now,” Epstein admits. “The SBA is a great place to get started.”

The problem, he complains, is the SBA's strict limit of $2 million in hotel loans, a total that hasn't changed in years. “It would be nice if SBA raised that limit. I guess that small business is meant to be really small,” he says.

Signs of securitization life

Most casual observers of the commercial real estate market may not realize it, but loan securitization hasn't gone away entirely. Banks and other lenders are able to take the SBA-insured portion of their portfolios and sell it into the aftermarket to raise capital.

Lenders like PMC Commercial Trust, a direct-lender real estate investment trust based in Dallas, are doing that with loans arranged through the SBA's 7(a) program.

“The rates are so low on those 7(a) loans that they aren't real attractive, but there is a market for them,” says Laurie Ivy, PMC's senior vice-president of marketing. “We are doing very little conventional lending now, but we are doing 7(a) loans.”

Even with the SBA lifeline, PMC is scaling back. The company laid off 25% of its staff a few months ago. As recently as two years ago some 90% of the company's lending was to hotels. That share has shrunk to 50% as PMC has widened its scope to encompass restaurants, retail stores, and even gas stations.

“Two years ago just 20% of our loans were guaranteed by the SBA. Today 95% are SBA-insured,” says Ivy. “Without SBA we might be out of money to lend today.”

H. Lee Murphy is a Chicago-based writer.

See also: Tips for borrowers in securing an SBA loan

SBA LENDERS PUT OUT THE WELCOME SIGN

While many lenders have stopped making loans, the SBA is overseeing a robust book of business. Still, the dollar volume of SBA loans dropped 11% from 2007 to 2008.

Number of SBA loans* Value
2000 726 $540 million
2001 1,400 $1.1 billion
2002 1,454 $1.2 billion
2003 1,485 $1.1 billion
2004 1,655 $1.3 billion
2005 1,972 $1.7 billion
2006 2,109 $2.1 billion
2007 2,163 $2.2 billion
2008 1,830 $1.9 billion
Source: U. S. Small Business Administration
* fiscal-year ending Sept. 30, 7 (a) and 504 loans