Hotel values have been soaring for the past two years as the industry pulled out of its prolonged post-9/11 slump. Deal volume is rising, too: Real Capital Analytics reports that investors bought $9 billion in hotel assets during the first quarter, nearly double the $5 billion volume posted during the first quarter of 2005.

Neither investors nor lenders show any sign of losing their enthusiasm for the sector. Not only are lenders tripping over themselves to fund deals in hotels — where fundamentals are expected to keep improving this year — but they are also loosening loan-to-value (LTV) requirements and accepting meager spreads.

“Spreads on both fixed and floating rate loans have tightened since the beginning of 2006 for hotels with strong sponsors in major markets,” says Arthur Adler, managing director and CEO of Jones Lang LaSalle Hotels. Despite the tighter spreads, Adler says that lenders have held firm on their aggressive underwriting standards over the past year.

Indeed, fixed-rate hotel spreads over 10-Year Treasuries have tightened by roughly 5 basis points since last fall; the spreads on floating-rate hotel loans have tightened by roughly 10 to 15 basis points over 1-month LIBOR. What’s more, narrow spreads may be here for a while. “Most lenders believe that, barring a major shock to the economy or a cooling off in lodging fundamentals, there won’t be any widening of spreads in the face of continued interest rate increases and a flattening yield curve,” says Adler.

Some recent deals illustrate how aggressive lending is driving many of the hotel market’s largest sales. In March, for example, Jones Lang LaSalle’s Real Estate Investment Banking group structured a 76% loan to value (LTV) package on a portfolio of five underperforming hotel assets. The owner/sponsor of the hotels was Apollo Real Estate Advisors, a private equity real estate investment firm. While a 76% LTV package is not extraordinarily high — many CMBS lenders are comfortable with 80% LTV on fixed rate loans these days — JLL’s Adler calls Apollo’s growth projections for the hotels “aggressive.”

But Apollo’s reputation, capitalization and experience allowed the lender to get comfortable making a high-leverage loan on the portfolio. Apollo, which was founded in 1993, has launched eight real estate funds worth more than $4.5 billion. Apollo and the Related Cos. developed Manhattan’s 2.8 million sq. ft. mixed-use dual-tower skyscraper at Time Warner Center in 2004, after securing a $1.3 billion construction loan (believed to be the largest private construction loan in U.S. history). The Mandarin Oriental Hotel occupies nineteen floors of the north tower.

Last week brought an even more highly leveraged deal. Morgans Hotel Group snapped up the 647-room Hard Rock Hotel & Casino in Las Vegas for $770 million. Morgans secured a $700 million loan from Credit Suisse to finance the deal (or 90% LTV).

Outstanding debt on the Hard Rock Hotel, which posted $13.3 million in net revenues for the nine-month period that ended on Sept. 30, includes $140 million in second-lien notes with an 8.9% coupon. The notes mature in 2013. Since Morgans assumed all outstanding debt on the property, its basis in the asset is intensely leveraged.

At least for Wall Street, it seemed like a deal too far. Analysts who follow the newly public $360 million hotel group (the stock debuted on Nasdaq as MHGC in February) were vocal in their disapproval. Morgan Stanley analyst Celeste Mellet Brown questioned how the company could handle such a large deal.

“It’s not an easy deal to swallow given the cost, earnings generation, (MHGC’s) existing debt, etc.,” wrote Brown in a Friday research note. Shares in MHGC closed at $15.70 on Monday, down 3.7% for the day and hitting their lowest level since the IPO priced at $20.00 per share.

Despite the Hard Rock deal’s lackluster reception, industry watchers expect more huge hotel loans to follow in coming months. That means that reduced average profits on hotel lending is here to stay for a while.

For investors, however, things can’t get much better than this, says Arthur Buser, managing director at Jones Lang LaSalle Hotels. “RevPAR is up 10% over last year in the top 20 markets and anyone who bought a hotel last year has already doubled their equity.”