by Richard Price & Bruce Woodry
Throughout recent history of
our economy, both in United States and globally, economic cycles have varied
and destination resort businesses, depending on tourism and corporate
spending, followed the economic trends.
From an economic cycle
standpoint, the cyclical nature of earnings is intertwined with the ability to
finance resort. Banks look at
historical NOI or EBDITA, while investors look at Pro Forma NOI or EBDITA. At different times and economic cycle, within the overall
funding envelope, different ratios of debt to equity prevail.
Unfortunately, at some point
traditional valuations, dead equity ratios, and investor returns are out of
balance. This may mean from a purchase standpoint it is a perfect time to buy,
but poor time to sell or refinance.
In today=s environment, funding a resort is difficult and can
take between six and nine months. During
this time the economic cycle may change from when your initial financial
strategy was set. Because of the
dynamic nature of the capital and credit markets, it=s
imperative to plan your financial strategy in advance, to allow for creativity
and flexibility should your first preferred funding option become non-viable.
Unfortunately, most resort operators have little experience in this
area.
To understand if the purchase
or refinance is viable from an investment standpoint, it is first important to
understand the fund-raising process. While
too detailed for this article, the main points are as follows:
Prepare a financial model to understand total funding requirements. Add
the additional funds needed for closing costs, working capital, unpaid taxes
and improvements.
Determine the amount of debt the property will support based on the
Loan-to-Value and Debt Service Coverage ratios.
Calculate the equity required, as the difference between the total
funding requirement and the debt.
Calculate the investor returns, and compare to competitive industry
rates.
One of the keys to success in
any destination resort property is to make sure that your financial modeling
depicts adequate funding for the purchase, but also anticipated capital
expansions, addition or updating of amenities, and for ongoing operations. Financial modeling of operations, improvements and
transaction costs will quickly determine whether the transaction is viable,
and can provide investor grade returns and support lending requirements.
Underfunded properties soon fall victim to poor maintenance, poor service, and
competitive pressure from resorts more adequately capitalized.
What happens if after careful
consideration and prudent financial modeling of the loan terms and the forward
looking projections, the economics just don=t work. Perhaps
a rethinking of the financial structure may be in order.
For instance, in certain times
of the economic cycle, finding equity for a transaction requires higher internal
rates of return than other periods to acquire equity at competitive market
rates. Therefore, capitalizing of
certain aspects of the development project may heavily impact retained equity.
During these periods, Acreative
financing@
may mandate certain trade-offs between operational cost and cost of capital.
The financial strategy, or the
amount of debt & equity to be arranged for any project, may need to be
adjusted for marketplace conditions. Perhaps
projects are delayed, improvements down scaled, necessary expansions tabled.
But it is also important to
understand the core capabilities of the management team & developer, as well
as what is realistically to be retained after paying of debt and suitable
returns to the investor. For
instance, the core competency may be in running the resort, but fund-raising
might be a limitation. Or more
traditional methods might give way to creative structuring=s, like hotelminiums, fractional ownership, etc.
where the cost of capital and asset collateralization is pushed off to a wider
ownership base. By spreading the risk, but also the rewards, to a wider base,
the project may become liable.
But care must be taken so that
any financial structure does not seriously impact long-term exit strategies for
the investors. For instance,
breakup strategies may provide short term fix for fund-raising problems, but
long-term, the value of a consolidated entity could be diminished.
If the initial financial
strategy does not work, is important to re-design your financial and corporate
strategy to be consistent with current marketplace conditions. Redesigning a
plan on the fly@
is often difficult and may cause enough concern from potential lenders or
investors so they back out of a project. Of
course, it is best have a cogent, integrated corporate & financial strategy
before going to the capital and credit markets.
Operators who are unfamiliar
with the fund-raising process, financial strategies, who do not have an
understanding of the current dynamics of the capital or credit marketplaces, or
cannot communicate their story in succinct financial terms would be well advised
to retain an expert adviser in this area.
Richard Price & Bruce
Woodry are investment bankers for Sigma Capital Group in Raleigh NC. They bring
a wealth of knowledge gained in a variety of real estate transactions totaling
over $3 billion.
WWW.SigmaCapitalGroup.net