Building a new hotel business or developing an existing one is often enabled by raising external capital. Hotel financing can be executed through loans, equity investors, or a mix of both. Securing the right financing partners can generate faster and more strategic growth than what would be possible with internal capital alone.
Investors are increasingly interested in hotels as a real estate asset, as consumers continue to prioritize travel. According to PwC, 25% of global employment growth in the next 10 to 20 years could come from travel and hospitality.
Especially those hotels that provide guests with unique experiences and are somehow differentiating themselves in the market are once again seen as attractive real estate investments after the uncertainty caused by the pandemic. This is good news for those who are looking to get funding for a hotel.
There are many things to consider when choosing the right financing option and partner. This article gives an overview of the pros and cons of debt and equity financing, and how to present your case to lenders and investors in a compelling way.
What is Hotel Financing?
Hotel financing is the process of obtaining capital from external sources such as banks, private equity firms, or institutional investors to support hotel-related projects. These funds may be used to:
- Acquire an existing hotel property
- Develop or construct a new hotel
- Renovate or reposition an aging hotel asset
- Refinance an existing hotel loan
Hotels as investments differ from other, more traditional real estate assets. Office buildings and logistics centers can benefit from 20-year leasing contracts, while hotels operate on nightly leases and have fluctuating income based on seasonality. Furthermore, hotels are considered more high-maintenance and complex as they require management across multiple departments such as rooms, F&B, and spa.
Due to this complexity, finacning hotel developments requires a different approach from other types of real estate lending. The quality of operations and the management team become points of evaluation for investors and lenders, because a great location or brand are, simply put, not enough on their own to sustain a successful hotel business.
This is why financing partners want to see thought-through operational planning and performance forecasts for the property before committing their capital to the cause.
How to Finance a Hotel: Types of Hotel Financing
The best hotel financing option depends on your specific goals. Are you looking to acquire land to construct a hotel, or is your established hotel business in need of a repositioning in the market? How involved do you want your external partners to be? Each option comes with its advantages and trade-offs. Below, we explore how they work.
Debt Financing
Debt financing refers to borrowing capital through a loan that must be repaid over time with interest. In the context of hotel lending, which can include hotel business loans from banks or lending institutions, commercial real estate loans, or even government-backed financing programs.
The loan terms, such as the repayment schedule and interest rate, are typically negotiated between you and the lender, and the conditions vary based on the lender’s risk assessment. Factors such as the stage of the economic cycle and the strength of your business plan may impact the result.
Pros and Cons of Debt Financing for Hotels
Ownership retention is considered to be one of the main advantages of debt financing. The interest rate or the cost of debt is what the lenders earn for the capital they provide, but they do not gain any decision-making power or ownership rights in the business. Another benefit of debt is that interest expenses are often tax-deductible, reducing your hotel’s overall taxable income.
The downside of debt financing is the associated risks. If you are not able to follow the agreed-upon repayment schedule or make the interest payments, it can lead to default. Many loans are tied to collateral, such as hotel real estate, meaning that the lender could seize the asset if obligations are not met.
That said, debt financing your hotel project is a great option if you have a solid business plan and stable cash-flow projections to cover the associated payments, all while allowing you to maintain full control of the business.
Green Financing for Hotels
The hospitality sector, which is known for contributing significantly to global carbon emissions, is going through a shift towards sustainability, partly due to pressure from investors and clients. As a result, environmentally focused funding solutions are becoming more accessible for hospitality projects.
Green financing refers to the funding of projects that have positive environmental benefits. In some cases, financing could be performance-linked, where interest rates or loan terms are tied to a business’s ability to meet specific sustainability targets, such as maintaining a green building certification or reducing energy consumption. In this case, the use of funds does not have to be ESG-related.
This type of funding can be a great opportunity for hotel ventures with environmental considerations at their core, such as sustainable property construction or operations. Furthermore, hotels can look into financing upgrades that reduce their environmental footprint, such as intelligent energy management systems.
What is Equity Financing for Hotels?
Pros and Cons of Equity Financing for Hotels
The Hybrid Option: Mezzanine Financing for Hotels
Debt vs. Equity Financing: Which One is Right for Your Hotel Project?
On the other hand, equity financing may be the right fit if you are aiming for aggressive growth or expansion, because it gives you access to larger pools of capital without the burden of repayment schedules. However, in exchange, you do have to give up some ownership and potentially, some control.
How to Get Funding for a Hotel
So, how to get funding for a hotel? It starts with building a compelling business case to present to potential financing partners, who do not just want to see a great idea but a concrete plan for the use of the capital you are asking for. Here are some important pillars to include in the business plan:
- Capital Expenditures (CapEx): A detailed breakdown of how much money is needed and what it will be used for, e.g., purchase, construction, FF&E (furniture, fixtures, and equipment), or technology upgrades.
- Forecasts and Return Expectations: What is the expected effect on revenues from the capital expenditures? Include realistic revenue projections and an estimation of breakeven. A well-modeled forecast helps investors understand when and how they will see returns on their investment.
- Strategy: What is your positioning in the market and your target client? Explain how the investment will make your property stand out (e.g., design, service, niche)
- ROI and Exit Strategy: Clearly define the intended return on investment (ROI) of the project and possible exit scenarios for equity investors.
In addition to showing the specifics of the project, it is important to present your hotel’s performance. Investors assess several key performance indicators (KPIs) when evaluating your hotel’s performance, including
- RevPAR (Revenue per Available Room)
- LTV (Loan-to-Value Ratio): measures the loan size relative to the property’s value
- NOI (Net Operating Income): the hotel’s earnings after operating expenses
- Debt Yield: NOI divided by the loan amount is used by lenders to measure risk
- Cash Flow: Indicates the hotel’s ability to meet short- and long-term obligations
Showing operational excellence in terms of management is also very important. Because hospitality is an operationally intensive industry, investors will consider any operational risk factors by looking at your ability to manage staff, guest satisfaction, and cost control effectively. When all departments are working seamlessly together, there is less risk, and the property is more valuable.
Ultimately, qualifying for hotel financing comes down to proving that your project is both financially sound and operationally possible to execute. Investors need to be confident not only in your concept but in you and your team’s ability to deliver on the presented plan.
Common Mistakes to Avoid in Hotel Financing
Securing hotel financing is just as much about credibility as it is about numbers. Avoiding the following pitfalls will help you present a stronger case and increase your chances of capital-raising success:
Inadequate Business Planning
Whether you’re acquiring an existing hotel or building one from scratch, financing decisions cannot be based on intuition. It is absolutely critical to thoroughly understand your project’s financials, the market context, and expected performance, because a vague or overly optimistic business plan signals poor preparation to investors.
Underestimating Operational Costs
Operational costs are the engine of your hotel’s profitability. Overlooking staffing, maintenance, or fluctuating utility costs can lead to falling short of budget, which directly impacts your ability to meet debt obligations or provide returns for investors. Be conservative and (painstakingly) detailed when modeling your operating budget.
Overlooking Operational Risk Factors
One of the most underestimated financing risks is inadequate hotel operations, and many financing proposals focus too much on forecasts and too little on execution. Ensure that your plan includes strategies to address any operations-related disruptions, such as labor shortages or changes in guest expectations. Lenders and investors know your hotel business is only as strong as your ability to deliver a consistent guest experience.
Failing to Align on Long-term Vision
Financing a hotel is, in most cases, a long-term commitment spanning several years. If your vision regarding growth strategy, branding, or exit timelines for the property differs from that of your investors, conflict is likely. Make sure everyone is on the same page early on to avoid misalignment later.
Secure the Right Funding for Your Hospitality Vision
Even though it often is a multi-year commitment, with the right knowledge and partners, hotel financing does not have to be intimidating. Yes, hospitality carries its unique risks, but it also offers exceptional potential for growth and innovation.
By understanding your financing options and their benefits and drawbacks, you will be able to build a watertight case and find investors who share your vision. A well-prepared approach not only enhances your chances of securing capital but also sets your hotel business up for long-term success.
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