After the recent interest rate news, hotel owners could be forgiven for wanting to skip the rest of September. Unfortunately, October 1 brings another change that deserves attention, particularly if you’re thinking about buying or selling a hotel.
I wrote about the Fed’s 250 basis point interest rate increase earlier this month. Rates tend to attract headlines, understandably: they affect borrowing costs, and a relatively small increase can become a meaningful expense on a hotel loan.
But I’m concerned that the upcoming changes to SBA acquisition underwriting will get less attention than they deserve. Interest rates can change at a future Fed meeting. The new underwriting requirements will remain in place unless the SBA revises them, and a rate cut alone won’t undo them.
If your plan has been to wait for rates to improve, it’s worth understanding what else will change while you’re waiting.
What changes on October 1
Under the updated SBA rules, 7(a) transactions classified as initial acquisitions will require a minimum debt-service coverage ratio of 1.25. That means $1.25 in qualifying earnings for every $1 in annual debt payments. Qualifying business expansions have a separate 1.15 requirement, so the classification of the transaction matters. SBA SOP 50 10 8.1
For example, a hotel with $500,000 in qualifying annual earnings could support $400,000 in annual debt payments under the 1.25 test. The amount a buyer can borrow against that payment will depend on the interest rate and repayment terms.
The new acquisition requirements also limit buyers’ ability to use projected improvements to qualify. Post-closing projections cannot satisfy the acquisition debt-coverage requirement. The new rules apply to loans receiving an SBA loan number on or after October 1; submitting an application before that date does not, by itself, preserve the existing rules. Coleman Report
That matters in an industry where many purchases involve an underperforming property and a buyer with a plan to improve it.
A renovation, a brand change, or better management may produce a better-performing hotel. But the buyer still has to finance the acquisition before those improvements happen. If the historical earnings don’t support the proposed debt, the expected turnaround won’t satisfy that requirement.
Why waiting for lower rates may not be enough
Lower rates would help by reducing debt payments and potentially allowing the same earnings to support a larger loan. They wouldn’t change which earnings the lender can use to qualify the acquisition.
An owner who expects a buyer to pay based on the hotel’s potential should pay particular attention here. The buyer may agree with that potential and still be unable to finance the purchase at the asking price.
More equity or another financing source could make the transaction possible. Both affect the buyer’s investment calculation, however, and neither guarantees that the buyer will accept the seller’s price.
(And no, the elusive “California buyer” isn’t likely to pay pie-in-the-sky prices for a distressed property. They’re looking for a return on their investment, too.)
If you’re considering selling
Before making plans around an asking price, find out how much financing the hotel’s current earnings could reasonably support. That won’t determine the property’s value by itself, but it will help you understand what an SBA-dependent buyer would need to bring to the transaction.
Get your financial records ready, including current monthly profit-and-loss statements, tax returns, and support for any expense adjustments. If performance has improved, make sure you can document when it improved and why. A buyer’s lender will need more than an explanation that the property could be doing better.
If you’ve recently renovated or changed management, discuss whether allowing more time to establish improved earnings could help a future sale. There may be a reason to wait, but it should be weighed against your holding costs, capital needs, and the risk that performance doesn’t improve as expected.
When evaluating offers, ask how the buyer intends to finance the purchase and whether the financials have been reviewed by a lender. That information can help you assess how likely the proposed price is to survive underwriting.
If you’re buying
Ask your lender to review the transaction under the rules that will actually apply to it. Confirm its classification, the qualifying historical earnings, estimated loan proceeds, and total equity needed—including renovation costs and working capital.
If the acquisition doesn’t qualify at the proposed price, find out how large the gap is before spending more on due diligence. You can then decide whether to negotiate, contribute additional equity, pursue other financing, or move on.
For a transaction already underway, an earlier financing conversation is worth revisiting. Ask whether the October 1 changes affect the lender’s assumptions and what still needs to happen before the loan can proceed.
I wouldn’t rush a purchase or sale simply to beat a rule change. I also wouldn’t assume that waiting for the next rate cut will resolve a financing problem that comes from the hotel’s historical earnings.
Before September ends, ask your lender to show you what the October requirements mean for your transaction. You may not need to change your plans, but you should know whether the financing behind them still works.
