The buyers of the most risky CMBS securities, sometime referred to as the “b-buyers,” have laid down some pretty strict guidelines for the remaining minimum term for franchise agreements on hotels to be eligible for CMBS conduit loans. As the buyers of the most risky CMBS securities, the b-buyers have the right to “kick out” a handful of loans from CMBS pools, and they have basically told CMBS conduit loan originators not to bother putting hotel loans in the pools if the franchise agreement has less than five years remaining because they are going to automatically kick them out.
Historically, CMBS conduit loans secured by hotels with franchise agreements with five years or less remaining on the term simply had to structure a collection of a Property Improvement Plan (PIP) reserve either at closing, over the loan term, or a combination that resulted in a reserve at franchise renewal of approximately $7,500/room for limited service hotels and $15,000/room for full-service hotels. These levels generally were sufficient to cover 100% of the costs to complete a mandated PIP to gain franchise renewal.
But sometimes just having the cash on hand does not guarantee a franchise renewal. For instance, the owner of a 15-year-old Holiday Inn Express was denied a franchise renewal despite having the cash on hand to complete the PIP, being in good standing with the franchise and having great guest satisfaction scores. What happened? Another multi-unit operator of Holiday Inn Express properties offered to build a new, larger Holiday Inn Express in the same market, so he got the franchise.
The former Holiday Inn Express converted to a Quality Inn. Revenue declined 40%, the owner defaulted on his loan, and the lender foreclosed. This story is not unique. Hence, the b-buyers’ requirement for five-plus years remaining on any hotel franchise agreement to be eligible CMBS!