Cornell University School of Hotel Administration
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11-2005
The Use of Fixed-Rate and Floating-Rate Debt for Hotels John B. Corgel Cornell University,
[email protected]
Scott Gibson College of William and Mary
Follow this and additional works at: http://scholarship.sha.cornell.edu/articles Part of the Hospitality Administration and Management Commons Recommended Citation Corgel, J. B. & Gibson, S. (2005). The use of fixed-rate and floating-rate debt for hotels. Cornell Hotel and Restaurant Administration Quarterly, 46(4), 413-430. Retrieved [insert date], from Cornell University, School of Hospitality Administration site: http://scholarship.sha.cornell.edu/articles/539/
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The Use of Fixed-Rate and Floating-Rate Debt for Hotels Abstract
A time-series simulation that compares hotel-industry revenue per available room (RevPAR) with London Interbank Offer Rate (LIBOR) indicates that hotel investors would fare more favorably with floating-rate loans than with the commonly used fixed-rate financing. Using data from 1987 through 2004, the study determined that LIBOR and RevPAR changes are strongly correlated, indicating a relationship of RevPAR and floating interest rates. Moreover, a simulation found that hotels using variable-rate mortgages would have been more likely to cover debt service in good times and bad than would hotels financed with fixed-rate loans. The correlation was strongest for midscale, limited-service properties but also operated for budget and resort deals. The relationship of RevPAR with floating rates suggests a reduction in the costs to borrowers and lenders arising from distressed loans. Keywords
hotel financing, fixed-rate and floating-rate mortgages, debt-service coverage, RevPAR Disciplines
Hospitality Administration and Management Comments
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This article or chapter is available at The Scholarly Commons: http://scholarship.sha.cornell.edu/articles/539
© 2005 CORNELL UNIVERSITY DOI: 10.1177/0010880405277072 V o lu m e 46, N u m b e r 4 413-430
The Use of Fixed-rate and Floating-rate Debt for Hotels By JO H N B. (JACK) CORGEL and SCOTT G IBSON
A tim e -s e rie s sim ulation th a t com pares hote l-in du stry revenue per available room (RevPAR) w ith London Interbank O ffer Rate (LIBOR) indicates th a t hotel investors w ou ld fare m ore favorably w ith floating-rate loans than w ith th e co m m o n ly used fixed-rate fin an c ing. Using data fro m 1987 th rough 2004, th e study d ete rm ine d th a t LIBOR and RevPAR changes are s tro n g ly c o rre la te d , in d ic a tin g a re la tio n s h ip o f RevPAR and floating in te re st rates. M oreover, a s im u lation found th a t hotels using variable-rate m ortgages w o u ld have been m ore likely to cover d e b t se rvice in good tim e s and bad than w ou ld hotels financed w ith fixed-rate loans. The correlation w as s tro n g e s t for m idscale, lim ite d-service p roperties but also operated fo r b u d g e t and re s o rt deals. The re la tio n s h ip o f RevPAR w ith floating rates su gg ests a reduction in the c o s ts to b o r r o w e r s and le n d e r s a ris in g fr o m distressed loans. Keywords: hotel financing; fixed-rate and floatingrate m ortgages; deb t-se rvice coverage; RevPAR
NOVEMBER 2005
H
otel company CFOs and property-level inves tors carefully consider decisions regarding the relative proportions of debt and equity that go into capital structures. The financing decision does not end, however, with the determination of the extent of leverage. Other important decisions remain—not the least important of which is whether the interest for that debt should carry fixed or floating rates.1 This issue arises largely because hotel properties represent a special category of commercial real estate, the users of which agree to short-term (usually, daily) tenancy, as compared with long-term leases typical of other commercial real estate. The resulting volatility ofrevenues is a defining characteristic ofhotels, a fea ture cited by investors as the reason that hotel proper ties are viewed as riskier investments than other types of real estate.2 Despite their variable cash flows, for hotels—as with most other types of commercial prop erty—long-term, fixed-rate mortgages with constant debt-service payments are the common means of financing.3 This makes sense with office- and retailproperty investments, for example, where the structure
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