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Construction and Value-Add Deals: Lender Perspective in Today's Economy

By Shivan Perera Managing Director of CRE, Bridge Marketplace | May 2025

The hospitality sector has faced a turbulent half-decade, navigating a series of economic challenges. To put this in context, before the pandemic, the industry enjoyed an unprecedented 10 consecutive years of RevPAR growth, a first in modern lodging history.

At the time, new hotel supply expanded rapidly and demand - for the most part - kept pace, preventing significant oversupply in most markets. Industry evolution naturally paved the way for emerging trends. Extended-stay and select-service hotels grew in popularity, driven by strong occupancy and efficient operating models. The industry also saw an increase in brand proliferation, with major hotel chains introducing niche brands targeting specific traveler segments. The emergence of alternative accommodations, such as Airbnb, introduced competition and initial concerns, but ultimately did not significantly impact hotel performance.

Major metropolitan areas experienced a surge in high-end and luxury developments, while secondary markets also saw strong growth. Most importantly, financing a project was much easier at the time. Banks were eager to bring on new borrowers, valuations were at a high and climbing, the distressed market was thin and leverage more often than not, was a non-issue. In hindsight, the challenges of that decade were minor compared to the unprecedented disruptions that followed.

The COVID-19 pandemic devastated the hotel industry in 2020, leading to an uneven but ultimately strong recovery, shaped by shifting travel patterns, labor shortages, and changes in hotel operations. By 2023, most markets had returned to pre-pandemic performance levels. However, just as a nationwide recovery seemed within reach, the economy was hit with high inflation, prompting the Federal Reserve to implement the most aggressive interest rate hikes in history. Skyrocketing rates stalled transactions as deals struggled to underwrite at previous leverage levels.

Two years later, with valuations having adjusted, underwriting has finally started to stabilize. However, banks, the primary lenders for middle-market and small-cap deals, continue to face liquidity constraints and are continuing to underserve the markets, giving rise to a slow start in 2025. Given this backdrop, securing project financing requires a deep understanding of these shifts and their impact on lending dynamics. As in all cycles, lenders are reverting to the core fundamentals of successful deals. Today, the structure of the deal, the hotel brand (flag), the sponsor’s track record, general contractor and the project’s location are more critical than ever in determining financing viability.

Getting Construction and Conversion Deals Financed

1. Construction Lending

Hotel construction has never been a preferred deal type for lenders due to its high costs and inherent risks. Experience has shown that inadequate oversight and poor underwriting can lead to disastrous outcomes. Before closing, lenders meticulously track the allocation of every dollar in a project, though even this process isn’t foolproof. Cost overruns, forgotten budget items and change orders can jeopardize the completion of a project and as any banker dealing with liquidation knows, an incomplete hotel holds little value. The larger and more complex the project is, the greater the likelihood of unforeseen expenses. If a liquidity-constrained borrower cannot cover these excess costs, the lender faces a difficult choice: overleveraging the deal or foreclosing at a higher risk of loss. For this reason, traditional banks will prioritize borrowers with sizable balance sheets and experience.

Furthermore, with construction deals not all markets are created equal. The “smile states” which include Arizona through Texas, Florida and up into the Carolinas continue to be easier states to develop due to affordable labor, reasonable fees and business friendly regulation. By far, labor, taxes, insurance, and materials are quickly becoming the most cost prohibitive line items for construction deals. This is exemplified in states that have high land, permitting and entitlement costs. There are always special cases and markets that can justify higher build costs, however, generally speaking these are the challenges that erode returns for borrowers and investors alike.

Banks have largely withdrawn from hotel construction financing, with select relationship lenders remaining active. Private lenders have stepped in to fill the gap, but with risk under intense scrutiny, even the private market is highly selective, especially with new clients. In tight financing economies, borrowers turn to the private debt market for hotel construction loans because traditional lenders, such as banks, tighten their lending standards, reducing loan-to-cost ratios and increasing equity requirements.

Private lenders offer greater flexibility, faster underwriting, and more customized loan structures that banks cannot match, including higher leverage and creative capital stacks. They are willing to fund projects that banks might reject, such as non-stabilized hotels or unique assets like boutique properties, resorts, or adaptive reuse projects. Additionally, private lenders provide higher loan-to-cost ratios and can structure interest-only periods or draw schedules, which help borrowers manage cash flow. While they charge higher interest rates, private debt funds are more willing to take on risk and fund deals that traditional lenders won’t, making them an attractive option during economic uncertainty.

2. Conversion Deals

While conversion projects may seem less risky than ground-up construction, they come with their own set of challenges for both lenders and sponsors. These projects remain attractive in today’s market because they allow developers to deliver new hotel products at a significantly lower cost per key and within a shorter time frame. A typical ground-up hotel takes 18 to 24 months to build, whereas conversions are often completed within six to 12 months.

Key considerations for conversion projects include lower construction risk since the building shell is already in place. However, hidden conditions such as structural issues, outdated MEP systems, asbestos, or code non-compliance can lead to major cost overruns. Budget uncertainty remains until demolition and inspections are completed. Ramp-up risk is also a factor as a conversion project with existing cash flow such as a repositioned hotel, carries less ramp-up risk than ground-up construction, which must build occupancy from zero. However, market demand for the converted product must be validated, especially if the asset is shifting segments.

To mitigate risks, borrowers should build in contingency budgets and time buffers to address unexpected challenges during a hotel conversion or rehab project. A contingency budget (typically 10%-15% of the total cost) helps cover unforeseen issues like structural problems or code compliance, while time buffers allow for delays in permitting, contractor availability, or supply chain disruptions. The industry saying for rehab deals is “you never know what you will find behind the walls.” As such most lender recognize the risk and will de-lever accordingly. For higher leverage rehab deals lenders will often impose stricter post-closing liquidity requirements and experience.

3. Ownership Matters

Hotels occupy a unique position between an operating business and an investment real estate asset. In today’s lending environment, lenders prioritize owners and groups with a demonstrated ability to operate hotels effectively.

Owner-operators have “skin in the game,” meaning they are directly invested in the hotel’s success. They are less likely to walk away during downturns compared to absentee owners or passive investors. Active management is crucial. Experienced owner-operators typically achieve stronger occupancy, RevPAR, and NOI. Third-party management companies, while useful, may lack the same level of commitment or operational expertise. Leverage considerations also play a role. If a deal has conservative leverage, lenders may be more flexible regarding hands-on management experience within the sponsorship group.

4. Location, Location, Location

Location is one of the top two most important factors for lenders when evaluating a hotel project. Hotel success is primarily driven by demand generators in the local market, though there is no precise formula for assessing location quality. Lenders analyze a range of factors to evaluate underwriting risk, with a particular focus on urban cores (CBDs) and resort markets, which are expected to experience strong RevPAR growth. Population trends can offer insights into long-term demand, but they are not always reliable predictors. Key performance indicators like occupancy, ADR, and RevPAR must align with market norms, and lenders will closely scrutinize penetration rates to gauge market share and performance. If a sponsor projects above-market performance, they must provide clear, substantiated evidence; otherwise, lenders will likely normalize assumptions to reflect more conservative expectations.

In addition to these quantitative metrics, lenders also consider qualitative factors, such as the property’s walkability, proximity to demand drivers, access to major transportation routes (e.g., highways or interstates), and whether the amenities align with the market’s needs. Experienced lenders also recognize the potential economic and legal challenges associated with lending in certain states, and borrowers should be equally aware of these factors. Beyond selecting projects in business-friendly states, borrowers must also have a deep understanding of the local market segmentation and how that aligns with their chosen brand or flag, ensuring that the property caters to the right target audience.

5. Investor Sentiment

Investor sentiment in the U.S. hotel market remains positive, with 94% of investors surveyed by CBRE planning to maintain or expand their hotel investments in 2025—up from 85% in 2024. This optimism stems from expectations of higher total returns and distressed investment opportunities. However, some investors are scaling back due to slowing RevPAR growth. While labor, insurance, and capital costs remain key concerns, their impact appears less severe than in previous years.

6. General Contractor Selection

The general contractor (GC) is often an overlooked but critical component of lender evaluations. An experienced and financially strong GC can make a deal, while even a slightly subpar GC can derail it. Lenders consider the GC’s experience in franchised hotel construction, financial stability, ability to secure payment and performance bonds, and track record of completing projects on time and within budget. Subcontractor relationships, state-specific licensing, and adherence to brand standards are also key factors. A thorough GC qualification process helps mitigate construction risk, ensuring the project stays on track.

7. Choosing the Right Hotel Flag

Selecting the right hotel brand is a strategic decision that impacts a property’s financial performance and collateral value. Economy and midscale brands offer greater franchise flexibility, lower conversion costs, and higher cash-on-cash returns. However, collateral values tend to be lower, and these assets typically trade at higher cap rates. Upper-midscale and upscale brands require more stringent adherence to brand standards but can command higher RevPAR and lower cap rates. Extended-stay versus select-service strategies also vary; a lower-tier extended-stay brand in a high-occupancy market can perform as well as a premium select-service brand in a market with only 60% occupancy. Understanding the revenue model, RevPAR versus occupancy-driven strategies is essential.

Borrowers with strong lending relationships, proven track records, and well-capitalized balance sheets have a significant advantage in today’s market. Lenders remain cautiously optimistic heading into 2025. However, the “wall of debt” from upcoming loan maturities transitioning from low-interest to high-interest environments is beginning to strain the market. Many banks have extended loan maturities as far as possible, but this pressure is creating opportunities for well-structured value-add projects.

While construction remains challenging, the lack of new supply in underbuilt or high-growth markets makes select ground-up projects viable. However, rising labor, insurance, and tax costs continue to erode P&Ls. Ultimately, lenders are reverting to core credit principles. Sponsors who understand these fundamentals and align their strategies accordingly will have the highest likelihood of securing financing.

Mr. Perera

Shivan Perera is the Managing Director of CRE at Bridge and is currently spearheading the launch of its hospitality lending platform. Mr. Perera has more than 10 years of specialized hospitality financing expertise with additional experience in business banking, private debt, and CRE loan syndications. His core expertise is in Private Credit CRE lending, Risk Management, and Financial Technology. Mr. Perera holds an MBA in Finance from the Thunderbird School of Global Management at Arizona State University. His academic background complements his professional experience, underpinning his commitment to innovation and excellence in the real estate finance sector. His leadership style is defined by a focus on innovation, client-centric solutions, and a forward-thinking mindset. He continuously seeks ways to improve lending processes, enhance risk assessment methodologies, and create value for both borrowers and lenders through technology. His ability to anticipate market trends and drive transformative change has established him as a respected voice in commercial real estate and hospitality financing. Extended Biography & Contact Information

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If you choose to purchase a subscription, member subscription payments can be made in U.S. Dollars, as well as a variety of international currencies. Membership terms are Annual Recurring, and Monthly Recurring. The Annual Recurring subscription is an annual commitment and subscribers will be charged each consecutive billing cycle. Annual Recurring subscriptions can be cancelled after the first billing cycle and within 30-days of the billing date for a full refund. Monthly Recurring subscriptions are ongoing and subscribers will be charged each consecutive monthly billing cycle. Monthly Recurring subscriptions can be cancelled after the first month and within 7 days of the monthly billing cycle for a full refund.

12. PAYMENT AUTHORIZATION

Payment for the services provided to you in, at, through or in association with HotelExecutive may be made by automatic credit card, debit card, direct debit, bankwire or Paypal and other approved payment means offered in, at, through or in association with HotelExecutive, and you hereby authorize HotelExecutive and its agents to transact such payments on your behalf.

You hereby authorize HotelExecutive's Internet Payment Service Provider to charge your credit card to pay for your membership to HotelExecutive. You further authorize HotelExecutive's Internet Payment Service Provider to charge your credit card for any and all purchases of products, services in association with HotelExecutive. You agree to be personally liable for all charges incurred by you in association with your access or other use of any content provided by HotelExecutive or any third party in association with HotelExecutive. You acknowledge and agree that your liability for all such charges shall continue after termination of your access or any type of membership arrangement with HotelExecutive.

In the event that you have chosen to have your membership automatically rebilled, unless and until you notify HotelExecutive that you wish to cancel or terminate your membership to HotelExecutive, you hereby agree and authorize HotelExecutive's Internet Payment Service Provider to automatically renew your membership to HotelExecutive on a continuing basis and to charge your credit card (or other payment means you have selected) to pay for the ongoing cost of your membership. You hereby further authorize HotelExecutive's Internet Payment Service Provider to charge your credit card (or other approved payment means you have selected) for any and all purchases of products, services and entertainment provided to in, at, through or in association with HotelExecutive.

13. PRIVACY POLICY

The following is the Privacy Policy for HotelExecutive

We can be reached via telephone, email, or online at our contact page. When you visit our site we do not log any information regarding your domain or email address. Information Sharing: We do not share user information with any third parties other than via press release distribution as described below.

Hotel Newswire is a newswire service that distributes press releases on behalf of our users. If you decide to submit a press release for distribution through our system we will transmit your entire press release including any personal information therein contained to our media contacts and online distribution points including search engines. This is the only redistribution of your information that we engage in. Your submission of press releases through our system indicates consent with this policy. The information we collect during your registration process is used to notify users about updates to our service and inform users of any special events hosted by Hotel Newswire. This information is not shared with other organizations for commercial or non-commercial purposes.

Cookies: Our system requires the use of cookies to enable the user to log back into our website to access information from the newswire, without having to log in each time using the required username and password.

If you do not want to receive email from us in the future, please let us know by following instructions included in our communication with you. Users who supply us with telephone numbers online may receive telephone contact from us regarding their account, or informing them of new products and services available on the HotelExecutive website. If you do not wish to receive such telephone calls, please edit your account and remove your phone number from your account profile. This can be done from your user account menu.

Ad Servers: We do not partner with or have any relationship with any ad server companies. From time to time, we may use customer information for new uses not previously disclosed in our privacy notice. If our information practices change at any time, we will post the policy changes to our website to notify you of these changes and provide you with the ability to opt out of these new uses. If you are concerned about how your information is used, you should check back at our website periodically.

Upon request we provide site visitors with access to all information (including proprietary information) that we maintain about them. Users can access this information by logging in to their account.

Security: We always use industry-standard encryption technologies while transferring and receiving user data exchanged with our site. We have appropriate security measures in place in our physical facilities to protect against the loss, misuse, or alteration of information that we have collected from you on our site. We do not store credit card information in our systems.

If you feel that this site is not following its stated information policy, you may contact us.