Capital Investments: Financing Your Renovation
By Nan Adams, Professional Innkeepers International
           
Whether you’re a new innkeeper or have been in the game for decades, you know how important it is to keep up with industry trends by making the physical improvements necessary to keep, or better yet increase, your market share. Sometimes it’s a relatively simple matter of renovating an out-dated kitchen or replacing old fixtures and the cracked tile in the bathrooms.

Perhaps you’ve decided you could increase revenue by converting adjoining guestrooms into a suite. You may even want to enlarge your personal living space by breaking through a wall of the main house and turning the garage into a family room. Adding a conference room, a luxurious spa or even a full-service restaurant may take your inn to a whole new level. Or you may have purchased a beautiful, historic home, taken out a residential loan, used all your cash and available credit during the conversion and still need more money to make your dream of creating a Bed & Breakfast/Inn come true.

Whatever the project you’re contemplating, you’re going to need capital to carry it off. If you managed to budget and save for capital improvements, great! But if you find yourself short of the cash necessary to begin or finish an important project, here are some tips and guidelines to make your adventure a bit more comfortable.

Loan Basics:

There are a number of different types of loans available to borrowers through banks, mortgage brokers and specialized lenders. Understanding these basics will save you time and make the process less confusing and your participation more savvy.

Unsecured Loans are offered by most lending institutions and are based on the borrower’s creditworthiness. These are usually for relatively small sums, less than $10,000, and though there is less paperwork, the interest rates are usually higher and are not tax-deductible.

Secured Loans are loans in which the borrower agrees to repay the money according to a pre-set schedule and gives the lender the right to seize the property and sell it if the borrower doesn’t keep up with the payments. The document that secures this pledge is usually called a mortgage or a deed of trust. A single property can be pledged in more than one loan, but when this happens, the loans are explicitly ranked in priority: as in First Mortgage, Second Mortgage. The interest rate on mortgages is tax-deductible. Interest rates on second mortgages are usually higher than on first mortgages.

Refinancing is the practice of renegotiating an existing mortgage on a property with significant equity, for a cash amount or a better rate, and can be a practical solution, especially if current interest rates are significantly lower than your original rate.

Since Bed & Breakfast Inns are businesses, it’s more and more common for lending institutions to use Commercial Mortgages for the purchase and/or renovation of same. These loans typically are for a shorter length of time than home equity loans (20 years as opposed to 30 years) and have a higher interest rate. The United States Government provides a variety of Small Business Association (SBA) Loans and loan guaranties available through commercial lending institutions.
 
Assessing Your Project Requirements:
 
After you have developed a wish list, prioritize the list, interview multiple contractors/builders and check their references to determine who is reliable and competent. Make a detailed list of construction costs and add 10-20% to your final figure for contingencies. Determine whether it’s feasible to stay open during construction and add the costs of partial or total closure for the duration of the project to your budget. Project an estimate of the increased market value of your improved facility, determine your new rates and adjust projections and financial statements accordingly. Then, make sure you are convinced that the increased cash flow from the improvements can comfortably carry the new debt. It’s a good idea to hire a specialized B&B/Inn consultant to help you through this process.

Hilary Jones has worked in the hospitality industry for over 20 years and is the owner/innkeeper of The Admiral Peary House in Freyburg, ME. She offers consulting services though her company Inngenium (hilaryj@inngenium.com) and helps B&B/Inn owners and potential owners prepare effective business plans—an important first step in acquiring funding. A coherent business plan “will help lenders view you as professional, organized and business-like, greatly enhancing your chances of getting the funding you need.” Hilary also stressed the importance of keeping good financial records that accurately reflect your business. As an innkeeper, one thing to keep in mind as you go about your day-to-day record keeping and year-end tax preparation is that it’s important, not only when refinancing or taking out loans but also for the eventual sale of your business, to show a profit and pay the requisite taxes.

“Anytime you’re working for yourself it’s tempting to write off every conceivable thing and put the cash back into your business in the short term,” admits Hilary. “Over the long term, however, this doesn’t always work out in your favor. Banks don’t want to be in the real estate business. They don’t want to own your B&B/Inn or to have to sell it if you default on your loan. When judging your application, they rely heavily on your reported income—and this means the income from the B&B/Inn; not incomes from an outside job you or your partner may have taken to supplement the B&B/Inn.” A good percentage of equity in your property is always helpful, but to borrow from a bank you must also have proof that you are running a business that has a positive cash flow and can support repayment of the lender’s investment.

Assessing Your Financial Position:

Rick Newman, Managing Partner of Commercial Capital Network (ccnllc@ptd.net) has some recommendations to help PAII Members prepare for financing capital improvements. Rick’s familiarity with the hospitality industry is rooted in his family’s inn of 25 years in New Hope, Pennsylvania. Rick specializes in financing B&B/Inns and has helped innkeepers acquire fixed rate conventional mortgages with 15 to 30 year terms, along with SBA loans at low rates. He is also a credit analyst who is able to secure financing for innkeepers with less than perfect credit or unusual accounting practices—something that precludes most people in this category from getting traditional financing.

Rick commented, “A thorough assessment of the inn and innkeeper’s financial situation is essential in determining the appropriate financing strategy.” Before applying for a loan, dedicate time to research your and your partner’s (if applicable) personal credit or FICO scores. Since most small commercial loans are full recourse loans (meaning you will be guaranteeing the loan), personal credit scores are very important to lenders and have a real impact on the rates and terms.

Go on-line and order your credit report and credit score from the three big agencies: www.experian.com, www.transunion.com and www.equifax.com. Order one report from each agency, print out your reports and study them well for any incorrect or negative information. Every borrower has the right under the “Fair Credit Reporting Act” to dispute misinformation. Contact the lender responsible for the mistake directly. Errors can often be fixed quickly over the phone. When corrected, send certified letters explaining the inaccuracies and the revised statements to the credit reporting agencies, keeping copies of all pertinent letters and documents.

Since lenders are primarily concerned with the issues of income, debt, credit history and property value, you will also need to have copies of the tax returns for all borrowers for the last two years, your current mortgage contract, an itemized list of your major debt and a recent value appraisal of your property.