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Tourism, Construction

Hotel Construction Bogs Down

CARIBBEAN BUSINESS visited 24 projects in the Puerto Rico Tourism Co.’s construction pipeline and found most are seriously behind schedule.


February 6, 2003
Copyright © 2003 CARIBBEAN BUSINESS. All Rights Reserved.

Outlook for new hotels in 2003 and beyond is bleak: With new construction off, renovation projects help to pick up the slack

For developers with hotel projects in the pipeline, the economic outlook remains daunting. Responding to the sluggish economy and the growing threat of war, developers have either postponed or slowed the pace of construction activity.

Of the 24 hotels under construction in Puerto Rico, totaling an approximate $580 million investment and 2,425 new rooms, only a handful are likely to open this year. CARIBBEAN BUSINESS visited the 24 projects and found most have fallen back to an earlier stage of development (see hotel development chart).

The deceleration of new hotel construction isn’t unique to Puerto Rico. The U.S. mainland saw a steep 47% decline in 2002 from the 1998 peak of more than 530,000 new hotel rooms.

Nevertheless, some blame the island’s cumbersome permitting process for the construction delay.

"To increase the number of hotel properties, the permitting process needs an overhaul, or it will hold the island back in terms of retaining developers and investors for development projects," said Rick Newman, president of Flagship Services, which manages the Rincon Beach Resort in Añasco and Costa Bonita in Culebra. "By no means should the environmental and infrastructure issues be ignored, but if a permit is going to be denied over these concerns, let’s not take two years to do it."

Roberto Cordova, senior vice president of commercial & corporate banking for Scotiabank Puerto Rico, cited the weak economy and 9/11 for creating uncertainty in the industry. "Investors, capitalists, private banks, and the government were looking for a period of stabilization. We [at Scotiabank] had three transactions held up by economic uncertainty which are now taking their course," Cordova said. Scotiabank is the most active hotel development lender in Puerto Rico and the Caribbean, with a portfolio in excess of $1 billion.

Whatever the reason, new hotel development is expected to remain stagnant through 2003, maybe longer. Industry experts predict hotel projects that involve renovations and repositioning will lead the turnabout, just as the macroeconomics of recovery justifies new capital investment.

In Puerto Rico, two hotels that have been closed for years but remained in the Tourism Co.’s construction pipeline have either already reopened in 2003 or are expected to reopen soon. They are the 255-room Courtyard by Marriott Isla Verde Beach Resort (formerly known as the Crowne Plaza) and the 156-room Wyndham Martineau Bay Resort & Spa (formerly known as the Martineau Bay Resort in Vieques).

Two other hotels that have been shuttered for some time but are in the process of reopening are the 225-room Carib-Inn and the 686-room former Condado Trio. If all goes smoothly, the Carib-Inn should be ready for business in the fourth quarter of this year. The Condado Trio should recommence operations in fourth-quarter 2004.

Hotel development is dependent on raising the capital for acquisition and construction and on having positive cash flow from property operations.

Hotels’ cash flow today is on a downward trend because occupancy rates are slightly off and the average daily room rate has been reduced. As such, lenders aren’t looking favorably at hotel assets as investment opportunities.

"We have noticed the interest to develop hotels in Puerto Rico is good," said Milton Segarra, designated secretary of the Economic Development & Commerce Department. "However, banks now have stricter parameters for lending money. That’s why we are trying to stimulate the private sector to get involved in a greater part of the lending process."

The Capital Risk Fund Law is one way the Puerto Rico government has tried to entice private banks to finance tourism-related projects. Although the law was approved last year, Gov. Sila Calderon has yet to sign the amended version. The law was originally drafted to give private banks tax exemption on the commitment for letters of credit in return for guaranteeing financing to new hotels. However, the part of the bill to support direct loans, so the income generated by the banks would also be tax-exempt, was discarded.

"In the past year and a half, we have never stopped feeling comfortable about carrying out nonresort transactions in the San Juan metro area," said Scotiabank’s Cordova. "The outlook is different now because the economy is showing signs of improvement and the bank has a more positive attitude about financing resort transactions. The key is an attractive financing structure. It must best serve the property but at the same time protect the interests of the investor, the government [if financing it], and the bank."

For years it was difficult to secure financing for hotel projects in Puerto Rico. In the early 1990s, the local government stepped in and created the Tourism Development Fund (TDF), a subsidiary of the Government Development Bank (GDB), and the Hotel Development Corp. (HDC), a subsidiary of the Puerto Rico Tourism Co.

The TDF, originally capitalized in 1993, is intended to jumpstart hotel real-estate investments by guaranteeing principal and interest. The HDC was developed, legislated, and funded to provide equity funding to hotel projects.

Why were the two created?

The TDF and HDC were established because there was insufficient funding coming from the private sector. If you asked developers today if the financial climate has changed, they would say no.

"It’s difficult to find financing for projects, even though some has been obtained," said Flagship Services’ Newman, who is also president of the Puerto Rico Hotel & Tourism Association. "Financing here is done on a project-by-project basis rather than in a truly competitive environment among the banks."

Tourism is both a cyclical and high-risk industry, which makes most private financial institutions skittish. Banco Popular de Puerto Rico, FirstBank of Puerto Rico and Westernbank have financed hotel projects, though on a small scale and most of the financing has been in the form of construction-related loans. When dealing with major hotel projects, however, the level of private banks’ participation shrinks.

Banco Popular concentrates on financing small hotels backed by local capital, though it has financed larger projects by companies with which it had a previous business relationship, said Emilio E. Piñero, the bank’s chief lending officer. Banco Popular has financed more than $120 million in hotel projects in the past four years. Popular Securities, a subsidiary of the financial institution, has been either lead manager or co-manager of $474 million in Afica bond issues in that time.

According to the Government Development Bank (GDB), the problem hinges on whether the investor has enough capital to sustain the investment. "There are projects that need capital," said Carlos Piñero, executive vice president of financing at the GDB. "Developers don’t like to gamble with their capital. They prefer to work with money from the banks, though financially strong owners of quality hotel properties with cash flow in solid markets have more lending options available to them."

No new hotel transactions

The TDF has a portfolio of 13 hotel projects (most of which closed their deals using the Afica financing method before 2000). Some of the projects are operating and others are under construction. The TDF has committed nearly $49 million in capital, which is equivalent to $549 million in loan guarantees. The TDF was recapitalized in 2001 with $100 million. Of that sum, $51 million is still available to provide an additional $500 million in guarantees.

Even though the government’s loan guarantee program has been replenished, there have been no new hotel transactions added to the pipeline, only a few that had been held up and are back on track.

Hong Kong-based Mandarin Oriental signed a letter of intent last year to open a five-star, 200-room hotel and 50 villas in Palmas del Mar, but there has been no news since. The Four Seasons Resort in Luquillo, which has been in the Tourism Co.’s pipeline since 1998, is still sorting through environmental issues.

In August 2001, the GDB used a Scotiabank loan to close the acquisition and rehabilitation of the former Crowne Plaza, which was shuttered after Hurricane Georges damaged the property in 1998. The government backed up the deal with a deficiency guarantee. The new Courtyard by Marriott Isla Verde Beach Resort opened in January.

The GDB also approved the rehabilitation of the Carib-Inn last year. Because the project required a small investment, a private bank felt comfortable taking the risk. "We complemented the financial structure of the Carib-Inn but reduced our exposure with a subordinated debt of $10 million," said the GDB’s Piñero. "The deal has yet to be closed, though."

The HDC was forced to invest $15 million in equity in order to get the much-publicized Fairmont Coco Beach Resort & Spa moving. The HDC is now a minority stakeholder in the project, which is scheduled to begin construction in early 2003. Scotiabank is the lead banking institution, financing the deal with a $90 million loan. The TDF is providing a $22 million subordinated loan, local entrepreneur Arturo Diaz is putting up nearly 27 acres of land, and Fairmont Hotels & Resorts is staking 15% of Coco Beach Resort’s equity investment.

A strong brand means more capital

Jerry Earnest, senior vice president of GMAC Commercial Mortgage Corp., said the market for hotel loans has increasingly been determined by credit quality.

"Top-tier owners and properties are enjoying hotel loans with full proceeds, competitive spreads, and attractive terms overall," said Earnest, whose company is an active hotel development lender in the U.S. and Canada. "Beyond these top-tier situations, however, capital availability is much more limited and less flexible."

Scotiabank’s Cordova admitted his bank did become much more selective after 9/11. "We were a little choosey because of the industry issues, but the underwriting guidelines were never altered to be more conservative," he said.

The fact remains that the stronger the hotel brand and development team, the less risk there is to lenders. Jim Whelan, executive vice president of Kimpton Hotel & Restaurant Group LLC, said lenders are requiring independent hotel owners/developers to pair up with legitimate national operators.

"Obviously, a strong brand flag. . .is attractive to finance because one benefits from its reservations system and is fed by its flag," Cordova said. "Those that don’t have that flag face a greater challenge in filling their rooms."

Less cash flow puts pressure on financial covenants

Underwriting criteria may not have changed materially after 9/11, but lower EBITDA (earnings before interest, taxes, depreciation, and amortization) numbers are affecting the loan that can be justified with current cash flows.

"Reduced cash flow…does put pressure on existing financial covenants throughout the lending bank. Typically what you find is that the required coverage is 1.2 to 1," Cordova said. "Our portfolio remains within covenants."

In the past year, mezzanine loans--a type of subordinated loan similar to a large commercial second mortgage loan--have played an important role in maintaining reasonable leverage levels on a wide range of hotel assets.

Mezzanine lenders will often lend up to 85% to 90% loan-to-value, typically behind first mortgages of 65% to 75% loan-to-value. Mezzanine lenders structure their deals this way because they can foreclose on a company much faster than on a piece of real estate. Since their loan-to-value ratio is so high, mezzanine lenders need to be able to move fast to protect their interests.

The lending market has become much more efficient in matching up senior and mezzanine lenders. Hotel owners previously had to find and match up different lenders to create a senior loan product.

Even in today’s environment of low interest rates, hotel assets that are coming up for refinancing are more than likely relying on mezzanine debt. Since values have fallen more than the amortized loan amount, more equity or mezzanine debt is required to move forward. Experts predict continued activity in refinancing hotel assets with a mezzanine component.

"Mezzanine or subordinated loans have played a significant role in Puerto Rico, whether from the government or from other tourism fund investments," Cordova said. "I see it as a key component in the overall project financing."

Island’s hotel growth in the ’90s attributed to dependability of Afica financing

Everyone knows the Puerto Rico government was successful in attracting new hotels to the island in the 1990s because of the 1993 Tourism Incentives Act. However, the Puerto Rico Tourism Development Fund (TDF) also had something to do with it.

The TDF is one of the local government’s many incentives for local and foreign investors to promote tourism on the island.

In the past, a tourism investor had to come up with 40% of an adjusted project’s cost in equity while the TDF guaranteed the remaining 60%, which became the debt to be financed. The TDF accepts only cash and land value as equity. It also required the investor to put up another 10% to 15% in contingency funds, which would go to the construction budget. The TDF’s primary mission was to guarantee revenue bonds issued by hotel developers and approved by Afica.

The TDF’s use of Afica financing enabled the construction of 12 of the 13 hotel projects in the government’s portfolio: Westin Rio Mar Beach Resort, Hampton Inn San Juan Hotel, Hostal El Convento, Embassy Suites Dorado del Mar, Embassy Suites Isla Verde, Martineau Bay Resort, Cayo Largo Inter-Continental Resort, Paradisus Coco Beach Hotel (Sol Melia), Hampton Inn Caguas, Serralles Hotel Inc. (Ponce Hilton), Palmas del Mar Inc., and Coco Beach Golf & Country Club.

The only hotel on the list that didn’t use Afica financing was the Courtyard by Marriott Isla Verde Beach Resort, formerly known as the Holiday Inn Crowne Plaza. Instead, the developer obtained a direct loan from Scotiabank Puerto Rico and the government backed the project with a deficiency guarantee.

Former GDB President Juan Agosto Alicea once said he believed the government still had too much exposure in the hotel business, especially after its money-losing ventures in the Ritz-Carlton San Juan Hotel, Spa & Casino and Martineau Bay Resort in Vieques. That’s when the GDB decided to change the way the TDF operated.

"We decided it was better to use the underwriting guidelines of the private sector than to guarantee the bond issue directly, because the tourism industry was more mature," said Carlos Piñero, executive vice president of financing at the Government Development Bank.

Nevertheless, some say a strikeout or two won’t seriously affect a player’s batting average. In the case of the Ritz-Carlton San Juan, the government was able to sell its $85 million Afica bond debt. The reason for the much-delayed opening of Martineau Bay Resort was an internal fight between the partners.

Even though the original 60/40 financing formula remains the rule of thumb, the GDB says it now evaluates the hotel projects. If it determines the risks are too high, it asks for more reserves.

"The debt portion of the project is evaluated upon its merits and on the ability of the investor to pay," Piñero said. "It’s difficult to establish a fixed formula."

The GDB began issuing up to 10% in subordinated debt to prospective investors in 2001. It said priority would be given to those hotel projects with private financing. The remaining 90% had to be split between private banks (50% of the total project) and investors (40% in capital or equity).

Industry leaders were outraged by the move. They said it demonstrated either a lack of commitment to the development of the island’s tourism industry or woeful ignorance of market conditions, or perhaps both. Today, however, many say there are no clear-cut rules any more.

The TDF was born out of the deep economic recession that racked the U.S. in the early ’90s. Real-estate values plummeted. As Japan’s economy plunged into turmoil, Japanese investors, who spent lavishly on landmark real estate, lost billions of dollars and went bankrupt.

"The TDF was originally designed because a real-estate crunch gripped the country," said Luis Fortuño, one of the original architects of the concept, in a previous CARIBBEAN BUSINESS interview. "Back in 1991-92, there was no financing available for certain types of real-estate projects or for hotels."

An industry expert, speaking on the condition of anonymity, attributes the island’s hotel growth during the ’90s to the dependability of Afica financing. "It used to be that people developing hotels in Puerto Rico didn’t have to worry about debt because they knew if they packaged it correctly and had a good project, it would be financed by Afica," said the source. "That isn’t the case today; hotel developers are in the same bag as everyone else."

That’s not to say private banking institutions should be blamed for the lack of hotel development in the Caribbean and Puerto Rico. "By and large, banks are open in the Caribbean," said the same source. "I’m seeing projects outside of Puerto Rico getting financed with a fair amount of regularity. Equity is generally less dependable now than the debt. I think equity was easier to attract before 2000 because there was more money floating around in the economy."

Others say even if Afica financing were still a significant player, it might not be too attractive right now because of its expense and because of the low interest rates on the market. Today it’s less expensive to get a direct loan.

"Afica requires you to reserve a lot of money for debt service and operational shortfalls," said Rick Newman, president of Flagship Services. "Afica was a viable option when the interest rates fluctuated between 8% and 9%."

Flagship Services negotiates 18-year lease for International Airport Hotel

Flagship Services Corp., a local management company headed by hotelier Rick Newman, is negotiating an 18-year concession contract with the Puerto Rico Ports Authority to operate the International Airport Hotel at Luis Muñoz Marin (LMM) International Airport.

Once the contract is signed, Flagship Services will invest $5.6 million to refurbish the property and increase its room inventory from 54 to 100.

According to the agreement with the Ports Authority, Flagship will have an 18-year lease on the hotel with an option for two five-year extensions. The annual rent will be $200,000 plus 8.5% of the hotel’s room revenue.

Expected to open in November, the International Airport Hotel will be affiliated with Budget Host International, which has more than 180 inns and 7,300 guest rooms in 37 U.S. states and Canada.

According to the Puerto Rico Ports Authority, construction work on the hotel should take eight months and should have a minimal impact on other concessionaires at the airport.

Flagship’s plans include the installation of a fire sprinkler system and the total renovation of the bathrooms, including new furnishings and new fixtures. The company also intends to replace the Miami windows with framed glass windows that have integrated hurricane shutters.

"We are also increasing the soundproofing of the building," said Newman. "We will have the lobby downstairs and the restaurant will be on the sixth floor. This property will be convenient for people commuting up and down the [Caribbean] islands, as well as for stranded airline passengers and cruise ship passengers who have a layover in San Juan."

Last week, a dozen workers at the International Airport Hotel were laid off when the management company turned over the property to the Ports Authority.

According to a Ports Authority spokesperson, "We had previously notified Union of Industrial Workers President David Muñoz about the hotel’s closing date and asked them to send employees’ resumes so we could forward them to the new operator. Other than that, though, there isn’t much we can do, except wait until we finish negotiations with Flagship and the hotel reopens."

The former operator of the hotel had been managing the property on a month-to-month basis with a legal contract since 1996, according to the Ports Authority. The agency finally sent a letter to Samuel Molina, general manager of the hotel, requesting his company cease operations.

According to Pedro Ruiz, legal counsel for the Ports Authority, in 1996 the hotel operator filed a lawsuit in the San Juan Superior Court against the Ports Authority in which it claimed to have a valid management contract until 2005. Ports, however, said the management contract--originally granted to the International Airport Hotel in 1992 and extended according to a supplemental agreement--had no legal validity because it was never signed.

Six years later, and with the case still unresolved, the Ports Authority, under the helm of Jose Baquero, granted LMM’s hotel management contract to Flagship Services Corp., stirring up the controversy. Flagship Services was officially granted the airport hotel’s management contract on June 26, 2002.

Hotel Projects Under Construction


Project: Location / New rooms / Proposed construction start / Construction jobs / Hotel jobs / Proposed opening / Current status

Caguas Hampton Inn: Caguas / 125 / September 2000 / 319 / 109 / June 2003 / On schedule

Casa Careyes: Culebra / 15 / February 1998 / 6 / 25 / December 2002 / Construction halted

Condado Lagoon Villas (Phase 1; Caribe Hilton): San Juan / 168 / May 2002 / 424 / 159 / December 2003 / Opening October 2004

Costa Bonita: Culebra / 164 / July 2000 / 120 / 90 / June 2003 / 60 rooms to open May 2003; 60 in October 2003. Remaining 44 in January 2004

Costa Caribe (Expansion Ponce Hilton): Ponce / 100 / October 2002 / 175 / 37 / March 2003 / 20 villas to open in fall 2003

Fajardo Inn (Phase 4): Fajardo / 12 / June 2002 / 20 / 20 / February 2003 / Opening delayed until summer

Gallery Plaza: Santurce / 182 / ** / ** / ** / ** / No construction work

Hacienda Santa Isabel: Santa Isabel / 16 / July 2000 / 17 / 15 / August 2002 / N/A

Hospederia Spa La Roca: Fajardo / 8 / May 2002 / 4 / 22 / January 2003 / No schedule, lacking permits

Hotel El Tuque: Ponce / 75 / November 2001 / 57 / 49 / July 2002 / Open

Hotel Promenada Plaza: San Juan / 16 / July 2000 / 20 / 27 / December 2002 / Not open, no date scheduled

Inter-Continental Cayo Largo Resort: Fajardo / 314 / April 1999 / 350 / 482 / October 2002 / Shooting for April opening but not likely until at least summer

El Legado Golf Resort: Guayama / 189 / April 2002 / 400 / 600 / June 2006 / No construction; undetermined opening date

Martineau Bay Resort: Vieques / 156 / April 1998 / 653 / 250 / -- / Opening scheduled for Feb. 15 or 18

Paradisus-Puerto Rico (Phase 1): Rio Grande / 490 / November 2000 / 350 / 489 / November 2003 / To open in March-April 2004; structure of cabanas done; still pending final design and architectural blueprints

Plaza de Armas: San Juan / 53 / December 2000 / 11 / 32 / August 2002 / Opened in January 2003

Punta Aguila (Phase 1): Cabo Rojo / 42 / 2000 / 55 / 25 / September 2002 / Open

Rincon Beach Resort (Playa Almirante): Añasco / 60 / 1999 / 150 / 20 / August 2002 / Opened 60 rooms in June 2001; 48 condo-hotel rooms opened June 2002

Rincon of the Seas (Rincon del Mar): Rincon / 112 / September 1999 / 200 / 175 / September 2002 / Opened January 2003; formal inauguration Feb. 8

The Villa at Horned Dorset Primavera: Rincon / 22 / October 2000 / 60 / 20 / December 2002 / Opened October 2002

Villa Montaña (Phase 3): Aguadilla / 48 / November 2001 / 40 / 10 / June 2003 / To be completed by fall 2003

Villas de Costa Dorada (Phase 2): Isabela / 24 / November 2001 / 60 / 20 / August 2002 / Not opened; to be ready in April

Villas del Rey: San German / 19 / May 2002 / 4 / 6 / July 2002 / Ready to open; needs Puerto Rico Tourism Co.’s endorsement

Yunque Mar: Luquillo / 15 / 1999 / 20 / 12 / November 2002 / Design changed; won’t open until June 30

TOTAL: 2,425 New rooms; 3,515 Construction jobs; 2,694 Hotel jobs

Source: Puerto Rico Tourism Co.


Tourism Development Fund Project Portfolio

As of December 2002


Projects: Financing method / Closing Date / Total project cost / Guarantee amount / Rooms

Westin Rio Mar Beach Resort: Afica / November 1998 / $209,635,200 / $150,890,000 / 600

Hampton Inn San Juan Hotel: Afica / Jan. 1996 / 17,755,000 / 11,550,000 / 200

Hostal El Convento: Afica / February 1996 / 14,673,333 / 9,340,000 / 58

Martineau Bay Resort:< Afica / April 1998 / 58,174,112 / 27,130,000 / 156

Embassy Suites Dorado del Mar: Afica / April 1998 / 61,912,361 / 38,975,000 / 174

Cayo Largo Inter-Continental Resort: Afica / September 1999 / 118,689,357 / 75,330,000 / 314

Embassy Suites Isla Verde: Afica / March 2000 / 60,000,00 / 38,400,000 / 300

Paradisus Coco Beach Hotel: Afica / September 2000 / 107,077,290 / 68,290,000 / 491

Coco Beach Golf & Country Club: Afica / September 2000 / 39,647,973 / 18,000,000 --

Palmas del Mar Inc.: Afica / October 2000 / 47,333,133 / 30,000,000 / --

Hampton Inn Caguas: Afica / October 2000 / 29,900,000 / 19,000,000 / 125

Serralles Hotel Inc. (Ponce Hilton): Afica / December 2000 / 62,456,785 / 39,000,000 / 200

Courtyard by Marriott: Scotiabank loan / August 2002 / 46,000,000 / 27,840,000 / 255


Project Cost: $873,254,544

Guarantee Amount: $553,745,000

Room Total: 2,873

Number of hotel rooms endorsed by the Puerto Rico Tourism Co.

1992: 8,415

2000: 11,928

As of Dec. 31, 2002: 12,829

As of January 2003, there are an estimated 2,194 rooms not endorsed by the Tourism Co.

This Caribbean Business article appears courtesy of Casiano Communications.
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