The Interest Reserve Is Where Hotel Construction Deals Die

The most common reason a hotel construction model comes back from this desk is that its interest reserve stops at completion. The hard costs are budgeted. The construction schedule is plausible. And then the model assumes that opening the doors means the hotel can pay debt service the following month.

It does not work that way.

A hotel can receive a certificate of occupancy and still need twelve months to build staff, distribution, reviews, group base, and rate. Construction may be finished. The loan is not out of risk.

That distinction is where many otherwise credible construction files fail. The reserve gets treated as a percentage of the loan or as a round number negotiated at the end. We treat it as a schedule: monthly interest from close through the point at which operations can carry the debt under a stressed ramp.

Completion is not the finish line

There are three dates in every construction model. The first is closing. The second is substantial completion or opening. The third is stabilization. The reserve needs to cover the full distance from the first date to the third.

For hospitality, the span between the second and third dates is not idle time. It is a revenue period with real payroll, utilities, sales costs, brand fees, property taxes, and operating variance. A property may generate rooms revenue in month one while still producing too little net cash to service a construction loan. The lender is paid from the reserve during that gap.

The operating backdrop is not a substitute for that math. First-quarter hotel RevPAR grew 3.8% year over year, with ADR up 2.2%, according to Hall Structured Finance. That is useful context for a feasible ramp. It does not make a 12-month ramp become a three-month ramp.

The credit context is equally clear. KBRA reported 30-plus-day CMBS lodging delinquency of 6.4% as of March, below the 23.2% June 2020 peak but uneven across price class and chain scale (KBRA). A reserve is not a view on whether lodging is healthy. It is the cash plan for a property that has not yet proved it can service the loan.

Work the monthly math

Use a worked example. The figures below are illustrative, not a quote. Assume a $40M interest-only loan, an 8.00% planning rate, 24 months from closing to opening, and another 12 months to stabilization. Annual interest is $3.2M. Monthly interest is about $266,667.

The calculation is simple:

A $9.6M reserve is not generous in this example. It is just $266,667 multiplied by 36 months. It assumes the balance stays at $40M and the rate never moves. A construction draw schedule, floating rate, or later stabilization date can make the requirement larger.

Now use the version we see more often. The sources and uses include $7.5M of interest reserve. At $266,667 per month, it covers roughly 28 months. The asset opens in month 24. The reserve is gone near month 28, roughly eight months before the planned month-36 stabilization point.

The missing $2.1M is not a rounding error. It is just under eight monthly interest payments. If the sponsor injects it, the sponsor needs the liquidity and willingness to do so at the least attractive moment in the plan. If the sponsor does not inject it, the loan has a payment problem while the hotel is still trying to establish its rate.

Test the ramp, not the ribbon cutting

We underwrite the months after opening as closely as the months before opening. The construction budget tells us whether the building can be delivered. The ramp tells us whether the capital structure can survive delivery.

A usable ramp starts with rooms out of service, opening occupancy, ADR, labor, franchise fees, property tax reassessment, insurance, and marketing costs. It shows monthly net cash flow, not only an annual average. It also explains the source of the group and transient demand. “New hotel” is not a demand generator.

We then ask one practical question: on what month does property cash flow cover interest under the downside case? That month, not the opening date, is the anchor for the reserve. If the model says month 32 and the reserve ends in month 28, the transaction needs four more months of cash, a different leverage point, or more equity.

We also separate interest reserve from contingency. Contingency is for completion variance: a change order, a delayed delivery, or a cost that was missed. The reserve pays scheduled carry. Counting the same dollar twice is a common source-and-uses error. If the contingency is needed for construction, it is no longer available to make month-29 interest.

The cleanest structures also preserve post-closing sponsor liquidity. A sponsor who puts every dollar into the equity check cannot solve a six-month delay. We want the reserve funded, the contingency identified, and liquidity beyond both.

What we will fund

We will consider hotel construction where the scope, GMP or hard-cost support, brand requirements, and delivery schedule agree with one another. We want the construction draws, reserve, and operating ramp in the same workbook. A 30-month loan term can work if its reserve and extension conditions match a 30-month path to stabilization. A 24-month term with a 36-month business plan cannot.

We will pass when the reserve is designed only to reach completion, when an annual pro forma hides the first twelve months of operations, or when sponsor liquidity is the unspoken substitute for the reserve. Those are not documentation issues. They change the amount of equity the deal needs on day one.

The answer is often smaller proceeds, more cash in the reserve, or a later opening assumption. None is pleasant. All are better than discovering the gap eight months after the doors open.

The box this week

• Loan size: $5M floor; $20M–$100M sweet spot; flexible above
• Asset focus: hotel and resort construction, conversions, and major repositionings
• Leverage: generally to 65% of cost, with proceeds sized off debt yield at stabilization
• Structure: interest-only; reserve sized monthly from closing through downside-case stabilization
• Timing: term sheet target of 72 hours on a complete construction package; closing target of 45–60 days

Send the draw schedule, sources and uses, monthly ramp, construction budget, contingency, and sponsor liquidity together. We will review the reserve before we discuss an opening date.