In large-scale hotel transactions, securing financing is not simply a matter of identifying a bank willing to provide capital.

Acquisitions, conversions, repositioning projects, greenfield developments, major refurbishments and value-add strategies require a far more sophisticated financial structure.

The key question is not how much debt may theoretically be available, but rather how much debt the transaction can genuinely support.

This is the purpose of the debt case.

A business plan typically illustrates the economic potential of an investment.

A debt case must demonstrate something different:

that the project generates sufficient cash flow to service and repay the financing even when operating performance falls below expectations.

For investors, banks, private debt funds and institutional lenders, this distinction is fundamental.

The bankability of a hotel project ultimately sits at the intersection of four factors:

asset quality + operating performance + sponsor strength + financial structure sustainability.

The debt case is not the business plan

One of the most common mistakes in hotel financing is using essentially the same financial model for equity investors and lenders.

The two perspectives are fundamentally different.

Equity investors primarily focus on:

  • IRR;

  • equity multiple;

  • EBITDA growth;

  • asset appreciation;

  • exit value;

  • overall value creation.

Lenders, by contrast, focus on:

  • repayment capacity;

  • cash flow stability;

  • quality of collateral;

  • LTV;

  • Debt Yield;

  • DSCR;

  • covenant headroom;

  • liquidity buffers;

  • refinancing risk;

  • asset value under downside scenarios.

In simple terms:

equity investors want to understand how much they can make.
Lenders want to understand how much capital they could lose, and under what circumstances.

A debt case must therefore be specifically designed to answer the second question.

1. The starting point: Sources & Uses

Every transaction should begin with a comprehensive assessment of the total funding requirement.

The first schedule to be prepared is the Sources & Uses statement.

Uses

The uses of funds should include, at a minimum:

  • acquisition price;

  • taxes;

  • advisory fees;

  • due diligence costs;

  • legal and notarial costs;

  • CAPEX;

  • FF&E;

  • OS&E;

  • design costs;

  • project management;

  • technical services;

  • pre-opening costs;

  • initial marketing;

  • working capital;

  • contingency;

  • capitalised interest;

  • financing fees;

  • reserve accounts.

Sources

Funding sources may include:

  • sponsor equity;

  • senior debt;

  • junior debt;

  • mezzanine financing;

  • preferred equity;

  • vendor financing;

  • shareholder loans;

  • subsidised financing instruments;

  • public grants.

The first mistake to avoid is therefore starting with a financing percentage.

Not:

“The bank finances 60%, so how much debt can I raise?”

But rather:

“What is the real capital requirement of the transaction, and what financing structure can sustainably support it?”

2. Debt sizing: debt should be sized against cash flow

One of the key differences between a basic financing assessment and a genuine debt advisory approach lies in the way debt capacity is determined.

The correct sequence should be:

Sustainable cash flow
→ CFADS
→ Sustainable debt service
→ Debt capacity
→ LTV test
→ Debt Yield test
→ Covenant test.

Not the other way around.

In many cases, the maximum debt theoretically permitted by the LTV will exceed the amount actually supported by cash flow.

Where this occurs, the cash flow constraint should prevail.

3. From revenue to CFADS: the lender’s real analytical pathway

A lender does not finance revenue.

Nor does it directly finance RevPAR.

It finances the asset’s ability to generate cash.

The analytical sequence should therefore be:

Occupancy × ADR
→ Rooms Revenue
→ Total Revenue
→ GOP
→ EBITDA
→ Normalised EBITDA
→ Cash Taxes
→ Maintenance CAPEX
→ Changes in Working Capital
→ CFADS
→ Debt Service
→ DSCR

The key metric is CFADS – Cash Flow Available for Debt Service.

What is CFADS?

CFADS represents the cash actually available to meet:

  • interest payments;

  • principal repayments;

  • other financing obligations.

In simplified terms:

CFADS = Normalised EBITDA
– Cash Taxes
– Maintenance CAPEX
– Changes in Working Capital
± Other Operating Adjustments

It is often a more meaningful indicator than EBITDA alone.

A hotel may report substantial EBITDA while having materially lower debt-servicing capacity once recurring capital expenditure, taxation and liquidity requirements are taken into account.

4. Normalised EBITDA: removing what is not recurring

Before calculating debt capacity, the quality of EBITDA must be tested.

Historical EBITDA may be influenced by:

  • exceptional costs;

  • non-recurring revenues;

  • understaffing;

  • owner-related costs not priced at market rates;

  • missing management fees;

  • non-market rents;

  • exceptional energy costs;

  • deferred maintenance;

  • maintenance expenditure that has not been incurred.

The EBITDA used for debt sizing must therefore be:

normalised, sustainable and repeatable.

A sophisticated lender will generally adjust or exclude any earnings component that cannot reasonably be considered structural.

5. LTV: necessary, but not sufficient

Loan-to-Value remains a key metric.

LTV = Debt / Asset Value

In hospitality, however, it cannot be assessed in isolation.

A hotel is not simply a piece of real estate.

It is simultaneously:

  • real estate;

  • an operating business;

  • a distribution platform;

  • a commercial platform;

  • an organisation;

  • a brand;

  • a hospitality product.

Its value therefore depends in part on the asset’s ability to generate income.

A seemingly conservative LTV may still conceal a fragile financial structure.

6. LTC: how much of the project is actually funded by the lender?

In development and repositioning transactions, the Loan-to-Cost ratio becomes equally important.

LTC = Debt / Total Project Cost

This metric helps determine how much capital the sponsor is genuinely putting at risk.

A financing structure may show a conservative LTV while still relying on a very limited initial equity contribution.

From a lender’s perspective, this raises an alignment issue.

The relevant question becomes:

How much sponsor capital is genuinely at risk before debt funding is drawn?

7. DSCR: the core debt-servicing test

The Debt Service Coverage Ratio measures the project’s ability to service its debt.

DSCR = CFADS / Debt Service

A DSCR of 1.00x means all available cash flow is absorbed by debt service.

A DSCR above 1.00x provides a financial buffer.

However, the average DSCR is not sufficient.

The analysis should include:

  • minimum DSCR;

  • average DSCR;

  • stabilised DSCR;

  • ramp-up DSCR;

  • downside DSCR;

  • DSCR following an increase in interest rates;

  • DSCR after the expiry of an interest-only period.

The correct question is not:

“Is the average DSCR acceptable?”

It is:

“How much room exists before the covenant is breached?”

That margin is known as covenant headroom.

8. Covenant headroom: the real margin of safety

Assume the financing documentation requires:

Minimum DSCR: 1.30x

while the business plan forecasts:

DSCR: 1.38x

Technically, the covenant is satisfied.

However, the margin is extremely limited.

A relatively minor deviation in revenue or costs could result in financial stress.

A professional debt case should therefore measure:

Headroom = Forecast DSCR – Covenant DSCR

and test how that headroom changes under downside scenarios.

Simply complying with the covenant is not enough.

What matters is the margin of safety.

9. Debt Yield: measuring income relative to debt

Debt Yield provides an additional perspective on credit risk.

Debt Yield = NOI or Normalised Operating Income / Debt

Its advantage is that it does not directly depend on:

  • interest rates;

  • loan tenor;

  • amortisation profile;

  • stated property value.

It therefore allows lenders to assess the relationship between operating income and the amount of capital advanced.

LTV, DSCR and Debt Yield should be used together.

They provide three different perspectives on the same underlying risk.

10. The CAPEX challenge: financing today an EBITDA that will only exist tomorrow

Many hotel transactions follow a value-add strategy.

The investor acquires an asset in order to:

  • refurbish it;

  • expand it;

  • reposition it;

  • upgrade its classification;

  • introduce a brand;

  • increase ADR;

  • increase RevPAR;

  • improve GOP and EBITDA.

The financing challenge is clear.

The lender is being asked to provide capital today based partly on operating performance that may only materialise in the future.

The debt case must therefore clearly illustrate the bridge from:

Current EBITDA
→ CAPEX
→ Closure or Reduced Operations
→ Reopening
→ Ramp-Up
→ Stabilised EBITDA.

In more complex transactions, the transition from historical to stabilised earnings should be modelled on a monthly basis.

11. Ramp-up: often the most vulnerable phase

The post-reopening period is frequently the stage of greatest financial vulnerability.

The debt case should explain:

  • occupancy build-up;

  • ADR development;

  • opening costs;

  • sales and marketing investment;

  • recruitment;

  • workforce stabilisation;

  • customer reactivation;

  • distribution mix development;

  • GOP progression.

A hotel does not normally move from zero to fully stabilised performance within a matter of weeks.

Any model that assumes otherwise risks overstating debt-servicing capacity.

12. Interest reserve, interest-only periods and amortisation holidays

During construction and ramp-up, the financing structure may incorporate:

  • interest reserves;

  • capitalised interest;

  • interest-only periods;

  • amortisation holidays;

  • progressive drawdowns;

  • delayed amortisation;

  • subsequent cash sweeps.

The principle should remain the same:

align the debt profile with the industrial cycle of the investment.

Financial structuring should not be used to disguise an inadequate business case.

13. The base case is not enough

An institutional debt case should include at least three scenarios.

Base Case

The operating scenario considered most likely.

Downside Case

This may incorporate:

  • ADR -5%;

  • occupancy -5%;

  • payroll +5%;

  • utilities +10%;

  • CAPEX +10%;

  • delayed opening;

  • higher interest rates.

Severe Downside

A more substantial stress scenario designed to test the transaction’s resilience under adverse conditions.

The central question becomes:

How far can EBITDA deteriorate before the debt structure becomes problematic?

14. Sensitivity analysis: identifying what can break the model

Sensitivity analysis should identify the variables that represent the greatest risk to debt sustainability.

Key sensitivities typically include:

  • occupancy;

  • ADR;

  • payroll;

  • utilities;

  • food cost;

  • distribution costs;

  • CAPEX;

  • reopening timing;

  • interest rates;

  • exit yield.

The purpose is not to build dozens of theoretical scenarios.

It is to identify which two or three variables have the greatest impact on debt capacity.

15. Financial break-even: how far can performance fall?

A sophisticated debt case should also calculate the operating and financial break-even point.

For example:

  • minimum occupancy compatible with debt service;

  • minimum ADR;

  • minimum EBITDA;

  • minimum CFADS;

  • minimum RevPAR.

The key question becomes:

“At what level of operating performance does DSCR fall to 1.00x?”

This analysis reveals the true margin of safety within the transaction.

16. Numerical example: building a hotel debt case

Consider the following purely illustrative transaction.

Transaction Cost

Property acquisition: €28.0 million

CAPEX: €10.0 million

FF&E and OS&E: €2.0 million

Transaction costs: €1.5 million

Pre-opening and working capital: €1.0 million

Interest reserve and fees: €1.5 million

Contingency: €1.0 million

Total Uses

€45 million

Illustrative Capital Structure

Sponsor Equity: €18 million

Senior Debt: €27 million

Total Sources

€45 million

LTC:

€27m / €45m = 60%

If the stabilised value of the property is estimated at €50 million:

LTV:

€27m / €50m = 54%

At first sight, the structure appears relatively conservative.

But the debt case cannot stop there.

17. From GOP to CFADS: an example

Assume the stabilised hotel generates:

Revenue: €15.0 million

GOP: €6.0 million

Corporate / fixed costs: €1.0 million

EBITDA: €5.0 million

Maintenance CAPEX: €0.6 million

Cash taxes and working capital: €0.4 million

CFADS

€4.0 million

Assume total annual debt service of:

€2.7 million

DSCR would therefore be:

€4.0m / €2.7m = 1.48x

The metric appears sound.

It must now be stressed.

18. The numerical downside case

Assume:

  • revenue falls by 8%;

  • payroll increases by 5%;

  • GOP declines;

  • CFADS falls to €3.3 million.

With debt service remaining at €2.7 million:

Downside DSCR = 1.22x

If the financing covenant requires a minimum DSCR of 1.25x, the transaction has already entered a potential technical default zone.

This example illustrates why a 54% LTV is not, in itself, sufficient evidence that the debt is sustainable.

The issue is not the collateral value.

It is cash flow.

19. Reverse debt sizing: how much debt can the hotel genuinely support?

Debt sizing can be approached in reverse.

Assume:

Sustainable downside CFADS: €3.3 million

Required minimum DSCR: 1.30x

Maximum sustainable annual debt service:

€3.3m / 1.30 = €2.54 million

The maximum loan amount can then be calculated based on:

  • interest rate;

  • tenor;

  • amortisation;

  • balloon payment.

This is a more rigorous approach than simply applying an LTV percentage.

20. Maximum debt is constrained by multiple tests

In an institutional financing process, debt capacity should be assessed under several tests.

For example:

Debt capacity based on LTV: €30 million

Debt capacity based on DSCR: €26 million

Debt capacity based on Debt Yield: €27 million

Debt capacity based on LTC: €28 million

The sustainable debt amount should generally reflect the most conservative constraint.

In this example:

approximately €26 million.

Not €30 million.

That difference can often represent the boundary between efficient leverage and a fragile capital structure.

21. Cash sweep: turning upside into deleveraging

In transactions with higher leverage, a cash sweep may be appropriate.

A portion of excess cash flow is allocated to early debt repayment.

For example:

  • 50% of excess cash flow distributed to the sponsor;

  • 50% applied to senior debt repayment.

This mechanism can:

  • reduce LTV;

  • improve DSCR;

  • lower refinancing risk;

  • accelerate deleveraging.

Operating upside is therefore progressively converted into financial protection.

22. Covenants: they belong in the model before closing

Common covenants may include:

  • maximum LTV;

  • minimum DSCR;

  • minimum Debt Yield;

  • liquidity covenants;

  • reserve requirements;

  • restrictions on distributions;

  • cash traps;

  • cash sweeps;

  • mandatory prepayments;

  • cure rights.

The model should show the evolution of each covenant on a quarterly or annual basis.

It is not sufficient to test compliance only at closing.

The relevant question is:

At what point could a covenant be breached over the life of the financing?

23. Cash traps and distribution lock-ups

A lender may require cash generated by the hotel to be retained rather than distributed to shareholders if certain financial conditions are breached.

These mechanisms may be linked to:

  • DSCR;

  • LTV;

  • Debt Yield;

  • liquidity.

The equity case must therefore recognise that positive cash generation does not necessarily imply immediate distributability.

24. Sponsor strength: lenders also finance execution

Two economically identical projects can have materially different risk profiles depending on the sponsor.

Lenders will typically assess:

  • track record;

  • hospitality experience;

  • equity commitment;

  • balance sheet strength;

  • ability to absorb cost overruns;

  • CAPEX execution capability;

  • governance;

  • management quality;

  • previous financing history.

The equation therefore becomes:

Asset + Sponsor + Operator + Financial Structure.

25. Cost overruns: who pays if CAPEX increases?

CAPEX is rarely risk-free.

The financing structure should therefore address:

  • contingency;

  • cost overrun facilities;

  • sponsor support;

  • equity cure mechanisms;

  • funding priorities.

A lender will generally not want to fund every increase in project costs automatically.

Construction and execution risk must therefore be contractually allocated.

26. Brand and operator economics must be built into the model

Where the hotel is affiliated with an international brand or operated by a third party, the financial model must reflect:

  • base management fees;

  • incentive fees;

  • franchise fees;

  • reservation fees;

  • marketing fees;

  • loyalty programme costs;

  • technical service fees;

  • pre-opening fees;

  • FF&E reserves.

These costs directly affect cash flow.

Using a theoretical GOP without incorporating them would overstate CFADS.

27. Fixed lease versus management contract: fundamentally different debt cases

A hotel operated under a:

fixed lease

has a different credit profile from an:

owner-operated hotel

or a hotel operated under a:

management agreement.

In a fixed-lease structure, lenders may focus on:

  • tenant strength;

  • rent coverage;

  • lease tenor;

  • break options;

  • guarantees.

Under a management agreement, the focus shifts towards:

  • operating volatility;

  • management contract terms;

  • performance tests;

  • operator termination rights.

The contractual structure of the hotel directly influences the financing structure.

28. Terminal value cannot be the sole basis for debt repayment

Another common mistake is to base debt sustainability primarily on the future sale of the asset.

A clear distinction should be made between:

operating cash flow

and

exit value.

If debt repayment depends on:

  • expanding valuation multiples;

  • yield compression;

  • significant capital appreciation;

  • particularly favourable market conditions,

the financing structure carries materially higher risk.

The exit should be one repayment route.

It should not be the only one.

29. Exit yield: one of the most important sensitivities

An increase in exit yield reduces terminal value.

For example:

Stabilised EBITDA: €5 million

Value at a 7% yield:

€71.4 million

Value at an 8% yield:

€62.5 million

A relatively modest increase in the market yield can therefore generate a substantial reduction in asset value.

Terminal value must always be stress-tested.

30. Refinancing risk: what happens at maturity?

Every debt structure should assess the outstanding balance at maturity.

The analysis should include:

  • outstanding debt;

  • EBITDA;

  • CFADS;

  • asset value;

  • LTV at maturity;

  • Debt Yield at maturity;

  • refinancing capacity.

A sustainable financing structure should not rely solely on the assumption that credit markets will be more favourable five years from now.

31. Balloon payments: useful, but they must be sustainable

Many real estate financings incorporate a significant balloon payment at maturity.

This may improve DSCR during the life of the loan.

However, it also increases refinancing risk.

The key question is:

Will the hotel’s value and cash flow at maturity genuinely support refinancing of the remaining debt?

32. Hedging: the cost of debt must be stress-tested

Variable-rate debt may require consideration of:

  • interest rate caps;

  • swaps;

  • hedging requirements;

  • interest rate sensitivities.

An increase in financing costs can rapidly erode DSCR.

The model should therefore distinguish between:

operational downside

and

financial downside.

33. ESG and CAPEX: protecting future financeability

The quality and efficiency of the property are becoming increasingly important.

Investment in:

  • building systems;

  • energy efficiency;

  • building envelope;

  • HVAC;

  • water management;

  • energy management systems;

  • certifications;

may affect the future competitiveness and value of the asset.

CAPEX should therefore not be viewed exclusively as a way to increase ADR.

It may also be required to preserve the asset’s future liquidity and financeability.

34. Large transactions require a capital structure, not simply a loan

Above a certain scale, financing is no longer simply about arranging a mortgage.

It becomes a true capital structure exercise.

The funding stack may include:

Senior Debt

Capital with the highest repayment priority.

Junior Debt

Debt subordinated to the senior facility.

Mezzanine

A financing instrument positioned between debt and equity.

Preferred Equity

Capital with economic priority over common equity.

Common Equity

The capital most directly exposed to operating and investment risk.

The optimal structure is not necessarily the one with the lowest nominal cost of capital.

It is the one that achieves the best balance between:

cost + flexibility + risk + control + return + sustainability.

35. The financial model should become a negotiation tool

An institutional-quality model should support discussions with lenders around:

  • leverage;

  • pricing;

  • amortisation;

  • bullet structures;

  • maturity;

  • covenants;

  • reserves;

  • security package;

  • cash sweeps;

  • cash traps;

  • cure rights;

  • refinancing.

It should therefore integrate:

**P&L

  • Balance Sheet

  • Cash Flow

  • CFADS

  • Debt Schedule

  • Covenants

  • Sensitivities

  • Exit Analysis.**

Its role is not merely to describe the profitability of the investment.

It must show how financial risk evolves over time.

36. The correct sequence for a professional debt case

A structured process can be summarised in twelve steps:

  1. asset analysis;

  2. EBITDA normalisation;

  3. business plan preparation;

  4. CAPEX definition;

  5. Sources & Uses preparation;

  6. CFADS calculation;

  7. debt capacity assessment;

  8. LTV/LTC testing;

  9. Debt Yield testing;

  10. covenant structuring;

  11. downside and sensitivity analysis;

  12. refinancing and exit analysis.

Only after completing these steps can an appropriate debt structure be determined.

37. The decisive question: how much error can the transaction absorb?

The quality of a debt case does not depend on its ability to predict the future with precision.

No financial model can do that.

Its quality depends on its ability to measure how far actual performance can deviate from the forecast before the transaction enters financial distress.

A high-quality debt case should therefore answer very practical questions:

How far can ADR fall?

How far can occupancy decline?

How much can CAPEX increase?

How much can the cost of debt rise?

How long can the ramp-up be delayed?

How much can EBITDA decline before covenants are breached?

This is the true measure of financial resilience.

The core principle: debt must be sustainable before it is attractive

Financial leverage can materially enhance equity returns.

At the same time, it increases the fragility of the transaction.

The correct analytical sequence should therefore be:

Asset Quality
→ Sustainable EBITDA
→ CFADS
→ Downside CFADS
→ Debt Capacity
→ Covenant Headroom
→ Leverage
→ Equity Return.

Not the other way around.

First determine how much debt the project can sustainably support.

Only then assess the equity return.

This is the difference between financing a hotel acquisition and building an institutional-quality financial structure.

Conclusions

In large-scale hotel transactions, access to capital is not enough.

The transaction requires a financial architecture capable of functioning throughout the entire investment cycle:

Acquisition → CAPEX → Ramp-Up → Stabilisation → Deleveraging → Refinancing or Exit.

A professional debt case should answer at least seven questions:

How much debt can the asset genuinely support?

What is the normalised CFADS?

What is the DSCR under the downside case?

How much covenant headroom exists?

How much sponsor capital is genuinely at risk?

What is the outstanding debt at maturity?

Can the transaction remain viable without relying on an exceptionally favourable exit scenario?

If these questions can be answered convincingly, debt becomes an instrument of value creation.

If they cannot, leverage can turn even a fundamentally attractive hotel investment into a vulnerable financial structure.

At InvestimentiAlberghieri.it, we analyse hotel investments, acquisitions, value-enhancement strategies and financial structures by integrating real estate, operating and financial perspectives.

RobertoNecci.it provides strategic, operational and economic insights into the hospitality industry.

Investhotel.it focuses on investment analysis, value creation, turnaround strategies, repositioning and the structuring of hotel transactions.

HotelManagementGroup.it combines hospitality advisory, management expertise and financial analysis applied to hotel assets and operating businesses.

For investment analysis, business planning, debt case preparation, financial feasibility studies and hotel valuation assignments:

info@investimentialberghieri.it


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