No doubt about it, the economic crisis has resulted in a significant change in the financial landscape. Many of the active lenders are no longer in existence, or are facing regulatory constraints limiting their ability to lend.
Here’s a macro-look at indoor waterpark investment
performance to help explain some of the current investor
indifference and offer some suggestions for indoor waterpark owners
In short, commercial real estate is experiencing a tough one-two
punch of rising capitalization (cap) rates and declining net
operating income. Most experts predict this will result in declines
of 40 percent to 50 percent from peak to trough values.
To understand why, you must understand a concept called the cap
rate. It is defined as the ratio between the net operating income
produced by the property and the amount paid to purchase the
property. The cap rate is a rough approximation of the cost of
capital (debt and equity) and the perceived risk of an asset (that
is, a higher perceived risk would result in a higher cost of
capital and thus a higher cap rate).
In 2007, relatively cheap and abundant money resulted in cap
rates of approximately 8.5 percent and allowed marginal projects to
work — indoor waterparks and other commercial real estate.
That led to overbuilding and the overcapacity that exists in all
sectors of commercial real estate. For example, when vacancy rates
for office buildings in the United States are near 20 percent, do
we really need to build more before utilizing existing space? The
answer is clearly “no.”
Furthermore, because the existing space can compete better on
price, new projects would not make economic sense to a lender or
investor. Today, risk aversion and higher risk premiums have
resulted in capitalization rates near 12 percent. Based on
analysis, most investors believe a 30 percent drop in property
values has occurred just from the change in cap rates, though there
have not been significant property sales to support this
In terms of income and revenues, though the depth of the
recession and its impact on waterpark resorts is still unknown,
other hospitality projects have experienced a significant drop in
net operating income. Nor has the performance of the indoor
waterpark sector escaped completely unscathed. Today, the industry
is divided into the large destination resorts, led by Great Wolf Resorts
based in Madison, Wis., and the smaller hotels with
Great Wolf Resorts, has reported a drop in revenue —
albeit less than the hotel sector in general — making it
clear that the indoor waterpark concept may not quite live up to
the old belief that it is completely recession-proof.
Furthermore, many smaller properties are struggling. Some are
unable to pay debt service and a number have been unable to even
cover operating expenses. Their lenders are not getting paid and
equity investors are not getting paid, creating an understandable
“bad taste” for the industry.
Given the current picture, the question becomes, what next? How
can waterpark resort operators and developers best prepare for the
time when credit markets bounce back?
For starters, it is more important than ever to know your
lender. A friend of mine received a loan from Prudential, and after
congratulating him on his financing, I asked which group within
Prudential provided the financing: CMBS group, pension fund,
general account, or opportunity fund. His response was, “I am
getting a ‘piece of the rock’ and that’s all that
matters.” He has since discovered that, yes, it does matter
where the money comes from because each group has different
motivations, lending styles and, most importantly, the ability to
be flexible. Therefore, seek to understand your lender’s
business goals and objectives, and what you can do to help meet
those goals and objectives. The more you can help your lender
today, the more they will remember you when the market returns.
Understanding your lender means open and frequent communication.
Anticipate the lender’s questions and provide answers before
questions can be asked. The more information an indoor waterpark
owner can provide to lenders and investors, the more comfortable
they are with their investments.
Additionally, a high level of communication enhances the
lender’s perception of you as a knowledgeable, capable
borrower, the kind the lender will want when the market
Remember, one of the five “C’s” of lending is
the character of the borrower, and how you handle yourself in these
difficult times will help define your character. It can help
eliminate risk. Because risk can be defined as uncertainty, when
lenders cannot understand or explain what is going on with a
property, their perception of risk may be greater than the actual
level of risk. This is especially important when a property is not
performing according to the original projections and providing the
original anticipated returns to the lender or equity investor.
Reaching out to your community and building goodwill is another
important strategy in these difficult times. Indoor waterparks are
significant economic engines and have a lot to offer the
communities where they are located. Partnering and sharing will
endear you to customers and neighbors, and provides an opportunity
to be a leader in your community.
Perhaps some of the best advice can be found in the poem
“All I Really Need to Know I Learned in Kindergarten”:
Share everything, play fair, and don’t hit people/ when you
go out in the world, watch out for traffic, hold hands and stick
Ultimately, commercial real estate markets will recover when the
economy is finished with the painful de-leveraging process that
we’re in the midst of. For example, it’s hard to
justify investment in a new indoor waterpark when I can buy one at
a foreclosure sale at 50 percent of replacement cost.
Buying such an asset at 50 percent of replacement cost means an
equity investor lost their investment and the lender has taken a
loss on the original loan. This is the de-leveraging process in
which we find ourselves today.
Until then, operators should not bury their heads in the sand.
They should be forthright and realistic with their lenders,
understanding their lenders’ and investors’ views of
the asset in comparison with other commercial real estate