Ground-up hotel construction is financed in two linked pieces
Building a hotel in Toronto almost always means stitching together a land loan (or land already owned free and clear as equity) and a separate construction facility that funds the build. Lenders treat these as one project even when structured as two facilities, because the construction lender needs certainty on the land position before advancing a dollar toward vertical construction. Major renovations and PIP-driven repositioning projects on an existing hotel follow a similar draw-based structure, just without the land-loan component.
Equity and pre-development requirements
Construction lenders typically want to see 30-40% of total project cost (land plus hard and soft costs) coming in as sponsor equity before they'll commit, higher than the leverage available on a stabilized, income-producing hotel. Before a construction lender will issue a term sheet, expect to have zoning and site plan approval in hand or well advanced, a substantially complete set of stamped drawings, a general contractor under contract (often with a guaranteed maximum price), and a signed or letter-of-intent franchise agreement if the project is going to carry a flag.
- Sponsor equity: typically 30-40% of total project cost
- Site plan approval and zoning in place or clearly on track
- GC under contract, ideally on a guaranteed maximum price or stipulated sum basis
- Franchise LOI or executed agreement, since brand affiliation affects both the appraisal and the takeout market
Draw schedules and the cost consultant's role
Construction funds do not arrive as a lump sum - they're released in draws tied to verified progress. A third-party cost consultant (sometimes called a quantity surveyor or construction monitor) inspects the site before each draw, confirms the percentage of work actually complete against the approved budget, and reports to the lender independently of the borrower and the GC. The lender advances against that report, not against invoices alone, which protects against both cost overruns and work that is billed but not yet built.
- Draws are typically monthly, tied to a cost-to-complete schedule agreed at closing
- The cost consultant's site visit and sign-off happens before, not after, each advance
- Soft costs (architect, engineering, permits, interest reserve) are usually drawn on their own schedule alongside hard construction costs
Ontario's 10% statutory holdback
Under the Ontario Construction Act, the lender (like the owner) is required to hold back 10% of the value of services or materials supplied on each certified draw, for a minimum of 60 days after substantial performance of the contract, to protect subcontractors and suppliers who register liens. This holdback is not optional financing structure - it's a legal requirement - and it means your effective available draw on any given certificate is 90% of the certified amount, with the retained 10% released once the lien period expires without a claim. Budgeting for this holdback in your cash flow plan avoids a mid-project liquidity surprise.
Cost overruns and contingency
Construction budgets move. Lenders build in an expectation of overruns by requiring a contingency line - commonly 5-10% of hard costs - within the approved budget, and by requiring the sponsor to fund cost overruns beyond that contingency out of pocket before the lender advances further. On a $15 million hard-cost hotel build, a 7% contingency is roughly $1,050,000; if overruns exceed that, most facilities require the sponsor to inject the shortfall dollar-for-dollar before draws resume. Building a realistic contingency into the original budget - rather than treating it as padding to be trimmed - keeps the project bankable when steel, labour, or PIP-driven scope changes push costs up mid-build.
Franchise approval and PIP obligations
If the project will carry a brand flag, the franchisor's approval of design, finishes, and operating standards typically needs to be locked in before or very early in construction, since retrofitting a partially built hotel to meet brand standards is far more expensive than designing to them from the start. On acquisition-and-reposition deals, the Property Improvement Plan (PIP) issued by the franchisor at the time of a flag change or renewal functions like a mandatory renovation budget, and lenders will often finance the PIP scope as part of the same construction facility used for other improvements, provided the PIP items and cost estimate are finalized before closing.
Interest reserves and the stabilization period
A hotel under construction generates no revenue, so most construction facilities include a capitalized interest reserve - a portion of the loan set aside specifically to cover interest payments during the build - so the sponsor is not required to service debt out of pocket while the property is non-income-producing. Once construction completes and the hotel opens, it typically takes 12-24 months to reach stabilized occupancy and ADR, sometimes longer for a new-to-market independent or a full-service property with meeting and banquet space. Construction lenders account for this ramp-up period explicitly, and it's a key reason construction facilities are structured as short-term, interest-only debt rather than long amortizing loans.
Take-out financing: planning the exit before you break ground
A construction loan is bridge capital by design - it's meant to be repaid, not renewed, once the hotel stabilizes. The take-out (the permanent or conventional mortgage that repays the construction facility) is typically underwritten against stabilized NOI at maturity, using the same DSCR and going-concern principles that apply to any hotel refinance. Because construction facilities usually mature 24-36 months after closing, it pays to model the take-out early: what DSCR-driven loan amount is realistic on projected stabilized NOI, and does that amount fully retire the construction balance, or will the sponsor need to bring additional equity at conversion. Lining up take-out interest - whether with the construction lender itself or a separate institutional lender - well before stabilization avoids a scramble at maturity.
Frequently asked questions
- How much equity do I need to build a hotel from the ground up in Toronto?
- Most construction lenders want to see roughly 30-40% of total project cost, including land, hard costs, and soft costs, coming from sponsor equity before committing to a facility. Strong sponsors with a flagged franchise and a guaranteed-maximum-price contractor can sometimes negotiate toward the lower end.
- How do construction draws work on a hotel project?
- A third-party cost consultant inspects the site and confirms the percentage of budgeted work actually complete before each draw is released, typically monthly. The lender advances against that independent report rather than against invoices alone, which protects against cost overruns and incomplete work being billed as finished.
- What is the 10% statutory holdback in Ontario construction financing?
- Under the Ontario Construction Act, lenders and owners must hold back 10% of the value certified on each draw for a minimum of 60 days after substantial performance, to protect subcontractors and suppliers who can register liens. This means your effective usable draw is 90% of each certificate, with the remaining 10% released after the lien period expires without claims.
- How are cost overruns handled during hotel construction?
- Budgets typically include a contingency line of 5-10% of hard costs built in at closing. If overruns exceed that contingency, most lenders require the sponsor to fund the shortfall out of pocket before further draws are advanced, rather than the lender increasing the facility.
- Does a franchise flag affect construction financing?
- Yes. Lenders generally want franchisor approval of design and finishes locked in before or very early in construction, since retrofitting a partially built hotel to brand standards later is far more costly. On repositioning projects, the franchisor's Property Improvement Plan (PIP) often functions as the renovation budget and can be financed within the same facility.
- What happens when a hotel construction loan matures?
- Construction loans are short-term, interest-only bridge facilities, typically maturing 24-36 months after closing. At maturity, a take-out (permanent) mortgage is underwritten against stabilized NOI and DSCR to repay the construction balance - planning that take-out early, before the hotel opens, avoids a liquidity gap if stabilization runs longer than projected.