It’s Not About “W”

By: Robert A. Rauch, CHA

No, we’re not talking about former President Bush.  The “W” hotel is the talk du jour as they basically handed the keys back to their lender this past week.  Is this the first of many to come? While the underlying market value of hotels typically declines only 20-30 percent during a recession, there will be some distressed assets that will trade at an even deeper discount.  In the case of the “W,” the owners, Sunstone, made a strategic decision. They are a public company with a non-recourse loan, and the value of the asset as well as the cash flow no longer footed to the debt on the property.  Any hotel purchased or refinanced in the “go-go” years of 2006 and 2007 might find themselves in a similar loan default.

What is the proximate cause of the decline in values and subsequent defaults?  One is the hotel finance market and the other is declining net income (NOI).  According to HVS International, at the peak of the market in 2006, $1000 of NOI created $11,364 in value. That value dropped to $8,850 at the end of 2008, a decline of over 20 percent, and worsened in the first quarter of 2009.  If that value were merely on paper, then everyone involved moves on, so long as the mortgage is paid.  However, a decline at that rate means most owners can no longer pay their mortgages out of day-to-day operations.  So value is only important if one is selling, refinancing or renegotiating a loan.

Declining net income is a realproblem because it drives the cash flow and the ability to repay a loan.  When a borrower has less cash flow than the mortgage payment each month, a decision needs to be made as to whether or not it is a short-term challenge or structural change in market conditions.  San Diego’s hotel industry has experienced structural changes over the past nine months and occupancy and rate levels have been reset to levels not seen since 2002.

In the case of the “W,” because the luxury market downtown added new supply in abundance, revenues declined precipitously.  Projections by Smith Travel Research for 2009 range from a 10 to 20 percent drop but certain markets and market segments are getting hit harder than others.  This revenue decline can translate into a 40-50 percent decrease in net income at some hotels and non-recourse owners might decide that they are not going to continue to pay the operating losses.  A few lenders will take properties back or borrowers will hand them the keys.

Hotel owners and operators are revising budgets downward on a regular basis.  No operator today is looking at forecasts made last quarter.  This is not a good time to sell unless you have no choice or can find a “strategic buyer” – there is probably no such thing at the moment!  It is also difficult to build – no construction loans are available – and if there were, lenders would be determining all the loan terms.  At the end of the day, there will be foreclosures, bankruptcies, and lenders in possession of properties.  This happens during every recession.  It’s no different today.


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