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Hospitality Lawyer: Hotel foreclosures on track to set new records in California and elsewhere.

26 June 2009

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Hospitality Lawyer with new data indicating hotel foreclosures will set new records

On June 26, 2009, Atlas Hospitality released the results of its study on foreclosures in California We think these results have much broader implications for the hotel industry on a national basis. Here is the latest.

The June 26, 2009 Atlas Hospitality Report

Atlas Hospitality Group specializes in the sale of California hotels. It was founded by Alan X. Reay in 1997. Since its inception, Atlas has sold more hotels in the state than any other brokerage firm. Alan Reay can be reached at (949) 622-3409, or

Here are some highlights from the Atlas report (download the full text below):

  • The number of hotel defaults or foreclosures in California has jumped 125% in the last 60 days. California now has 31 hotels foreclosed on and 175 hotels in default.
  • Approximately 2,500 California hotels were either financed or refinanced between 2005 and 2007.
  • California hotel values today are estimated to be 50-80% lower than at market peak in 2006-2007 because of the 2009 year-to-date date drop in room revenues of more than 21.5%, combined with the jump in cap rates.
  • Alan Reay says that this means that there is no equity left in virtually any of the 2,500 hotels financed in 2005-2007. Increasingly, these hotel properties are challenged to generate revenues sufficient cash to meet operating expenses like payroll and utilities, much less providing enough money to pay the mortgage.
  • The wave of distress in California hotels started with smaller, non-flagged hotels in secondary and tertiary markets, but now it affects all property types from economy to luxury. Look at economy chains like Extended Stay and Red Roof Inn, and then look at the St. Regis Monarch Beach and W San Diego.

These numbers are stunning. Recall that in the last great downturn of the early 1990s there were a record-setting 2,000 hotel foreclosures and bankruptcies. Now the Atlas report suggests that there could be more than that number in California alone.

Are California hotel foreclosure risks representative of other U.S. markets? (Probably)

Consider some of the facts recently presented here on the

Some of the best data is available for CMBS loans which represent about one third of the total debt on all commercial real estate. Another third is debt owed to banks, and the rest is debt to all other lenders.

The loans in CMBS pools are probably reasonably representative of all the debt. Therefore, the performance or defaults of real estate loans will likely be similar for all such debt.

Realpoint reports that loan delinquencies through May 2009 were up 5 times from one year ago to approximately 2.28%, and they predict, based on stress analysis, that the default rate by the end of the year will at least double to 4.4% and could reach 5.7%.

Bloomberg reports that Morgan Stanley analysts say hotel delinquencies (as opposed to all commercial real estate) are already at 4.7% and will likely reach 8.2% by December 2009.

California, Texas, and Florida have 30% of the loan delinquencies today, and the top 10 states have 60% of the loan delinquencies.

If 75% of all hotels in California (and the rest of the U.S.) were financed or refinanced in the 2005-2007 period, they have no equity left, may not be covering operating costs and likely will not recover their peak values until 2014 under the Steve Rushmore prediction, or later according to more pessimistic views.

PKF projects that the “typical U.S. hotel” will suffer almost a 47% decline in NOI through 2010 (37.8% in 2009 and an additional 9.2% in 2010). This is the first time in 72 years that PKF has recorded unit-level profit declines in excess of 20%, and the prediction is for double that threshold.

If Atlas is right that 2,500 California hotels — from economy to luxury — are under water, there must be double or triple that number in the United States, maybe approaching 10,000 hotels which have no equity and may soon fail to cover operating costs.

3 big questions are:

  1. How long will owners continue to fund debt service that is not covered by the property?
  2. How long will owners fund payroll, utilities and other operating costs that cannot be paid from cash flow?
  3. What incentive do owners have to fund shortfalls if they don’t recover any equity for several (many?) years?

What does this all mean?

There is a lot more pain ahead for all commercial real estate, and particularly for hotels. It is not going to get better quickly. There needs to be a complete RESET in the industry — a reset of values, leverage and expectations. That has not really happened yet, but there is about to be a terrible wrenching that will force it to happen.

In practical terms:

  • If you are a lender, watch your assets carefully. You may have rolled a maturity, but any hotel financed between 2005 through 2007 is likely going to have seriously deteriorating cash flows that have eliminated all equity, and threaten to impair ability to pay operating expenses. Don’t be caught by surprise when a borrower gives back the keys and tells you payroll is due Friday (and there is no money in the operating account to pay it). </li?

  • If you are a borrower, what are your options? Do you have the capital to withstand the big RESET that is going to come, or can you get it? Is there another plan that makes sense for you? How do you handle a continuing downturn in the hospitality industry fundamentals and a long, slow recovery?
  • As a lender or investor, what is your investment horizon or time schedule? If it is very short, sell or foreclose (and sell) now — before further price deteriorations. If it is longer, and you have the capital and stamina, why not get the 30% IRR investors are looking for today on your own assets? Get some good advisors to help you plot the strategy to survive and thrive.

Other articles on this topic

Click here to download the Atlas report referred to in this article.

Other recent articles that relate to the state of the industry paint a pretty consistent picture of data and trends. Here are a few links to articles for your convenience:

This is Jim Butler, author of and hotel lawyer, signing off. We’ve done more than $60 billion of hotel transactions and have developed innovative solutions to unlock value from troubled hotel transactions. Who’s your hotel lawyer?

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