US Hotels taking a big hit…

This was taken from an article recently featured in Hotels magazine:

The average hotel in the United States was valued at US$100,000 per key in 2006. By next year, that value will have sunk to US$50,000 per room, according to a forecast by HVS International. To make matters worse for sellers, for the next 18 months, any transaction will most likely be done at a liquidation value because no one who does not have to sell will sell at these fire-sale prices. As a result, HVS Chairman Steve Rushmore suggests that the typical US$100,000 per key hotel in 2006 could very well sell at US$25,000 per key in the months ahead.
No doubt, this situation brought on by illiquidity and dramatically lower operating performance is going to create a huge transfer of wealth around the world. Financially strapped owners and lenders will take huge losses and buyers should see great returns on investments—perhaps by 2014, when HVS predicts values should next eclipse those 2006 levels and if fi nancing becomes available.
The lack of available credit is causing defaults in all markets and among every property type. New Yorkbased real estate research firm Real Capital Analytics reports that as of June 30, there were 1,060 distressed hotels in the United States valued at US$15.7 billion. The biggest chunk of that distress comes from bankrupt Extended Stay America.
“We started seeing distressed hotels 18 months ago and it started with smaller independents in secondary markets,” says Alan Reay with the brokerage fi rm Atlas Hospitality Group, Irvine, California. “Right now (mid-July) in California there are 32 hotels being foreclosed on, and 31 of those are independents. Only one is a franchise.”
Reay says hotel deals in default have increased 125% in California, and everything from small independents to full-service resorts such as The St. Regis Monarch Beach, the Renaissance Stanford Court and W San Diego are under pressure. “It is broad-based now,” he says. “This will turn out to be the worst downturn in business since the 1930s, and what happened in the early ’90s pales in comparison.”
Looking ahead, US$20 billion of hotel-related commercial mortgage-backed securities (CMBS) matures in 2010. RealPoint LLC, a credit-rating firm based in Horsham, Pennsylvania, reported in June that 753 Marriotts had a combined outstanding securitized loan balance of US$10.4 billion; 270 Hilton-branded hotels had US$5.6 billion in debt; and 48 Hyatts had US$1.6 billion in outstanding debt. This huge wave of CMBS loans about to hit the shore has no form of fi nancing to resolve the situation and will force further defaults, foreclosures and bankruptcies.
Just about any hotel built or refinanced since 2005 is in trouble, according to the experts, as crashing industry fundamentals do not support the ability for any owner to generate enough net income to pay debt service. The options going forward for these owners is to keep ¢ feeding cash into the property to keep it afl oat; for lenders to offer relief in the form of extended terms, as they do not want to own the dwindling asset either; or for the owner to turn over the keys to the lender in what is so aptly called “jingle mail.” Any way you slice it, this is the worst of times for hotel owners, and the bottom for industry fundamentals and real estate values has still not been established.
“Half the lenders (in the United States) will force borrowers to give back keys and
the other half will work it out to extend terms and provide relief,” Rushmore predicts. “Lenders don’t want to take the properties, as there is no financing available for them to find a buyer.”
Laurence Geller, CEO of Strategic Hotels & Resorts, Chicago, agrees that most lenders do not want to take control of these assets. “If loan maturity is the issue and interest is still being paid, it will be likely extended,” he says. “Provided your hotel is in good shape; you haven’t drained the money out for your own purposes; you are operating at, or better than, market share; your margins are better than most in your market; and you have been an honest communicator; why would the bank want to take it form you?”
Geller says owners will stay in for a period of time—say, a year to 18 months—hoping to refi nance, sell or hold. But they will operate almost certainly in accordance with a plan agreed upon with the lender. “A bulk of the troubled assets probably fit into this category, and less than 10% will actually sell because credit is so limited and neither the owner nor the lenders in general want to take an unnecessary writedown if there is a limited market for properties at this time,” he says.
The banks will take back the asset from owners who
have no money and drained the asset. “About 50% to 70% will get sold rapidly, and some will be exceptional buys,” Geller adds.
Jim Butler, chairman of the global hospitality group at the law firm of Jeffer Mangels Butler & Marmaro, Los Angeles, believes the industry is close to the much needed “capitulation,” where there will be a complete “reset” of market values, leverage and expectations for hotels and many other investment classes. “We won’t have the predicate for recovery until this happens, so as painful as it will be, it is a necessary and inevitable precondition for the turnaround,” he says.
Butler thinks many rational lenders will realize “that if they don’t like the value of their hotel collateral today, they will like it even less in six to 12 months. In addition to lower values, they may also risk having to ‘feed’ hotels’ negative cash flows to meet payroll and utility costs.”
Global Phenomenon?
While the economy is struggling through this deep recession, hotel defaults and foreclosures are not expected to occur nearly as much outside of the United States.
The most impacted markets in Europe are the UK, Ireland and Spain, with markets like Italy and France seeing much less pressure at the moment, according to Arthur de Haast, global CEO of Jones Lang LaSalle Hotels, London. “Foreclosures have started and are gathering pace in the UK and Ireland, but mostly of smaller assets owned by developers or private investors who were highly geared and do not have the fi nancial capacity to meet short-term cash fl ow problems,” he says, adding that pressure is building on larger borrowers, but banks in all Europe markets are generally adopting an “extend and pretend” strategy.
In Spain, many banks have effectively taken control assets and are trying to sell them, but at prices that are not finding buyers. “Spain is storing up a lot of problems, and more foreclosures will happen, but not until late 2009 or 2010,” de Haast says.
In Germany, pressure is developing on borrowers, but de Haast says there have been no foreclosures on major hotel assets so far, of which he is aware.
In Central Europe, the picture is very grim, with hotel performance particularly hard hit in the Baltics. “Main lenders in this region have been Scandinavian, German and Austrian banks who are beginning to talk about foreclosure, and we expect things to start happening in the coming months,” de Haast says.
Reports out of Bulgaria claim the banks will foreclose on and own 300 hotels by the end of 2009—again due to steep drops in visitation to the country.
On the other hand, in Asia, there have been no defaults or foreclosures to speak of (other than a few in Australia and New Zealand), and there exists a fair amount of optimism about market conditions, according to Robert Hecker, principal of Horwath HTL, Singapore. “Despite many investors on the sidelines hoping for such opportunities to arise for them to buy distressed assets, most don’t really think many such opportunities will arise,” he says. “The owner-lender relationships and methods of doing business in Asia differ somewhat from North America such that work-outs of one kind or another are more likely to occur than ¢ outright defaults or foreclosures.”
Buying Opportunities
The consensus is that real estate values will hit bottom around the mid-2010, which should finally bring cash holders and newly created funds off the sidelines to buy. Experts forecast that many hotels will suffer 50% to 80% price discounts from valuations made between 2005 and 2008, which will be very attractive to those with the stomach to buy.
“We won’t see a lot of activity this year, but next year owners and lenders will see it is getting worse and will mark down these assets,” says Tom Morone, principal with advisory firm Warnick & Co., Los Angeles. He says a lot of private equity capital is being formed—some in the form of vulture funds seeking to pay 20 to 30 cents on the dollar and others formed with a combination of equity and debt offering high yields and no more than a threeyear hold. “In 2010, we will see a number of those funds showing up,” Morone says.
For now, however, most cash kings are biding their time, knowing values have more room to drop. “It is prudent not to be too aggressive, as no one knows how far down this is going, and the number foreclosures and pain-building on the asset side hasn’t shown itself yet. It is coming,” says Michael Depatie, president and CEO of Kimpton Hotels & Restaurants, San Francisco, which is sitting on a US$250 million war chest ready to buy assets. “We are looking but see nothing changing hands of interest to us. We would step up and buy at the right place, because no one is smart enough to call the bottom, but we see no trades that we missed.”
Clark Hanrattie, chief investment offi cer with HEI Hotels & Resorts, Norwalk, Connecticut, is looking to acquire via his fi rm’s existing US$550 million equity fund and believes the timing is just about right. “Historically, we have been a very focused and diversified investor with 200- to 500-room hotels, not highly leveraged, in markets with limited exposure. As a result, we have been managing fairly well through this downturn,” he says. “We will continue to invest in assets where we have management expertise and begin to make investment off our historical fairway because we have the expertise to execute a business plan. We might recapitalize assets managed by third parties or acquire debt as opposed to straight asset acquisition… There is so much deterioration in value on equity side that anyone leveraged does not have any equity to transact.”
Thomas Smit, Londonbased CEO of Waldeck Capital, which has a fund preparing to buy non-performing assets in the luxury sector, says, “We don’t have baseball bat attitude of ‘sell it at our price.’ We are dealoriented. At same time, we are sitting and waiting. The pressure is mounting and we are in for a dismal summer. Hoteliers are going to have to face the music beginning in the fourth quarter and make calculated decision to write down losses on both the debt and equity side.” He believes that by December, banks will realize their exposure is far greater than anticipated. “They will bite the bullet and make massive allowances for next year and take the writedowns,” he says.
Rushmore says waiting to buy could be a mistake. “Very good properties in great locations will be available in the short term for 30% of replacement cost,” he says. “If you see something today, not as many are chasing it and you might as well buy it if it fits into your parameters. These types of assets should be available by the end of this year.”
Lesson Learned
When this mess is sorted out over the next five to seven years, what will be the lessons learned?
“The lessons learned (again) were being preached by veterans of prior downturns at least as far back as 2005: avoid high leverage, don’t underwrite on overly optimistic valuations and income projections, keep recourse to align owner and borrower interests, and watch out for onerous management agreements and subordination non-disturbance and attornment agreements,” Butler says.
But, he reflects, if this had been the case, not many deals would have gotten done over the last three years. The question is whether the industry be better off today if it had not done those deals?
“Fortunately or not, we seem to have short institutional memories,” Butler continues. “People swear off high debt levels and aggressive underwriting after every major downturn. After the excesses of the pig went through the python in the 1990s, it didn’t take that long until we had it all back again. It is the old syndrome: ‘We will never do this again’— until the next time we do it.”
This time, however, Butler believes we are likely to have major structural changes, including government regulations, investment proscriptions, lower leverage on all assets and changed consumer attitudes in an attempt to “codify” some of these lessons. l
Direct comments to
jweinstein@reedbusiness.com

The average hotel in the United States was valued at US$100,000 per key in 2006. By next year, that value will have sunk to US$50,000 per room, according to a forecast by HVS International. To make matters worse for sellers, for the next 18 months, any transaction will most likely be done at a liquidation value because no one who does not have to sell will sell at these fire-sale prices. As a result, HVS Chairman Steve Rushmore suggests that the typical US$100,000 per key hotel in 2006 could very well sell at US$25,000 per key in the months ahead.

No doubt, this situation brought on by illiquidity and dramatically lower operating performance is going to create a huge transfer of wealth around the world. Financially strapped owners and lenders will take huge losses and buyers should see great returns on investments—perhaps by 2014, when HVS predicts values should next eclipse those 2006 levels and if financing becomes available.

$100,000 in 2006 down to $25,000 per hotel room? That’s a serious drop in value…

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