As the hospitality industry emerges from a devastating year of occupancy and revenue declines, there is a lot of speculation about who, if anyone, will be able to profit from distress in that commercial property sector.

 

Lenders, investors, brokers and attorneys for hotel transactions descended on downtown San Diego for the Americas Lodging Investment Summit co-hosted by the American Hotel & Lodging Association and the Burba Hotel Network from Jan. 25 to 27 at the Hilton San Diego Bayfront Hotel.

 

U.S. hotel room demand dropped 5.8 percent in 2009 while supply increased 3.2 percent, according to Hendersonville, Tenn.-based Smith Travel Research. Occupancy dropped by 8.6 last year, average daily room rates dropped 8.8 percent and revenue per available room, or RevPAR, dropped a staggering 16.7 percent.

 

Smith Travel is predicting that U.S. supply and demand will swing back into balance this year, with both measures increasing 1.8 percent in 2010. The firm does not expect occupancy to rise or fall significantly this year but has forecast an additional 3.2 percent decline in room rates and 3.2 percent drop in RevPAR.

 

Mark Woodworth, president of Atlanta-based PFK Hospitality Research, said that hospitality property values will appreciate this year as hotel performance improves.

 

Jones Lang LaSalle Hotels is forecasting $3.5 billion in 2010 hotel sales in the Americas, including $1.7 billion in U.S. transactions. Hospitality transactions sank to $2.1 billion in the Americas last year after almost $10 billion in investment in 2008 and nearly $50 billion in 2007.

 

Arthur de Haast, global chief executive officer of Jones Lang LaSalle Hotels, said that sales of distressed hotel assets will be limited again this year because banks don't want to take properties back from troubled hoteliers.

 

Lenders prefer to work out distress situations because they have bigger problems in other commercial property types, de Haast said. But for the hotel owners, banks and special servicers that do want to sell hotels this year, there will be plenty of buyers.

 

"Buyers are getting a discount to replacement costs, so they will move," he said. "The increase in profitability will be dramatic."

 

At the end of 2009, California had 62 hotels in foreclosure, a rise of 313 percent since the beginning of the year when lenders had foreclosed on 15 hotels, according to Irvine-based Atlas Hospitality Group. The number of hotels with loans in some form of default increased 479 percent from 53 to 307 last year.

 

"Lenders are getting to realize it's an expensive thing to hold on to and manage a hotel," said Atlas President Alan Reay.

Lenders that have hotels in default or foreclosure that couldn't sell assets last year at the prices being offered because of the impact to their balance sheets are saying this year that they intend to dispose of distressed hotels at current market prices.

 

Values have fallen 50 percent to 80 percent since 2007, Reay said, and could take another substantial hit in 2010 if lenders dump troubled hotel assets on the market in large numbers this year.

 

Reay said the first wave of distress involved hotels with mortgages originated between the peak years of 2005 to 2007, but properties going into default now have loans originated as far back as 2002.

 

Every major market in California saw double-digit percentage declines in revenue last year. Atlas is forecasting a 5 percent to 10 percent decline in RevPAR in California for 2010 after a 19.3 percent decline in 2009.

 

Wall Street investment bankers anticipate that more companies will pursue initial public offerings in 2010 to raise capital for commercial real estate purchases, including hotels.

 

Chicago-based Hyatt Hotels Corp. closed an IPO in November in which it sold 43.7 million shares for net proceeds of $127.3 million, which the company plans to use for working capital and general corporate purposes.

 

Paul M. Whyte, managing director at Deutsche Bank Securities, said that private equity funds and real estate investment trusts successfully raised funds in the public markets during the last half of 2009 for opportunistic investments in commercial properties.

 

Investors in such public offerings are most interested in companies that can use the capital that's raised to capitalize assets that are already on their balance sheets as well as add properties to existing portfolios, according to Jack Vissicchio, managing director at Bank of America Merrill Lynch.

 

"Investors will hedge their bets around existing assets," he said. "They're afraid the money will sit for a while otherwise."

 

John Putrino, North American head of lodging and leisure for investment banking at Credit Suisse, said 2010 is the beginning of a long-term trend of REITs buying hotels to increase the size of their portfolios.

 

Investors will buy hotel REIT stocks for companies with compelling strategies. Putrino said REITs are expected to use capital they raised last year to clear up debt or distress on their balance sheets so that they're prepared for acquisitions in 2010.

 

Vissicchio said banks are not going to be selling distressed assets in high numbers. Bank of America's strategy is not to sell loans or properties at a big loss to the bank's balance sheet. Lenders will not sell real estate in big numbers until after they begin to show significant profits again, he said.

 

Whyte said local and regional banks will dispose of assets, which will not be institutional investment quality, through near-term sales forced or overseen by the Federal Deposit Insurance Corp. while national and international banks will clear their balance sheets over the next several years.

 

"Lodging as a subsector of real estate is attractive right now," Whyte said. "Where else can you reprice your space on a daily basis and where else can you buy at such a discount to replacement cost?"

 

Robert Stiles, executive vice president and principal at Cushman & Wakefield Sonnenblick Goldman, said that hotels still have some value to lenders and investors if buyers can assume existing debt and if they have some positive cash flow, but the debt providers are unlikely to hold on to troubled hotels that need additional equity investment for capital expenditures.

 

Arthur Adler, managing director and chief executive officer of Jones Lang LaSalle Hotels, said U.S. hotel values are down 40 percent from the most recent peak because of the lack of debt financing available for transactions and decline in cash flow.

 

Last year, all of the holders in the capital stack for hotel mortgages were trying to determine how they wanted to handle troubled hotel assets, according to Adler. This year, he said they have strategies in mind for individual assets and portfolios, so some properties will be sold this year.

 

Robert Koger, president of Washington, D.C.-based hotel brokerage Molinaro Koger, said that there will not be an increase in transactions until lenders get more aggressive about taking hotels back from borrowers who are in default.

 

Hotel owners are walking away from assets when net operating income is significantly below their mortgage payments or properties have significant capital expenditure needs without cash flow to cover those expenses, but lenders aren't taking properties back, except for the hotels in the worst condition, because they aren't comfortable operating hotels, Koger said.

 

"There will be more transactions this year," he said.

 

Patrick Deming, managing director at property brokerage Eastdil Secured, disagreed.

 

"If you're waiting for the floodgates to open, it will be several years," he said.

 

Hotel property values are down 40 percent to 50 percent, but they have risen in the past 90 days, Deming noted, adding that debt financing is coming back to the commercial real estate market, though it will be six months before there is a significant change in hotel debt availability.

 

David Mumford, senior principal at Newport News, Va.-based hotel brokerage Mumford Company, said investment activity in the lower-priced mid-market and economy sectors of the hotel spectrum has been more active than for luxury properties and other high-end hotels, but transaction volume still is 60 percent of what it was at the peak even though lenders are selling an increasing number of distressed properties.

 

Mumford said investors who want to buy distressed hotels with loans held in commercial mortgage-backed securities have to be patient because the special servicers for those assets have to try every kind of resolution they can before they are able to dispose of assets from the trust that holds the properties in CMBS.

 

"I think we're going to be surprised how long the lenders will hold their assets," Stiles said.

 

Banks and special servicers could hold on to hotels for up to 10 years before they dispose of the assets, he said. Special servicers realize a lower loss to the CMBS trust if they take properties back and hold them than if they sell hotels now at current values.

 

Deming said Cushman & Wakefield Sonnenblick Goldman provided 1,500 broker opinions of value to lenders last year and only 35 of the assets were prepared for sale at the brokerage's recommended values.

 

Stiles said the first wave of hotel buyers to reenter the market has been foreign investors and private high-net-worth families and individuals. For budget, economy and mid-market hotels, Mumford said smaller owner-operators are the main buyers. Stiles said opportunistic funds will lose out on transactions to major owner-operators for core assets. Deming expects to see some deals with REITs as buyers this year.

 

Michael Scheinberg, a partner at law firm Pircher Nichols & Meeks in Los Angeles, said that lenders should go through the files on their loans before borrowers turn over the keys to their properties. If lenders have current documentation on leases, management agreements and pending litigation, there will be more certainty for potential buyers, and bids are likely to come in higher when foreclosed assets are sold.

 

Phillip Nichols, a founding partner of Pircher Nichols & Meeks, said that in order for opportunistic funds to put money to work, 2010 will be the year of the document. Investors will have to look through every clause in loan documents and other agreements to find the most effective avenue for investing alongside borrowers or lenders to buy properties and loans or restructure debt.

 

"If you can buy into the borrower's position and have a place at the table, it might not be worth much, but it gets you in to talk to the lender," Nichols said. "The frustration for investors will be spending money to understand everything they need to understand because this time they can't buy things so cheap that it doesn't matter."