Bob Eaton, the San Francisco-based executive managing director of PKF Capital, says that lodging properties usually take the most immediate hit when a recession strikes. "The effect of bad economic news is probably felt more quickly at the front desk of a hotel than it's felt in the rent rolls of an office building," he says. "In other words, if a company cuts back on travel today, that means that tomorrow a hotel room that would otherwise be occupied is not. You've got literally millions of one-day leases."
PKF recently worked on two deals that would qualify as distressed situations. In October, it arranged the sale of the 86-key Hotel Montgomery in San Jose, CA on behalf of Gramercy Capital, which had taken back the property in a foreclosure. The buyer, Khanna Enterprises, paid $12.4 million for the independent boutique property, with the seller providing financing. In the other transaction, the 44-unit Rosario Resort and Spa in Eastsound, WA, was sold via an auction for $5.9 million. It is currently closed for redevelopment. "The owner needed and wanted to sell but didn't want to do a classic marketing program because that had been done several times before and it hadn't worked," Eaton recalls.
Similar transactions are expected as RevPAR losses deepen in 2009. PKF forecasts that RevPAR will fall 7.8% in 2009. Meanwhile, PricewaterhouseCoopers, using current projections for the US economy and historical data from Smith Travel Research, estimates a 5.8% drop in RevPAR in '09, which follows a 0.8% decrease in 2008, which marks the first consecutive two-year RevPAR decline since 2001-02, when the benchmark fell by 7% and 2.7%, respectively.
Tumbling RevPAR has a ripple effect on both hotel values and NOIs, especially if a hotel cannot control costs, points out Rich Conti, president of the Plasencia Group, a brokerage, investment advisory and consulting firm in Tampa, FL. The situation is further compounded by the high loan-to-value ratios placed on lodging assets in recent years, which makes refinancing difficult with lenders underwriting in a more conservative fashion. "A 25% NOI drop indicates a 25% decline in value. If you have an 80% LTV, you could be underwater," Conti says. "When we get to the end of '09—and the consensus is for a RevPAR decline of around 8%—we are going to see hotels that are not covering debt service and will, in fact, be in default of the loan. Now when that happens, the owner of the hotel will either have to get cash from another investment or another source to pay that debt service, or the lender could do a workout or default the particular hotel."
Currently, Conti says that his firm is "talking with a lot of lenders," suggesting they undertake sensitivity analyses on lodging loans in their portfolios, cutting the projected NOI for 2009 by 25% to 30% over 2008 levels. That way, the banks can ascertain which properties might have cash flow deficiencies. "Now is the time to do the analysis, create the watch list, so they can determine how they want to do their workouts or defaults. We are going to see [more issues] starting the second half of '09, because then there will have been four consecutive quarters of RevPAR decline at an accelerating level."
Whether a lender decides to negotiate with a borrower or proceed to a foreclosure is dependent upon many factors, Eaton explains. "A small community bank that has made a loan on a hotel really has no in-house expertise available to oversee and take back that property, so they are going to be more inclined to try to work something out with the borrower," he says. "In other cases, where you have more institutional-caliber collateral and a very experienced and savvy lender, that lender would have no problem taking a property back. So it depends on the asset itself, the specific market and then the lender."
In today's constricted debt environment, finding a lending source for a refinance is difficult, Eaton admits. "If it's a great asset with a great borrower with low leverage and the ability to pay a high interest rate in an urban setting with huge barriers to entry, you are much more likely to have a number of people interested in that loan than the other extreme, which is a suburban, single-market-focused property with a weak borrower and poor market performance."
The acquisition market is similarly subdued, although Eaton says deals are being made. "Most of the equity players in the hotel business remain active," he says. "They recognize that now may be a time for them to strategically plant a flag or pick a location that otherwise has been difficult for them to find and they may deploy capital. They are the same as lenders. They are more risk adverse today. But there are transactions that will happen, there is financing that will happen. It has been very slow because there's been a resetting of everyone's expectations."
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