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W San Diego Portending New Real Estate Strategy

Think giving the keys back on a hotel makes sense? Here's why it may.

Friday, July 10, 2009
Glenn Haussman
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With many sectors of the lodging business in turmoil, most specifically hotel real estate, hoteliers are being forced to make some real tough choices. And one of the most difficult is letting a hotel go into default. On the surface it seems like the antithesis of a smart business decision. But in today’ reality, letting a hotel be taken back by the bank may actually make the most fiscal sense for an ownership group.

It’s a business model some are predicting will become a trend in the next couple of years as billions of dollars in commercial mortgage backed securities (CMBS) debt becomes due. And with room rates and occupancy depressed making those payments as originally agreed up may become impossible.

So how exactly does letting a hotel slip into receivership make sense? It was a subject that came up this week at the Americas Lodging Investment Summit Summer Update, held this week in Los Angeles.

Turns out that in some instances letting the property go can actually help the health of a company that has many other solid hotel investments. So freeing yourself of a property that cannot be saved financially may be an organization’s only recourse.

The most notable company to take this route of action is Sunstone Hotel Investors, which last month decided it was a better move to let the 258-room W San Diego slip into default rather than pump in $65 million of cash to what they considered losing situation.

According to Sunstone Hotel Investors’ Chairman Robert Alter, the company is sitting on $200 million cash stockpile and owes the bank $65 million. “[We] chose not to make payments because we viewed it as sending more bad money after good. It looked like in the analysis [to us] the value was not going to reach the $65 million debt limit,” said Alter.

In addition to that property, the lodging real estate investment trust (REIT) has interests in 43 hotels comprised of 14,755 rooms primarily in the upper-upscale segment. Sunstone’s hotels are generally operated under nationally recognized brands, such as Marriott, Hilton, Hyatt, Fairmont and Starwood.

When Sunstone bought the property in 2006 for $92 million company executives expected the San Diego hotel industry to remain stable. But more supply flooded the market such as Hilton San Diego Bayfront which has 1,190 rooms and the uber upscale Se San Diego and two other Starwood branded hotels.

“There was a lot of equity initially in hotel and then income fell dramatically. New hotels opened. So that income went down dramatically,” said Alter.

According to Sunstone, the $65.0 million, fixed-rate CMBS mortgage that bears an interest rate of 6.14%. The mortgage matures January 1, 2018, and is non-recourse to the Company. Scheduled 2009 debt service on the mortgage is approximately $4.0 million. The principal amount of the mortgage equates to more than 30-times the hotel’s 2009 forecasted EBITDA, and more than $250,000 in debt per room.

With numbers like that, Sunstone representatives said they tried to work out the loan with the lender but “the special servicer has recently declined the Company’s proposed modifications,” said a pres release.

Because of this, Sunstone decided to forgo last month’s debt service payment on the hotel’s mortgage.

Michael P. Levy, Managing Director with Morgan Stanley said he understand why Sunstone made such a decision and that is makes fiscal sense in this instance. “In general Sunstone has a fiduciary duty to its shareholders. You can do a lot with $200 million in capital and they thought that on a risk adjusted basis to deploy their cash elsewhere. This is something that is taking place en masse around the world,” said Levy. He also notes that more often bankruptcy and foreclosure are being used as tools to deal with the issue of committed capital and getting appropriate risk adjusted return on it. “That decision is taking place around the world today,” he said.

Michael Murphy, Head of Lodging and Leisure Capital Markets with First Fidelity Companies said the move will also free up more cash very month to also be utilized elsewhere. “Now they can clean up their balance sheet. Its axiomatically better and [they] saved [themselves] $2 million in cash flow,” said Murphy.

Alter sees this as something that is going to become a more utilized move here in the United States.

“When you can’t engage a servicer in a conversation, what else can you do? I believe by taking that action you set up the rest of industry to be put on notice. There was a lot of non recourse debt out there and people will look at the facts and decide how to proceed,” said Alter.

Credit
Glenn Haussman    Glenn Haussman
Editor in Chief
Hotel Interactive, Inc.

Bio: Glenn Haussman is Hotel Interactive's Editor-In-Chief, where he manages all editorial content for the hotel industry’s leading online information resource. In addition to publishing the daily magazine, he hosts a weekly on demand radio shows and develops educational content for the company’s BITAC and HI Connect Design ...
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