Hospitality – A Nickel Isn't Worth a Dime Today 

We’re not out of the woods yet...

The sentiments going through each of our minds as we bid 2009 a “good riddance” and trek cautiously and more hopefully into 2010 emulate Franklin Roosevelt's famous quote: “We have nothing to fear but fear itself.” 

In response to the depressed state of the real estate and capital markets, large amounts of capital are now chasing opportunities to purchase defaulted hotels as well as hotel real estate loans at a discount. Not since the savings and loan crisis in the late 1980s has the market expected a comparable volume of distressed hotels to be sold. For savvy buyers, this is a chance to earn enviable returns. 

"This is like deja vu all over again." -Yogi Berra

Between 1989 and mid-1995, the Resolution Trust Corporation closed or otherwise resolved 747 thrifts with total assets of $394 billion.

When asked about what is the most exciting component of 2010 - Andrew Segal, president of Boxer Property in Houston said it well: “Unprecedented low priced buying opportunities." When asked about what are the biggest worries of 2010: “Unprecedented low priced selling opportunities."

Bloomberg: “Luxury hotel sales may increase in 2010 as property values drop. Luxury hotels will be among the U.S. lodging industry’s most traded real estate next year as buyers go after high-end properties that have slumped in value,” said Arthur Adler, chief executive officer for the Americas at Jones Lang LaSalle Hotels. “The luxury hotel sector is among the top active sectors because there are more challenges; luxury hotels have suffered the most. The possible discounts, if properties come to market and trade, will be greater in this sector than in others.” 

Reuters: “Global hotel transactions are forecasted to rebound by up to 40 percent in 2010, boosted by Asian and Middle Eastern investors, after sales volumes plunged to a decade low this year. Between $11 and $13 billion worth of hotels are expected to change hands next year, recovering from the market's 64 percent year-on-year decline to $9 billion in 2009,” said investment services firm Jones Lang LaSalle Hotels.

"You've got to be very careful if you don't know where you're going, because you might not get there." -Yogi Berra

Last time around during the RTC debacle, at least there was some capital available; this time, not so much. We are seeing lenders cautiously getting back into the market but with debt coverage ratios at more historic levels and interest rates pegged to Prime vs. LIBOR that better reflect the risk of these investments. Over the years, the benchmark DCR or debt coverage ratio (debt coverage ratio is calculated by dividing the net operating income of a property by its annual debt service; annual debt service equals the annual total of all interest and principal paid for all loans on a property; a debt coverage ratio of less than 1.0 indicates that the income generated by a property is insufficient to cover mortgage payments and operating expenses) for hospitality properties has historically been approximately 1.4. When we look at upcoming CMBS and other loan rollover, that is a “high watermark” based on real time stressed occupancies and ADR’s.

Per the Urban Land Institute’s December newsletter – hotel occupancy rates (a moving 12-month average) stood at 58.7 percent in third-quarter 2009, down from 60 percent in the first quarter of 2009, and 680 basis points below the same quarter a year ago. Completions were up slightly as a percentage of rooms, from 2.6 percent in third-quarter 2008 to 3.2 percent. Revenue per available room (RevPAR) fell in the third quarter of 2009 compared to the same quarter a year ago, off by 23.1 percent.

According to PKF Hospitality Research’s (PKF-HR) December 2009 report: “The year 2010 will continue to be a tough one for U.S. hotel owners and operators.” PKF-HR is forecasting that, on average, properties will continue to suffer year-over-year declines in revenue and profits from an already dismal 2009. However, given the deceleration of room rate discounting observed during the third quarter of 2009, the severity of the losses incurred in 2009 and 2010 will be less than previously forecasted. In addition, year-over-year growth in important measurements – such as occupancy, RevPAR, and demand – will be realized a full quarter earlier than thought three months ago.

“Accordingly, this year’s annual ADR forecast has been reduced to a decline of 8.8 percent, and the 2010 ADR forecast is now a minus 1.5 percent. These compare to declines of 10.4 percent and 3.1 percent that we forecasted last quarter.”

“The steep declines in RevPAR and the resulting historic contraction in Net Operating Income at the property level have severely undermined the ability of many owners to meet their debt service obligations. This difficulty has been compounded by the economic reality that many hotels serving as the sole source of collateral for the mortgage holders of these assets are no longer worth the face amount of the debt. Data from Trepp LLC illustrates how rapidly this situation has deteriorated. At the beginning of the financial panic in September 2008, only 0.55 percent of the roughly 3,700 CMBS hotel loans were in some form of delinquency or default. By June 2009, this number had increased to 4.31 percent. As of December 2009, the volume of non-performing CMBS hotel loans had sky-rocketed to 13.47 percent.”

According to Moody’s Investors Service: “Although the pace of decline has continued to slow in recent months, commercial property prices have fallen nearly 44% since their peak two years ago, and now look more like what the industry saw in 2002.”

"The pace of declines has tapered off since the large drops measured in April and May; however, further declines are anticipated," the report states. With the 43.7% drop in the Moody’s/REAL National All-Property Aggregate since the October 2007 peak, "it is now necessary to look to properties purchased in 2002 to find positive price appreciation." 

In particular, the report notes that the effect of price drops on loan-to-values are especially pronounced with more recent acquisitions. “On average, loans originated at a 75% LTV in 2005 or later are now ‘under water’ with an average LTV today of 108%.” Although most of the loans will not mature for several years, thus giving values a chance to recover, "later vintage loans are in a deep hole" and face increasing risk of term default as property fundamentals continue to erode. 

“When it comes to the rate of recovery for commercial real estate, federal policymakers are setting the pace more so than market fundamentals,” say experts in a report based on PricewaterhouseCoopers’ quarterly Korpacz Real Estate Investor Survey. 

Dr. David Kelly of J.P. Morgan Asset Management recently reported: “Unemployment always goes up more quickly than it comes down. We may not reach that [full-employment] level (defined by most economists as an unemployment rate of around 5%) until sometime in 2014.” The United States was at 10.0 percent unemployment in November, the highest since 1983.

According to Bloomberg: “The delinquency rate [in commercial real estate] will not improve until the unemployment rate drops and consumer spending revives.”

“Baseball is 90% mental – the other half is physical." -Yogi Berra

The gravity of the real-time problem is staggering. Approximately 1,341 commercial properties in California and 8,393 commercial properties across the United States have maturing CMBS debt in the next 18 months; almost $7 Billion dollars of which is hotel debt alone.

California hotel loans: $6.959B
CMBS hotel loans maturing in 18 months: 195 in California; 1,484 in the U.S. 

Keep in mind that CMBS debt is only approximately 25% of all commercial real estate debt based on $3.47 trillion in commercial real estate and multifamily mortgage debt outstanding. 

The vast majority of this hotel debt coming due was underwritten between 1999 and 2003, prior to peak valuations in 2007. Today’s valuations are probably higher than they were at the time of loan origination.

How much of this debt will be present with a minimum debt coverage ratio of 1.2 to 1.4 at roll-over time?

Moody’s Investors Service reported that multifamily delinquencies rose by nearly a full percentage point between October and November 2009. In fact, multifamily came second only to hotels in terms of the month-to-month increase in the amount of delinquent loans. 

Data from Trepp LLC illustrates the highest delinquency rates in CMBS loans:

13.47% for hospitality 
13.0% for multifamily
9.7% for retail
7.2% for other
4.9% for office

Two of the larger CMBS portfolios that exhibited stress in 2009 were:

1) A $967.2 million mortgage on a hotel portfolio controlled by CNL Hotels & Resorts
2) A $344.6 million loan on a hotel portfolio owned by “Beanie Baby” investor Ty Warner

"You can observe a lot just by watching." -Yogi Berra

Coming out of the Holiday season, a Charles Dickens story seems appropriate: A Tale of Two Cities. These are two real-time case studies evolving at this time with branded hotels in established markets:

Baird/Baird Real Estate – Hotel default of the week I: 

The 400-room Hyatt on Capitol Square in Columbus, OH was purchased for $38.7 million in 2007 and funded with a $32 million, 10-year CMBS loan originated by LaSalle Bank. Today the loan is in special servicing with LNR Partners after the hotel generated only $3.2 million of NOI in 2008. Last reported the hotel was covering debt service below the 1.15x covenant which triggered special servicing for the loan. The hotel was built in 1984 and is reportedly in good condition but suffering from overall weak demand in the Columbus market. Bloomberg reports that the borrower is seeking a restructuring of the loan terms.

Baird/Baird Real Estate – Hotel default of the week II:

The 234-room SpringHill Suites Seattle hotel's $32.7 million CMBS mortgage has been transferred to CW Capital's special servicing group. The mortgage is 60 days delinquent as its debt service shortfall hasn't been funded by the current owners since October. The 6.4% fixed rate mortgage was originated in November 2006 by CGM. Debt service has dropped under 1.0 despite hotel occupancy of 71% YTD. Built in 2001, the hotel on Yale Avenue in Seattle was purchased in 2006 for $50.7 million ($217,000/key). Both of these examples get to the core of our concerns: well located hotels; just hammered by local market conditions with debt coverage ratio issues to match.

We are quoting non-recourse debt for hospitality with a preferred loan size of $10M – $30M (larger loans considered on a case-by-case basis); LTV’s of 60% – 70%; interest rates between 7.5% – 10.0% subject to the perceived risk of the borrower and the site; and 5 – 7 year terms. 

Full-recourse programs in hospitality range in preferred loan size of $15M+ with virtually no ceiling; LTV’s up to 70%; pricing at Prime + 2.5%, so 5.75% today; and 2 – 6 year terms.

We have active lenders who will look at new-build hotels and resorts as well as review broken projects on a case-by-case basis.

“A nickel isn't worth a dime today." -Yogi Berra

In closing:

• 1,484 hotel and resort CMBS loans come due in the next 18-months
• CMBS debt is only approximately 25% of all commercial real estate debt
• The delinquency rates in CMBS loans so far have been 13.47% for hospitality – the highest of all food groups 
• Unemployment will not get back to normal levels until 2014
• Nobody knows what debt will look like when it returns in abundance, other than: a) it will be far more conservative; and b) it will be far more expensive

“Probably the worst deals are done during good times, so I supposed some of the best deals will be done during these times.” -Anonymous


Buon vento!

Don

Dr. Donald W. Wise
Global Hospitality Industry, Managing Partner
Johnson Capital
Hospitality and Leisure Real Estate Investment Banking
1436 Second Street, Suite 310
Napa, California 94559
707.252.6975 Office
949.283.9706 Mobile
donwise@johnsoncapital.com

Comments