Real Estate Forum - May/June 2009

nessed ADR decreases in two consecutive years, the drops were 1.4% and 1.5%, respectively.

“In the first quarter, the ADR decline is already at 7.7% with no indication that it will get any better and every indication that it will get worse,” Swig points out, using STR stats. “In fact, in the top 25 markets, the downturn is 8.9%, whereas in the other markets it’s 6.5%. The major hotels are getting hammered the worst and so are the top 25 markets, where you have the greatest expense of delivering the product.”

Those are also where the industry generates the lion’s share of its profits.

However, Swig says it would be a mistake to simply focus on the loss of room revenue. Net operating income, or EBITDA, is just as important, and that is where the outlook gets even scarier. In past recessions, a drop in occupancy nearly mirrored the decline in NOI. For example, a 10% drop in occupancy meant an NOI loss of between 10% and 12%.

But this time around, the revenue declines are so dramatic that hotels could see their net operating incomes sliced by a third or nearly in half. “With this dramatic loss of revenue really driven as much by rate as occupancy, profitability is nil, which means everybody is in trouble,” Swig says.

What this means for the industry as a whole is a whole lot of distress that will manifest itself in workouts between borrowers and lenders or a potential rash of foreclosures. Already, some high-profile hotels have been served with foreclosure notices. In the Phoenix area, the 293-room InterContinental Montelucia Resort and Spa as well as the 224-key W Hotel Scottsdale were served with foreclosure notices. (See http://www.globest. com/reforum/0506_09/ montelucia.html.)

Such distress also brings about opportunities for workout specialists. Consulting firm HREC has embarked on a series of seminars around the country

to help lenders figure out what to do with operationally challenged hotels. “We’ve been out in front of literally hundreds of lenders over the past month and a half,” says Geoff Davis, the New York City-based president of HREC Investment Advisors, the brokerage and investment banking arm of HREC. “What you are seeing is a lot of maturity defaults, and it’s really the tip of the iceberg now, because a lot of debt is not even coming due until 2010-11. You also have a lot of technical defaults and on top of all that, monetary defaults. The reasons why are pretty simple. When you look at market

Fitch-rated fixed-rate US CMBS. Such properties, according to the rating agency, have seen their room revenues fall more than 20% from 2008 levels, which, in turn, would result in net cash flow declines of between 35% and 40%.

However, Rothfeld is quick to note that all lodging properties are at risk in these perilous economic times. “Over the next several years, the likelihood is that you are going to see a substantial increase in loan defaults across the entire hotel sector,” he says. “We identify the most significant risk in the upside and luxury sector for many reasons. In a consumer-

With revenues falling at unprecedented

levels, many lodging properties face

defaults and foreclosure

performance, we are in an unprecedented time in terms of RevPAR declines.”

Those RevPAR declines are having a major impact on the creditworthiness of the loans that back lodging assets. In a recent study, Fitch found that 50% of upscale and luxury hotels that back recent-vintage CMBS may fail to throw off enough cash flow to cover debt service by the end of this year, thereby rendering US CMBS transactions with large concentrations of hotel loans ripe for downgrades.

Fitch managing director Eric Rothfeld attributes this trend to a slump in both consumer and business spending. And he does admit he was a bit surprised by what the data uncovered. “Fifty percent is a big number,” he says. “We didn’t anticipate it would be that high. But it’s an indication of the vulnerability these hotels have in a downturn.”

Fitch reviewed $6.5 billion of high-end hotel loans included in 2006 and 2007

led recession, consumer and corporate spending are dropping significantly and it seems to be a case where many people are looking to scale back. If they are looking to book hotel rooms, they are going to choose one that meets their budget rather than taking advantage of a discounted rate to upgrade. That is what you saw in previous recessions that were not necessarily consumer-led.”

Standards & Poor’s recently revised its average RevPAR decline projection for 2009 upward to between 14% and 16% from 10%. With that steep a drop in revenue, S&P predicts that the CMBS lodging delinquency rate could match previous peak levels and hit 8% later this year or in early 2010, thereby raising the possibility of hotels being foreclosed upon in the coming months. “CMBS delinquencies include foreclosures, so yes, we expect the number of lodging foreclosures to rise,” says Larry Kay, a director in S&P’s CMBS surveillance group. “Of course, this will vary widely by market and segment.”