The U.S. lodging industry finds itself in uncharted waters due to a global economic and financial crisis that has taken a severe toll on the net operating income (NOI) of hotel owners, setting the stage for a wave of loan defaults and foreclosures.

Why such a dire prediction? PKF Hospitality Research forecasts a 39.1-percent decline in NOI for the typical U.S. hotel this year, the biggest drop on record since it began tracking hotel data in the 1930s.

“That 39.1-percent decline has some devastating consequences for loan defaults,” says Steve Van, president and CEO of Dallas-based Prism Hotels & Resorts, an owner and manager. “If you are dropping NOI by 39.1 percent, you are burning through debt service. That’s going to fuel and set fire to a lot of loan defaults.” To put that figure into perspective, in a strong economy a full-service hotel can generate a 25-percent annual increase in NOI.

There are an estimated 50,000 hotel loans in the U.S. today, says Van. Among hotel loans structured as commercial mortgage-backed securities, for which the data is the most widely available and transparent, the default rate is 11.4 percent, according to Deutsche Bank.

Against that backdrop, National Real Estate Investor, a Penton Media publication, in August convened a five-member panel of hotel experts to share their experiences in the trenches and offer practical advice to owners. The webinar, titled “Solutions for Troubled Hotel Assets,” attracted more than 360 attendees.

In addition to Van, panelists included Mark Elliott, senior managing director of Hodges Ward Elliott; Michael Feldman, partner and co-chair of the Lodging and Gaming Practice Group at law firm Proskauer Rose LLP; Steven Rushmore, president and founder of HVS International and a columnist for Lodging Hospitality; and Stephen Peca, director and senior credit consultant with Moody’s Analytics.
Plunging values

HVS, which tracks hotel values in 50 U.S. markets, projects a 32.1-percent decline in room value for the typical U.S. hotel in 2009 and a 9.2-percent dip in 2010. The value per room reached $100,000 in 2006, but is forecast to fall to $50,000 in 2010, a 50-percent drop. It is expected to take until 2014 before valuations return to peak levels.

The slump in value per room only complicates matters for lenders. Will the lion’s share of troubled mortgages be modified or will those properties end up in foreclosure? “While it’s hard to predict, I believe that a majority of deals done as acquisition financing from late 2005 through 2008 will end up in foreclosure,” says Feldman of Proskauer Rose.

“The prices paid for the majority of those assets was so high that they will either not be able to meet debt-service payments when the interest-only periods end, or they will not be able to be financed at maturity without a lot of new capital coming into the deal,” adds Feldman.

Caught off-guard
In previous downturns a troubled hotel would slowly drift into default, explains Van. The warning signs such as unpaid bills, deferred maintenance or falling debt-service coverage ratios would start to show up a year in advance of a default. “There would be all sorts of things a hotel owner would be doing to try and save their hotel.”

But the swift and steep drop in NOI for owners in this downturn has resulted in a dramatically compressed timeframe to rectify the problem before it gets out of control. Van describes a disturbing scenario that has occurred at least a handful of times.

“The borrower will call up the lender on a Monday and say, ‘I’ve got a non-recourse loan and payroll is due Friday. It’s $250,000. The keys are in the mail, and [the hotel] is yours.’ It doesn’t give the asset manager or the special servicer as much time to react as before.”
REMIC Hotel Management, a division of Prism Hotels, is a specialist in turning around distressed hotels for lenders and CMBS special servicers. REMIC has completed 175 distressed hotel assignments.

“We basically do things in the first two or three days that are necessary to stop the bleeding and get the patient out of the emergency room,” explains Van. Then REMIC Hotel Management turns its attention to boosting market share.

“Usually most of these hotels have cut costs to the bone, if not through it,” says Van. Often there is no marketing staff by the time REMIC arrives on the scene. “We start by asking, ‘What can we do to begin to increase sales?’ That’s the only way to get oxygen back in this body.”

REMIC will operate a hotel for several months up to a few years, says Van, depending on how long it takes the lender or special servicer to sell the property. “Hopefully we can make a difference in the recovery of the price of the asset.”

Matt Valley is the editor of National Real Estate Investor, a Penton Media Publication. To listen to the panel discussion, go to www.nreionline.com/webinars.