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Wednesday, June 19, 2009 | Downtown’s W Hotel is accustomed to being in the spotlight.

With great aplomb, the luxury hotel opened in 2002 after building considerable hype. It even employed a hotel-room-on-wheels with Plexiglas walls where underwear-clad models frolicked on plush beds as it drove through the city streets. Another iteration featured partying swimsuit-wearers to promote the hotel’s beach-style bar with a sand floor.

Now, the W is attracting attention again, but of a decidedly soberer tone. The hotel’s owners announced last week they will stop making their mortgage payments, sending a ripple of disquiet through the local hotelier community. While the W’s trouble might be dismissed as an isolated incident, the market for hotel and office and retail space in San Diego in general is in deep trouble.

“We are at the tip of a very, very large iceberg,” said Alan Reay, president of Atlas Hospitality Group, an Orange-County-based hospitality real estate firm. “We’re going to see a lot more of that.”

Across the country, hotel revenues have dropped off a cliff. In San Diego, those revenues are expected to drop 24 percent this year, according to a report released Tuesday by PFK Hospitality Research.

“Two-thousand-nine is going to be the worst year on record in the U.S. lodging industry in the more than 70 years that they’ve been keeping records, and 2010 isn’t going to be much better,” said Jim Butler, an L.A.-based hotel lawyer and author of the Hotel Law Blog.

Hotels, and especially luxury hotels, serve as an extreme example of impending trouble for the commercial real estate sector, which analysts have been projecting loudly for the past year. The market exploded this decade for high-end luxury hotels, especially in downtown, in recent years — the W, Ivy, Sè San Diego, Hard Rock Hotel, Hotel Solamar and The Keating among them.

They are extravagant, lavishly decorated and oriented toward hosting a big-spending corporate group in San Diego for a conference or attracting locals to trendy nightspots. They are modern attractions, thematically designed like the hotels of Las Vegas and Miami with rooftop bars and posh lounges.

A drop-off in discretionary income, corporate expense accounts and regular old splurging has left a major mark on the industry. But the problems for hotels extend beyond the recessionary conditions affecting businesses across the board.

Owners looking to acquire or build a new boutique hotel found a buffet of financing options this decade — the market for securitized commercial loans overflowed with mortgage investors salivating over big-ticket purchases. That was the case, too, for many other commercial properties, from office to retail. Many got loans with five- or 10-year introductory periods, counting on their investments pulling in boom-style revenues for years to come and leaving them in a position to handle the increased payments at the end of that period.

This might sound familiar.

The plight of overleveraged homebuyers who stretched to buy houses and condos at the peak of the market is well-known. Now, without equity, and with a dearth of accessible financing, homeowners are forced to either keep paying on an asset that is worth less than they owe, or to walk away with a short sale or a foreclosure.

These days, big companies are weighing similar options.

The W’s owners, Sunstone Hotel Investors, Inc., said their hotel is underwater. Sunstone paid $96 million near the market peak in 2006, financing its purchase with a $65 million mortgage that carried a 6.14 percent interest rate and is due in 2018. The company estimated its principal payments were 30 times the amount of expected cash flow in 2009. Plus, the spot is a few blocks out of the way of much of the Gaslamp District’s activity, and there are other new luxury hotels closer by.

“As a result of negative supply and demand fundamentals in the San Diego market, we believe the intrinsic value of the W San Diego is now meaningfully below the principal amount of its debt,” said Ken Cruse, the company’s chief financial officer, in the company announcement.

Many of these hotels are owned by private companies, the revenues and financing details of which are not easily determined. Even in foreclosure or bankruptcy, an owner dispute with a lender might not affect at all the day-to-day operations of a hotel, which are often managed by a different company and kept up while the property is repossessed or sold.

One of the W’s competitors is the Ivy Hotel. Owned by Michael Kelly’s Kelly Capital Group, the $90-million, 159-room hotel opened in 2007 as a luxury “adult playground.”

Kelly declined to comment on what Sunstone’s decision to walk away from the W meant for his business. He said the Sunstone decision was a private financial calculation, the details of which he didn’t know. “It’s a really tough time in the industry,” he said.

Room rates are down, revenues are down, but Ivy’s restaurants and bar revenues are helping to support it, Kelly said.

“Although we agree that market value appears depressed right now, as long as the owners are able to hold on and weather the storm, we’re confident we’ll regain whatever equity may have been diminished in the not-too-distant future,” he said.

More luxury hotels have come online in recent months even in this climate.

Sè San Diego, a luxury 184-room hotel immediately adjacent to the House of Blues, opened on Dec. 27, four days before this declaredly worst year for hotels began. The lobby, according to its website, is appointed with a 9,000-pound bronze door, black ebony columns adorned with turquoise patina beads, teardrop crystals, Nepali carpets, silver leaf covered walls and shagreen upholstery — not to mention the two front desks “upholstered in pelts of stingrays” and a rotating silk chandelier.

Tohnia Miller, the hotel’s director of sales and marketing, admits the market is tough. Before the hotel even opened, it scaled back its staffing and rates. Now, a room that might in a normal market be rented for $300 a night carries a midweek rate of $179, she said.

Miller said she, like a lot of people, read the news about the W’s looming foreclosure with concern.

“I think it’s indicative of the times,” she said. “Hotels are really real estate and real estate is one of the things that is driving this.”

But she doesn’t think that the market for high-end hotels grew oversaturated, and she said she believes it will roar back in time.

“San Diego was due for the same kind of sophisticated properties that other great cities have,” she said. “I think it’s going to be some time. We hope, obviously, it’s as quickly as possible.”

Local real estate analyst Gary London said Sunstone’s decision indicates the company is not optimistic that its 2006 revenues were achievable again in the near future. The county became home this decade to “an abnormally high number” of luxury boutique hotels, which were often financed based on an assumption of achieving ever-increasing, high-tier revenues over a 10-year span, London said.

“That couldn’t have played out even if we didn’t have the mother of all recessions,” London said. “Commercial real estate has sort of suffered from this sense that the world will go on at the same high-growth rate in the future as it did the past.”

Butler, a hotel attorney, said that he’s seen three situations in the last six months where the lenders were thinking they were going to do some kind of workout or extension on the hotel but the owners of the hotel walked away.

“They were mailing the keys and saying, ‘By the way there’s payroll due on Friday and there’s no money in the account,’” he said. “This kind of thing is happening all over the place.”

London said that even though this trouble won’t be contained in the hospitality industry, he doesn’t think the office and retail buildings will be hit as hard.

“The hotel industry is by definition the most complicated real estate ownership that there is, because you essentially have to re-rent the space every night,” he said. “It’s even in good times the riskiest of all commercial investments.”

Please contact Kelly Bennett directly at kelly.bennett@voiceofsandiego.org with your thoughts, ideas, personal stories or tips. Or set the tone of the debate with a letter to the editor.

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