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When the downtown W Hotel’s owners stopped paying their mortgage last June, real estate analysts considered it the start of trouble for San Diego’s hotel market.
Nine months later, the extent of that trouble is still unclear. But the distress is growing.
More local hotel owners are following suit, falling behind on their loans or flat-out sending the keys back to the bank. The number of San Diego County hotels in default more than quadrupled last year — from six in January to 29 by December, according to Atlas Hospitality Group, an Irvine-based hotel real estate firm.
Among those, the W’s former owner, Sunstone Hotel Investors Inc., stopped paying on three other hotels in San Diego’s core, including two in Old Town and another downtown.
But what happens after those defaults is slow and drawn out and doesn’t mean the hotels will shut their doors. While the year ended with those 29 hotels in default, banks only repossessed three.
At the W Hotel, the lenders in charge are “taking a very long time” to decide what to do about the hotel’s future, said Alan Reay, Atlas’ president. In the meantime, it’s still open for business.
The trouble in San Diego’s hotel sector is about more than just a recession-driven drop-off in vacationers. It also opens a window into the risks of a complicated financing structure that allowed so many hotels to change hands at the peak of the real estate boom.
Groups of owners leveraged and re-leveraged during the boom, taking advantage of some of the loosest years ever for commercial mortgages. Investment firms cobbled together huge collections of hotels, paying extravagant prices. They penciled the deals out counting on the revenues of the heyday to continue.
And they got loans for the majority of those sky-high prices — loans that Wall Street in turn cobbled together and repackaged as new commodities for purchase as commercial mortgage-backed securities.
Many of these loans came with introductory periods where owners needed to pay only the interest that was building, but little or none of the principal owed. The owners borrowing the loans counted on hotel business staying great. And that they’d have no problem in five years convincing a bank to give them a new, better-rate loan on the property that they could pay off over time.
For many of those investors, 2010 is the year the loans come due.
Now, they are stuck in loans that must be refinanced. And even the banks and investment groups responsible for giving these huge loans to hotel buyers are dumbfounded that so many of them could go bad. Instead of foreclosing all the way and putting a hotel up for sale, many lenders are hoping someone else will come along to buy the loan instead.
“No one ever, ever, ever expected this to happen,” Reay said. “That’s why you’re seeing this complete freeze in the marketplace.”
Though it defaulted on the W Hotel and three others last year, Sunstone Hotel Investors still owns other local hotels. But defaulting was an easy way out of what the company thought had become bad investments.
After the company bought these four properties in San Diego’s core, a few hurdles popped up that the company couldn’t surmount — or didn’t want to. An explosion of new luxury, hip, boutique hotels challenged the W’s niche. The recession caused a general significant decline in hotel demand. Some new large hotels dumped even more rooms on the market.
It was a money-draining venture to run the four hotels in San Diego’s core, said Ken Cruse, Sunstone’s executive vice president, and the public company would not push that burden onto its backers.
“We like San Diego quite a bit long-term,” he said. “But that doesn’t change the fact that we’re obligated to protect our stockholders.”
Both the price of rooms and the number of hotel guests dropped significantly last year, thrashing the bottom line for hotel owners. Revenues for San Diego hotels plunged last year, according to PKF Hospitality Research, ending the year down 22 percent, a worse outcome than the stark 17 percent decline nationwide.
Analysts expect revenues to turn positive this year. Cruse has hope.
“A year ago there was a great deal of turbulence in the market, and a great lack of clarity as to where the economy was going to head,” he said. “As we sit here today there’s a considerably better view. And as the economy goes, so goes the lodging industry.”
Even in that case, though, the companies that borrowed too much — at too high a cost — face a huge reckoning, said commercial real estate broker Steve Martini. Though banks have repossessed few hotels in San Diego, he expects that to change.
“I think it’s just coming — I think we’re going to see a lot in this upcoming summer,” Martini said. “That whole side of it is going to be much more in everybody’s face.”