Jun. 9, 2009--The hip W Hotel in downtown San Diego is headed for foreclosure, following a decision by the owner that the once-high-priced property is so devalued, it's no longer worth the $65 million that is owed.

At one time the coolest, swankiest boutique hotel downtown had to offer, the 258-room W is no longer in a class of its own and has become a drag on its owner's portfolio of 43 upper-end hotel properties.

Sunstone Hotel Investors Inc., a lodging real estate investment trust that purchased the W for $96 million three years ago, concluded it no longer made financial sense to continue paying off its loan.

A number of factors influenced Sunstone's decision, not the least of which is an ailing economy that has hit luxury hotels especially hard at a time when leisure and business travelers are slashing their spending. Making matters worse was increasing competition from boutique luxury hotels downtown and a new 1,190-room convention hotel.

"This hotel is down so much, but the economy is the biggest issue," said Arthur Buser, president and chief executive of San Clemente-based Sunstone, which owns six other hotels in San Diego County, including the Hilton Del Mar and the Embassy Suites in La Jolla. Sunstone said it made the decision to default on its June payment after its loan servicer rejected a proposal to modify its loan.

"San Diego is one of our worst-performing markets," Buser added. "Over Memorial Day, people were saying they could get rooms for $99 or $109 a night in the San Diego luxury market. When you see how low people are dropping prices and how big the debt is and how much additional money we'd have to commit to debt service, it is clear this hotel will not be worth the principal amount of its debt for the foreseeable future."

A spokesperson for the W insisted yesterday that despite the problems between Sunstone and its lender, the hotel will continue to be operated by Starwood Hotels and is expecting a number of sold-out nights during the summer.

While the W has its own set of issues, including a downtown location that is blocks away from the more bustling Gaslamp Quarter and East Village, hotel analysts predict that more high-end hotels may go the way of the W.

Declining occupancy and room rates underline the effects the dismal economy has had on hotels.

For the first four months of this year, the average room rate for downtown San Diego luxury hotels was $194, a 12 percent drop from a year earlier when the rate averaged nearly $221, according to Smith Travel Research. Similarly, occupancy dropped 11 percentage points to 66 percent through April of this year.

In recent months, the luxury Aviara resort in Carlsbad has attracted considerable attention because of efforts by the owners to oust Four Seasons Hotels and Resorts as the manager, claiming the hotel was not being run in a cost-effective manner. Four Seasons has countered that the owners significantly increased their debt when they refinanced the hotel in 2006, making it difficult to cover those costs in an economic downturn.

"I would anticipate a number of scenarios similar to the W that will play out over the next six to 12 months," said Jeff Higley, a vice president with Smith Travel Research. "There's just no funding mechanism available for companies to refinance these things, and values have dropped dramatically, so it makes sense for companies to walk away instead of salvaging their property.

"Most people in the hotel industry are expecting a fire sale on distressed assets that in some cases are 30, 40, 50 percent of the original value."

While Sunstone did not have the W hotel appraised, the property's declining profitability speaks volumes about its dim prospects, executives said.

Profits for the hotel, before taking into consideration debt service and taxes, are expected to plummet to $2 million this year from $7.4 million in 2006, Sunstone said. Sunstone so far has not identified any other hotels it owns that are in danger of foreclosure, though it held open the possibility.

"It's not our intent to convey a significant number of our hotels to our lenders," said Chief Financial Officer Ken Cruse.

Such a decision would only be made, he said, if cash flows fall "considerably short of debt service," the value of the hotel were to remain permanently below the principal amount of the mortgage, and the lender is unwilling to modify the loan.

Like the W San Diego, competing boutique hotels acknowledge that they, too, are facing challenges in a down economy and are looking for ways to economize without alienating their pampered guests.

The 159-room Ivy Hotel in the Gaslamp Quarter has had to lower room rates and launch promotions to draw people into its Ultra Lounge.

"The luxury hotel market has been hit hard across the country. You can get five-star rooms in Las Vegas now for $59 a night," said Jessica Cline, the Ivy's director of communications. "So this is not a San Diego-specific problem. We have to tighten our belts and trim the fat to continue the same services we'd like to provide our guests when we're not getting the room rates we were getting a year and a half ago."

When the sumptuous Se San Diego opened late last year, it took a "conservative" approach with staffing, recognizing the challenges the hotel industry was facing, said Tohnia Miller, director of sales and marketing.

"It's corporate meetings and events that have taken the big hit, so as a reaction, a lot of hotels have lowered rates to drive additional leisure demand," Miller said. "Luxury hotels were charging $250, $300 a night, and now you can get rates for under $200, which is a great value for San Diego."

The W's biggest problem, several observers agree, was that Sunstone purchased it for far more than it was worth at a time when the lodging industry was much healthier. Sunstone acknowledged that the $250,000 debt per room at the W is roughly twice that of its other mortgaged hotels.

"You're supposed to buy low and sell high, and they did the reverse," said San Diego hotel consultant Jerry Morrison. "They were probably running 10-year projections and market studies that told them the market would inflate, but the bottom line is the market doesn't work that way.

"I think you'll see more of this happening in San Diego, as well as in other parts of the U.S. Unfortunately, it's the nature of the beast."

Lori Weisberg: (619) 293-2251;

Union-Tribune

Lori Weisberg: (619) 293-2251;

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