October 25, 2009 --By all accounts, this year has been miserable for struggling hotels as travelers clamped down on discretionary spending, sending revenue spiraling to a decade low.

Making matters worse, hotel values have plunged, leading to a mushrooming number of properties in danger of being turned back to lenders as owners fail to make mortgage payments. In just eight months, the number of San Diego hotels facing possible foreclosure has nearly quadrupled, and many analysts predict that more will follow.

That's good news for bargain-hunting consumers who are likely to benefit from discounts on room rates as long as the slumping economy and high unemployment batter the travel industry.

Despite the pessimism, some forecasters are seeing signs of a slow recovery, although a return to some semblance of normalcy isn't expected until at least next year or, more realistically, 2011.

"My biggest concern as a hotel operator is (that) with all these owners walking away from these properties, I'll be competing with lender-owned hotels that will be sold for cents on the dollar," said local hotelier and consultant Robert Rauch, who led a conference this month on "the inhospitable economy in the hospitality industry."

"There will be a bloodbath with people trying to buy up cheap hotels who can then charge lower rates, which will kill the people who are in at full price. Still, I think we've begun to hit bottom, and by next summer and certainly the third quarter, I expect a strong improvement in demand."

A recent report released by the Irvine-based Atlas Hospitality Group, which specializes in the sale of California hotels, revealed a sharp spike in the number of hotel owners defaulting on mortgages, climbing from six in January to 26 in September.

Meanwhile, the number of local hotels pushed into foreclosure doubled from two to four, Atlas Hospitality found. They are the Pacific Coast Inn & Suites in Pacific Beach, Mount Woodson Golf Resort in Ramona, the now-closed El Camino Motel in Imperial Beach and the Harbor House hotel in Little Italy.

Hotels in default include all of the Extended Stay America hotels in San Diego, several Homestead Studio Suites hotels and the Mission Plaza Hotel and Suites on Sports Arena Boulevard, said Alan Reay of Atlas Hospitality.

Statewide, 260 hotels were in default as of last month, and 47 had been pushed into foreclosure, Atlas reported.

Two of the more notable properties on the distressed list are the trendy W Hotel in San Diego and the posh St. Regis Monarch Beach in Dana Point.

Now overseen by a receiver, the W fell into default early this summer when its owner, Sunstone Hotel Investors, decided it was no longer worth the $65 million owed on the loan.

Sunstone, a lodging real estate investment trust, bought the 258-room W for $96 million three years ago. Like many hotel owners, Sunstone could no longer generate the revenue needed to pay on a mortgage taken out when hotel values were far higher. In many cases, hotel mortgages mature within five to 10 years.

"The hotel industry is really suffering, but higher-end hotels and resorts like the W in San Diego are suffering the most in terms of revenue and value," Reay said. "San Diego also added a lot of hotel rooms, so that exacerbates the problem."

Between 2007 and 2009, San Diego County saw an increase of 3,400 hotel rooms, including the 1,190-room San Diego Hilton, which opened in December near the Convention Center.

"The forecast is we'll definitely see an increase in foreclosures, and that means downward pressure on prices," Reay said. "From a consumer standpoint, you'll get the best bargains in hotels, travel and cruise lines. Even though economists are announcing the recession is over, employment won't come back until 2012, 2013, and that directly affects hotels, so we're looking at four to five years out for a recovery."

Rauch, who owns the 80-room Hilton Garden Inn in Torrey Hills and the adjacent, 120-room Homewood Suites, acknowledged that he's much more bullish, predicting that by next year, business travel will return, demand will start to outpace supply and hotel revenue will start to climb -- albeit modestly.

That's in comparison with a dismal 2009, which by the end of the year is expected to record a 25.5 percent drop in revenue per available room, a key measurement of the hotel industry's financial health, according to PKF Consulting.

Unlike other prognosticators, including San Diego County's Tourism Promotion Corp., PKF is forecasting that hotel revenue will turn positive by year's end, posting a 7.2 percent increase.

It's not surprising, then, that PKF hotel broker Bob Kaplan isn't as pessimistic as others about future hotel foreclosures. Just because defaults are on the rise doesn't necessarily signal that a foreclosure will follow, said Kaplan, a senior managing director with PKF Capital, which acts as a real estate adviser for the hospitality and leisure industry.

"Hotel owners are defaulting because they want to say to the lender: 'We need to talk. This loan doesn't make sense. You don't want the property back. We're not to blame for the economy,'" Kaplan said. "All the stress in the hotel industry is an absolute mirror image of the problems we're having in our economy, more so than any other asset class.

"We'll end up with a majority of loans being modified so the lenders don't have to foreclose. In some cases, though, there may be no choice."

Recognizing opportunity as the hotel industry approaches bottom, Sunstone plans to seize the moment and make some strategic acquisitions at bargain prices.

This month, it announced a public offering of 20 million shares of common stock, in part to raise capital for future hotel purchases.

The San Clemente company already has a pipeline of properties it is exploring for possible purchase, said Chief Financial Officer Ken Cruse.

"We think our stock is cheap, but individual hotels are even cheaper," Cruse said. "Yes, properties have devalued, but we think the long-term value of these properties is very strong."

Sunstone, which specializes in upscale hotels in urban markets, still owns a number of properties in San Diego County, including the Hilton Del Mar, Marriott Del Mar and Embassy Suites La Jolla.

Cruse emphasizes that just because Sunstone was forced to turn back the San Diego W doesn't mean it can't now look for bargains.

"The W is a situation where the asset value declined to below the value of the debt, and as a public company we have a fiduciary responsibility to our stockholders to give the asset back," he said. "For the same reason it made sense to give the W back, we see opportunities to acquire assets in today's market."

Ultimately, some hotel owners will be forced to make strategic cuts in their operations to keep paying the bills. They just have to walk a fine line so they don't alienate the very guests they're trying to attract for return visits.

"We closed our deli on Saturdays and Sundays, closed our restaurant for lunch, and more managers are doing more shifts," said Rauch, who noted that in some cases 40-hour-a-week employees have seen their weekly hours reduced to 32.

"In our restaurant, we also changed portion sizes to keep our prices reasonable, so we're serving a 5-ounce filet mignon instead of 8 ounces. These are small steps, but added together they can save hundreds of thousands of dollars."

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