There has been speculation on major shifts in the hotel ownership landscape as a result of the current market conditions. Average yearend 2009 hotel revenues are expected to be 17% to 20% lower than the previous year, which may result in net operating income or EBITDA declines of between 30% and 40%, depending on whether the hotel is limited service (lower decline) or luxury (higher decline). Values have plummeted, ensuring that a large percentage�and maybe a majority�of hotels are now worth less than their total debt levels as equity has disappeared.

With the aforementioned declines in NOI, hotel owners are finding themselves in negative cash flow positions, especially during the lowest demand periods. Many were able to survive the traditionally weak first several months of this year thanks to summer and fall vacationers. But what will happen after November, with seasonal tourism declines, as well as historically low demand in convention and business travel?

It is obvious that hotel real estate values have plunged, debt levels exceed the values of many hotels and continuing the �new normal� is unsustainable. But the question remains, what will shake the system loose and recalibrate value and ownership structures? The answer lies with hotel lenders, many of which are hiding in foxholes, knowing that life will change once they poke their heads out.

The CMBS and syndicated loan formats, which supplemented traditional loans, were not ultimately based on the success of the underlying real estate value, but on the amount of fees that could be generated for the related participants. Few lenders apparently understood the potential to �loan to own,� as many of them have no financial reserve infrastructure to manage distressed real estate. These lending structures depended on continued growth without acknowledgment of potential market corrections, which, of course, eventually occur.

The inevitable correction has occurred and the process of unraveling the tangled kite strings of debt structures is daunting. There is little incentive for owners or lenders to unwind the mess because it will be painful with the departure of participating entities and resulting financial loss. Somehow nobody volunteers for prospects like these.

Some hotel owners are actually forcing the issue with their lenders by initiating the transfer of assets to them, realizing they will never recoup their cash losses or asset value. Many lenders are resisting the transfer, realizing they have overstated the values of the same assets on their own books and will face serious financial circumstances. Others may just �extend and pretend,� hoping distressed owners will magically resolve their financial challenges.

Forecasts from firms such as Smith Travel Research and PKF Consulting indicate that there will be little or no revenue growth in 2010. During the first few months of next year, lenders or their servicers will have to come out of their foxholes. Financially challenged hotel owners will no longer have the reserves to sustain their debt service obligations, not to mention their operations.

There is also the billions of dollars worth of CMBS debt scheduled to mature in 2010 and 2011. From what source will the replacement debt emerge, or will current lenders become instant owners? Questions remain about what structures will be in place to handle what could be a massive transition in hotel real estate. Can syndicate lenders become effective owners? Will current owners be asked instead to become custodians on behalf of their lenders? Will debt miraculously appear to complement vulture equity, which is waiting on the sidelines? And�what is a hotel asset actually worth these days, anyway?

The hotel real estate sector has always been alluring for investors and lenders, even those without a grasp of how these businesses function. As a result, there has been consistent weaning of owners and lenders when cyclical downturns occur. While this cycle will be no different, it is critical that some steps must be taken to mitigate financial disaster. Hotel businesses will still require oversight, expertise and financial subsidy to continue their operations. Lenders and borrowers must resolve their financial relationships before the entire industry is plunged into chaos.

Rick Swig is president of RSBA & Associates, a hospitality industry consulting firm based in San Francisco. He may be
contacted at [email protected].

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