Hotel performance has been on a downward spiral over the past two years, putting a strain on the ability of many property managers and owners to cover expenses. One such expense that is incurred by most hotels is interest, the amount owed to lenders who supplied a hotel with funds some time in the past. Hotel loans are more susceptible than loans on other forms of real estate to problems with covering interest expenses because of the absence of lease protection, relatively high expense ratios, and the volatility of lodging demand.

Deficient Properties

The Hospitality Research Group of PKF Consulting (HRG) examined over 3,900 financial statements contained in the Trends in the Hotel Industry database and found that the number of deficient hotels rose significantly in both 2001and 2002. Deficient hotels are classified as those that do not generate sufficient operating income during a certain time period to cover interest expenses. The percentage of hotels in HRG�s Trends database that were unable to cover interest expenses with the property�s operating income over the period 1992 through 2001 showed a sharp downward decline, followed by a prolonged period of year-over-year increases.

In 1992, 23.9 percent of the hotels in HRG�s Trends database, the highest percent recorded, were deficient, while 19.8 percent of properties in the database are estimated by HRG as deficient in 2002. The financial institution environment in 2002 is completely different than what it was in 1992 so more lender forbearance is possible today to help prevent property foreclosures. Many things can happen between the point that borrowers miss their first payments and actual foreclosure, including loan restructuring that could grant borrowers new loan arrangements such as additional time to make payments and more favorable loan terms.

During the current industry recession, hotel owners and lenders worked together to manage interest expenses and temper the number of hotel loan problems. While some hotel owners took advantage of loan refinancing, some hotel owners paid interest shortfalls out of their own pockets. Both strategies helped avoid financial stress in the industry thus far, but now there seems to be a resurgence of loan problems.

Delinquent Properties

Monthly hotel loan delinquency rate data is tracked by Trepp and JP Morgan and shows the percentage of properties that are delinquent from June 1998 to January 2003. Delinquent hotels are classified as those that actually miss a mortgage payment.

The delinquency rate increased sharply through the beginning of 2002, but then decreased in the spring and summer months. After a slight increase, the delinquency rate generally fell each month starting in the summer of 2002, which seemed to signal that although the delinquency rate was higher than past years, hotel loan problems were at least being kept in check. As reported by Trepp, the 2002 year-end delinquency rate for hotel loans was 5.1 percent. However, toward the end of 2002 and into 2003, the delinquency rate has been rising, indicating renewed loan problems in the industry. The hotel loan delinquency rate is forecast by JP Morgan to jump to over 7 percent by year-end 2003. 

�Natural Selection� to Continue

While the HRG forecast for interest deficiency rate for 2003 is expected to decrease slightly to 18.5 percent, the hotels in this deficient pool are generally older, tired, independent properties with serious income shortages. These lower-quality hotel assets are likely to continue to experience greater shortages in cash flow than high quality, well known, branded properties. The hotel property market is experiencing a process of �natural selection� during this period of revenue weakness as older hotels drop out of the industry. Fears of war with Iraq and estimates of an industry rebound not to begin until the second half of 2003 are expected to cause more of these problematic properties to become delinquent.

John (Jack) Corgel, PhD, is the Managing Director of Applied Research for The Hospitality Research Group of PKF Consulting. Kristin Rohlfs is a Senior Research Associate. Both are based on the firm�s Atlanta office.