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Bigger down Payment and Higher Interest Rate Impeding American Property Management Corp's
 Effort to Buy the Historic La Valencia Hotel in La Jolla, California

By Mike Freeman, The San Diego Union-TribuneMcClatchy-Tribune Regional News

May 16, 2008 - La Valencia, the historic La Jolla hotel known as the Pink Lady, could end up being left at the altar by its current suitor.

The credit crunch has made it difficult for American Property Management Corp., a San Diego hotel owner and operator that has an agreement to buy the 115-room hotel, to finance the deal.

"We're still in process. We're still slugging, trying to get it done," the company's chief executive, Michael Gallegos, said yesterday. "But the environment is just the worst we've seen for lending in 70 years. And if you talk to anyone who is still alive on Wall Street, they'll tell you the same thing."

Gallegos said American Property has gone "outside the box completely" and is pitching the deal to European lenders -- specifically German and Spanish banks -- to see if they will finance the purchase. He expects to know more within two weeks.

American Property, which owns or manages 45 hotels nationwide, confirmed in February that it had an agreement to buy the 115-room La Valencia and her sister property, the 50-suite Rancho Valencia in Rancho Santa Fe.

Gallegos declined to name the purchase price, citing a confidentiality agreement. But hotel industry experts estimated that the La Valencia could fetch up to $100 million and Rancho Valencia $40 million.

The purchases are being pursued as separate deals, Gallegos said. The Rancho Valencia might be easier to complete -- in part because it's smaller, generates sales revenue from time-share condos and needs no upgrades.

The 81-year-old La Valencia -- painted pink and perched on a seaside bluff in downtown La Jolla -- requires about $20 million in renovation, Gallegos said.

"While the La Valencia is a special hotel, there's not a tremendous amount of in-place cash flow," Gallegos said. "During renovation you're going to sacrifice revenue and income. That combination of factors makes for a challenging situation in this environment."

Longtime La Valencia owners The Collins Cos. and a Getty trust put the hotel on the market late last year after owning it for 60 years. The company did not return a phone call seeking comment.

Eighteen months ago, lenders would provide loans at 5 percent interest with less than 20 percent down payment for hotel purchases, said Alan Reay, president of Atlas Hospitality Services in Irvine. Today, both down payment requirements and interest rates are up significantly.

Lenders are requiring 35 percent to 50 percent down, Reay said. Interest rates can be in the 7 percent range or higher.

"For deals that are $25 million and above, financing is very tough," he said. "You can still find financing for smaller deals. The local banks are doing those. But the bigger deals are very difficult."

Wall Street lenders have commonly bundled hotel and other commercial real estate loans into commercial mortgage backed securities. Those securities were sold to institutional investors such as pension funds.

But buyers of mortgage-backed securities have been burned by huge losses on home loans. They fear that the same fast and loose underwriting that occurred in housing was also prevalent in commercial lending. So they're not buying many commercial mortgage-backed securities anymore.

Consequently, the lenders willing to make large loans for hotel or office acquisitions are so-called "balance sheet lenders," those healthy enough financially to keep big loans on their books.

Only a few such lenders exist, said Reay. So they're demanding difficult terms -- such as bigger down payments and higher interest rates.

Gallegos echoed the theme. "There really is only one lender that has shown interest, and the terms that this lender has given us are just not friendly," he said. "We talking very low leverage, very high interest rates and personal guarantees."


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