The tony W Hotel in downtown San Diego, which has been in financial distress for more than a year as the economy continued to weaken, was foreclosed on late last month and is now in the hands of the lender.

Saddled with nearly $85 million in debt that far exceeded the hotel’s worth, the W was put up for sale at a public courthouse auction June 29, at which time Bank of America took control of the property, which opened more than seven years ago.

Operators of the 258-room W said guests will see no discernible differences while staying there, pointing out the foreclosure sale was simply the final stage in a process that started last year when the owners decided to no longer continue paying off its loan.

Sunstone Hotel Investors Inc., a lodging real estate investment trust that purchased the W for $96 million four years ago, made the decision after concluding that the hotel was no longer worth the $65 million that it owed.

The trustee’s deed filed with the San Diego County Recorder’s Office shows that the current unpaid debt and related costs have grown to nearly $85 million.

“This is the final step in deeding back the hotel, so we’re happy to have this process resolved,” said Ken Cruse, chief financial officer for Sunstone Hotel Investors Inc., a lodging real estate investment trust that formerly owned the W and currently has a portfolio of 30 largely upscale hotels. “There’s no change in the operation of the hotel from the perspective of the traveler, and I certainly encourage people to enjoy the W. Everything will absolutely be business as usual.”

Although Sunstone is walking away from its original $65 million loan, which it is no longer under obligation to repay, the company still will record a significant gain on the W acquisition because it is recorded on its books as a $35 million asset, Cruse said.

Now that the foreclosure process is complete, it will be up to the lender to decide whether to hold onto the devalued property or bide its time until the lodging industry regains its financial footing following a prolonged recession, said San Diego hotel owner and consultant Robert Rauch.

“The lender wants to know, do I need to put more money in, and should I sell it now or hold onto it until the market comes back,” Rauch said. “In this economic environment, I’d be surprised if they don’t hold onto it for awhile. Selling it today would give them the lowest possible price.

“San Diego in 2009 was down $48,000 per room, according to HVS, an international appraisal firm.”

Despite the growing distress in the hotel industry, lenders have been reluctant to foreclose or sell troubled properties because of the steep decline in values over the past couple of years, said Alan Reay, president of Atlas Hospitality, which tracks the California lodging market.

In his latest quarterly report, Reay identified seven San Diego County hotels that are lender-owned, compared with three that were listed at the end of the year. Among those are the W San Diego, the 182-room Ramada Plaza Hotel in Mission Valley and the 316-room Mission Plaza Hotel & Suites on Sports Arena Boulevard.

The number of San Diego hotels in default rose from 29 at the end of the year to 40 as of June 30, Atlas Hospitality reported. The most high-profile among those is the Sè San Diego, an upscale boutique hotel that fell into default earlier this year on the original $67.8 million loan. Last month, the owner of the 184-room property filed for Chapter 11 bankruptcy, two years after opening in the midst of an unraveling economy.

“Lenders are reluctant to sell at market prices,” Reay said. “We have over 100 hotels (in California) foreclosed on and only 12 that have been resold to new investors, and there’s a huge backlog of defaults. Lenders are doing whatever they can to not take the hotel back. They want to see if the market can rebound quickly enough to bail them out.”

The rapid depreciation of hotel properties was clearly what motived Sunstone to ultimately walk away from what at one time had been downtown San Diego’s swankiest boutique hotel. At the time Sunstone made its announcement, company president Al Buser talked about the toll the recession had taken on the lodging industry.

“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,” he said.

W General Manager Stan Kaminski noted that Sunstone at one time had planned a $6.5 million renovation of the hotel but put it off last year after defaulting on its loan.

“Now we’re hopeful the new owners will come in and reopen the remodeling plan we once had,” Kaminski said.