The spiraling decline in hotel profits since the record-breaking year of 2000 — when pretax operating profits topped out at $13,481 per room — has been nothing short of dramatic. Three straight years of plummeting revenues have resulted in a cumulative 31% decline in pretax operating profits, to just an estimated $9,622 per room in 2003, according to The Hospitality Research Group in Atlanta. That leaves many owners sweating just to keep their businesses afloat, and a growing number of them looking for ways to restructure their debt.
To help hotel owners skirt financial disaster, lenders are refinancing loans at lower interest rates, providing long-term loans to pay down short-term debt, and easing the terms of loans to free up cash that can be used for operations. And as a growing number of commercial mortgage-backed securities (CMBS) approach maturity, lenders are extending the due dates on the notes to prevent owners from defaulting on their loans. In the process, they're helping owners survive until the industry rebounds.
“In this cycle, lenders have recognized that a lot of problems owners are having are due to macro-market problems, and they've worked with their borrowers to try to find solutions versus taking the hard line and foreclosing,” says James Merkel, vice president at Columbus, Ohio-based RockBridge Capital Inc. “You've seen owners working through those situations and stabilizing properties.”
Indeed, lenders are going out of their way to help owners find solutions to their financial woes instead of taking drastic measures. Nationwide foreclosure statistics indicate that lenders are eager to assist owners before it's too late. Foreclosures have increased at a slower rate than delinquencies, from 1% in December 2001 to 1.67% in November 2003, according to Trepp LLC, a New York-based research firm specializing in CMBS. By contrast, delinquencies — loans with payments that are more than 30 days late — have risen from 2.06% in 2000 to 7.25% as of Sept. 30, according to Standard & Poor's, the New York-based rating agency and research firm.
For some owners, a complete financial overhaul is the way to save their properties. Atlanta-based Lodgian Inc. was forced to file for Chapter 11 bankruptcy protection in December 2001 due to a crushing debt load and declining revenues. However, the publicly owned company succeeded in winning back ownership of 96 of its 105 properties following a reorganization plan and — more recently — a timely loan from Lehman Brothers Inc. The financing from the New York-based lender brought 18 properties out of bankruptcy while paying off an $80 million chunk of the company's more than $500 million in debt.
| Hotel | Office | Retail | Multifamily | |
|---|---|---|---|---|
| September 2002 | $674.8 million | $781.7 million | $576 million | $240 million |
| December 2002 | $590.8 million | $893.4 million | $573.9 million | $272.9 million |
| March 2003 | $666.3 million | $937 million | $768.9 million | $270.9 million |
| June 2003 | $923 million | $669.2 million | $808.8 million | $368.2 million |
| September 2003 | $1.3 billion | $624.3 million | $699.4 million | $422.1 million |
| * A specially serviced loan is one that has been restructured or is in the process of being restructured. Source: Standard & Poor's | ||||
“We were heavily leveraged and under stress from the downturn, which started in spring 2001,” says Thomas Parrington, who became CEO of the company in May 2003, replacing interim CEO David E. Hawthorne. “This [Lehman Brothers] loan is the marker that shows we can stop thinking of ourselves as a company in bankruptcy and instead think of ourselves as a hotel operating company.”
Some positive signs are beginning to emerge for Lodgian and other companies that are hoping to boost income. In the third quarter of 2003, occupancy levels increased by 2% and revenue per available room (RevPAR) rose by 2.3%. And although RevPAR for the entire year was projected to decline by 0.5%, The Hospitality Research Group predicts that RevPAR will increase by 8.8% in 2004 due to steadily rising occupancy rates and an improving economy.
That would be a big turnaround for an industry that has largely been in a tailspin since the double whammy of the economic recession and the terrorist attacks of September 2001, with RevPAR plummeting from $69.13 in 2000 to a projected $58.28 in 2003.
“It's been a long time coming,” says Parrington. “With occupancy levels improving, it's only a matter of time before room rates also begin to strengthen and the industry builds back its profitability level.”
Looking for a Way Out
With the number of problem loans on the rise, Denver-based HREC Investment Advisors has experienced a sizable increase in the number of owners seeking to restructure debt.
“It's been a big piece of our business this year,” says Geoffrey Davis, president of the company. The bulk of the company's business — roughly 70% — used to be property sales, but over the past 18 months it's been split 50-50 between sales and structured finance, he says.
The national numbers offer more conclusive proof of the trend. According to Standard & Poor's, the dollar amount of hotel CMBS loans in its specially serviced category — loans that the borrower is seeking to restructure or refinance in some way — has doubled in the past year, from $675 million to $1.3 billion (see chart above). When traditional bank loans are added to the delinquency mix, the scope of the problem becomes even more apparent. According to a survey of 4,000 hotels nationwide by San Francisco-based PKF Consulting Inc., 16.7% of hotels were not able to cover interest payments on loans of all types in 2002 — including CMBS and traditional bank loans — and that figure was projected to reach 17.3% at the end of 2003 (see chart on p. 22).
“I think it's a good indicator that a lot of [hotel] owners have hung on as long as they could,” says Davis. “Many owners were hoping to ride out the storm, but the storm isn't over yet and there may be a lot of ships sinking out there.”
Still, there are plenty of owners who are determined to find solutions to their cash-flow problems. For instance, New York-based Schrager Hotels, the company that launched the boutique trend in the mid-1980s, is seeking permission from its lender to modify the covenants of the CMBS loan that financed its purchase of the Paramount Hotel in New York. The company wants to transfer money out of the loan's escrow account to boost the property's cash flow, according to Standard & Poor's. Schrager Hotels declined to comment on its move to revise the debt structure on the hotel, which has a loan balance of $68 million.
In August 2003, the company was forced to file for bankruptcy protection at its Clift Hotel in San Francisco. Schrager Hotels completed $25 million worth of renovations at the Clift Hotel in 2001, just as the San Francisco market began sinking. Revenues plummeted as occupancies at the hotel slipped to 50%, causing the company to default on the property's $57 million CMBS loan.
“A lot of money was spent on that asset,” says Arthur Adler, managing director and CEO, North America, for Jones Lang LaSalle Hotels. “That hotel never really had the chance to get its traction and grab market share.”
However, Adler believes these kinds of financial woes will become less prevalent over the next couple years. “In 2004, RevPAR is expected to increase, and operating income is what services debt,” he says. “I think we've seen delinquencies peak.”
Back from the Brink
But what happens to companies, like Lodgian, that got caught in the downturn and are now counting on the industry rebound? Lodgian filed for Chapter 11 bankruptcy protection in December 2001 after post-9/11 revenue declines made it impossible for the company to pay down its mushrooming debt. But by November 2002, the company was able to bring 78 of its 105 properties out of bankruptcy — including Crowne Plaza, Holiday Inn and Marriott brands — following the implementation of a restructuring plan that included returning eight properties to a lender and paying off some of its creditors through the issuance of common and preferred stock.
In addition, Lehman Brothers arranged $80 million in CMBS financing to lift another 18 properties out of bankruptcy in May 2003. To reclaim ownership of the 18 hotels, Lodgian was required to pay down an outstanding loan, and Lehman Brothers financing provided the necessary funds.
Lodgian received three other proposals, but selecting Lehman Brothers was an easy decision. “The Lehman Brothers proposal stood out from the rest because it was willing to provide first mortgage financing for the whole $80 million, whereas the other lenders were only going to provide first mortgage financing for part of the deal and arrange mezzanine financing for the rest,” says Daniel Ellis, senior vice president and general counsel for Lodgian.
Lining up two different types of loans would have taken more time than the four months required to complete the CMBS financing, says Ellis, and it would have been more expensive since mezzanine loans carry interest rates of up to 18%. The three-year CMBS loan carried a 7.25% interest rate vs. 4.8% for the previous loan. The higher interest rate for the new loan takes into account the riskier credit profile of a company emerging from bankruptcy.
The CMBS financing that brought 18 of Lodgian's hotels out of bankruptcy was a crucial step in the company's road to recovery. “We're helping them out of a bad situation,” says Michael Hartmeier, a managing director and head of the lodging division at Lehman Brothers. “They needed to raise a high amount of proceeds.”
The financing was vital to Lodgian because it enabled the company to concentrate on implementing a strategy for returning to profitability. That strategy will include selling 19 non-core properties, a move that is expected to raise $88 million to be used toward paying down part of its $485 million in debt and investing in renovations at its core properties.
“Now we're in a position to start moving forward again,” says Parrington. “We'll be focusing on renovating properties, improving operations and, ideally, getting back into growth mode in the last part of 2004.”
Renovations have already paid dividends for the company — several properties that were improved in 2003 are producing higher revenues than the rest of the company's portfolio. However, third-quarter 2003 revenues at the company declined by 2.2%. Delays in renovating some of the portfolio's core properties, along with the continued effects of the industry-wide downturn, were the main culprits, according to the company.
Creative Solutions
Owners who are extending the maturity dates on their CMBS loans out of necessity — to avoid the balloon payments that would otherwise be due — are discovering creative ways to pay down debt. Bank conduits began pooling loans into mortgage-backed securities in 1993, and the CMBS market picked up steam in the latter half of the decade as CMBS financing filled the void created by the demise of the savings and loan industry. Now, those CMBS notes originated during the late 1990s boom years are coming due.
When Dallas-based Wyndham International Inc. extended the maturity dates of two CMBS pools in June 2003, it also was able to obtain additional capital to pay down part of a revolving credit facility. By boosting the loan-to-value ratio above the amount of the original CMBS deal, the $425 million refinancing provided incremental proceeds that are being used to pay down the credit facility while extending its maturity date from June 2004 to April 2006.
“This was a very valuable and creative solution,” says Hartmeier. “It enabled Wyndham to repay existing debt and focus on its business instead of worrying about potential defaults or other types of problems.”
MeriStar Hospitality Corp., which owns 101 hotels in North America, also is using CMBS financing to improve its finances. The Arlington, Va.-based company received a 10-year, $101 million CMBS loan from Column Financial Inc. in September 2003 that it is using to reduce its debt load.
The deal is part of the company's strategy of improving its balance sheet by adding long-term, low-interest rate financing to pay down debt carrying higher interest rates and shorter maturities. The loan, which is secured by four of the company's hotels, carries an annual interest rate of 6.88%, and will be used to pay off loans with interest rates of nearly 9%.
In another restructuring option, mezzanine financing can be a valuable tool for companies that want to boost the performance of individual assets. But it is pricey, with interest rates topping out at nearly 20%. For that reason, mezzanine debt, which bridges the gap between equity and senior debt, isn't the best solution for a company that already has a heavy debt load.
“Adding mezzanine financing to a deal where money was not being invested in the asset would only serve to increase the cost of debt, which would only exacerbate an already bad situation,” notes Merkel of RockBridge Capital.
| Hotel | Retail | Office | Multifamily | |
|---|---|---|---|---|
| December 2000 | 2.06% | 0.57% | 0.20% | 0.55% |
| December 2001 | 6.03% | 1.12% | 0.47% | 0.69% |
| December 2002 | 6.37% | 1.19% | 0.57% | 0.79% |
| September 2003 | 7.25% | 1.24% | 1.24% | 1.14% |
| * A loan is considered delinquent if payments are more than 30 days late. | ||||
| Source: Standard & Poor's | ||||
Not the Worst of Times
Despite the precipitous rise in loan delinquencies since 2000, lenders emphasize that the financial health of owners is far better than it was in the early 1990s, when properties were more highly leveraged and interest rates were higher. Davis of HREC Investment Advisors notes that it wasn't uncommon for lenders to provide financing with loan-to-value ratios of up to 85%, whereas lenders are now reluctant to go above a 65% loan to value.
“There's clearly much less distress this time around than anybody would have expected primarily because lenders have been more disciplined,” adds Stacey Berger, a vice president at Midland Loan Services in Overland Park, Kan. Indeed, the current percentage of hotels not able to cover interest payments is about 6 percentage points lower than the 23.9% of properties that were late on loans in 1992, according to PKF Consulting.
And Merkel is encouraged by the forecast of improving revenues across the sector beginning this year. “We're starting to see the initial signs of a recovery,” says Merkel. “We're not there yet, but the foundation is being built.”
Steve Webb is a Jacksonville, Fla.-based writer.