San Clemente-based Sunstone Hotel Investors Inc. became the first publicly traded hotel owner in the downturn to hand back keys to a lender.
By all accounts, it may not be the last,for Sunstone or others.
Last week, Sunstone said it was walking away from the W Hotel in San Diego rather than keep paying interest on the hotel after failing to rework a loan.
Sunstone, which owns all or part of some 40 hotels, bought the 258-room W for $96 million in 2006 from a group led by developer Gatehouse Capital Corp.
Sunstone owes $65 million on the W with $4 million in payments due this year. The loan carries an interest rate of 6.14%.
On a conference call last week, Sunstone executives said they could walk away from “a handful” of hotels that are worth less than their mortgages, that aren’t generating enough cash to cover interest payments and where lenders are unwilling to rework loans.
“We would like to point out that it’s not our (intent) to convey a significant number of hotels back to the lenders,” Chief Financial Officer Ken Cruse said.
Sunstone said it is turning over the W to New York-based Centerline Capital Group, part of New York’s Centerline Holding Co., after it failed to reach a compromise on reworking the hotel’s mortgage.
“We offered several different things and they came back with ‘no,'” Chief Executive Arthur Buser said in a statement. “Our basic choices are to keep on paying or not to pay. Based on those alternatives, it’s an easy choice.”
Sunstone, which had $174 million in cash at the end of the first quarter and is raising money to pay down debt, stopped paying on the W on June 1.
“While the company maintains more than adequate liquidity to support or repay this mortgage, we believe a conveyance of this hotel in settlement of the debt would be in the best interest of our stockholders,” Cruse said.
Sunstone is set to lose its $31 million stake in the W.
The hotel has failed to generate enough cash to cover operating costs and debt since 2007, according to the company.
Unloading More?
Sunstone may be preparing to unload more hotels where lenders aren’t willing to rework or delay debt.
The company declined to identify any other properties that might be in danger of default.
For Sunstone and other hotel owners, properties bought during the industry’s peak a few years ago could be vulnerable.
In early 2007, Sunstone bought the Boston Marriott Long Wharf Hotel for $228.2 million, including a 10-year mortgage for $176 million at 5.6%.
In late 2006, Sunstone and a partner acquired the Doubletree Guest Suites Hotel in New York’s Times Square for $68.5 million, though the deal was struck with a relatively low $28.5 million loan.
In early 2006, Sunstone paid $242.5 million for the Hilton Times Square, including $81 million in debt at 6% interest.
Sunstone last month took a move to make it easier to forfeit hotels.
The company announced plans to sell about $100 million worth of shares to pay off credit lines and to buy back $123.5 million worth of debt due in 2027.
As part of the debt buyback, Sunstone included a provision that would allow it to default on mortgages of up to $300 million without triggering a default on its bonds,or immediate payment requests from lenders.
The move was in preparation for the company’s forfeit of the W, according to David Loeb, an analyst at Milwaukee-based Robert W. Baird & Co.
Analysts say the forfeiture is good for Sunstone investors.
“We believe the property could have lost at least 70% of its value over the past four years,” Loeb said.
Most expect this to be the first of many high-profile lender hotel repossessions, according to Loeb.
“This was the first public company to back out of the deal, but we believe there will be more instances of this occurring as hotel cash flows remain under pressure, both at Sunstone and in the (real estate investment trust) sector,” Loeb said.
While Sunstone loses its stake in the W and bears the stigma of walking away from a hotel, lenders and mortgage bond investors are taking the big hit because of the way the W and other deals were structured, according to Loeb.
“While volumes could be written on the moral issues related to a corporation walking away from a subsidiary’s obligations, the law and the contractual language is clear: Non-recourse debt is not an obligation of the parent,” Loeb said.
The underwriter and bond investors linked to the W mortgage “took that risk” and “are likely to incur substantial losses on this mortgage,” he said.
The risk for Sunstone is that lenders may be wary of working with the company when the market turns around.
“I believe our ability to borrow will not be undermined,” Sunstone’s Cruse said. “We just believe that (there) will be an additional conversation. We’re not naive to the fact that we will be on people’s radar screens as they sponsor these non-recourse loans.”
Industry Decline
Most hotel loans from 2004 to 2007 are underwater because property values have dropped as much as 50% from their peak in 2007, according to analysts.
The hotel industry has been battered by a sharp decline in travel spending that began during the financial crisis last fall and has accelerated this year.
Resorts and other upscale hotels have suffered the most as consumers and businesses delayed vacations and meetings or traded down to less expensive hotels.
Sunstone’s revenue per available room,a key measure of occupancy and room rates,was down 24.4% in May from a year earlier.
Profits for the W, excluding interest payments and taxes, are expected to shrink to $2 million this year from around $7.4 million in 2006.
“San Diego is one of our worst performing markets,” Buser said.
White Plains, N.Y.-based Starwoods Hotels and Resorts Worldwide Inc. operates the W brand and likely will continue to do so after it reverts to the lender.
Last month, Sunstone sold a Marriott hotel in Napa for $36 million.
The company estimated the hotel would have required about $6 million in renovations to comply with Marriott standards this year.
The proceeds of the Napa sales were expected to go to the company’s debt buyback. Sunstone has $1.7 billion in debt with none of it due in the near term.
