As Hotel Vacancies Rise, So Do Risk of Defaults

From the Wall Street Journal.


As Hotel Vacancies Rise, So Do Risks of Default
January 26, 2009

By KRIS HUDSON

The downturn in the U.S. hotel industry is becoming so acute that it has thrust the sector into crisis, leaving vacancies at a 20-year high and putting many properties in danger of missing payments to lenders.

In the wake of cutbacks by business and leisure travelers alike, U.S. hotels this month are expected to post their 15th consecutive month of declining occupancy, longer even than their 12-month losing streak after the Sept. 11, 2001, terrorist attacks.

That occupancy drain, coupled with declining room rates as hotels compete for customers, is expected to result in the hotel industry's steepest decline in revenue per available room since 2001, according to market-research company PKF Consulting Inc. The report, scheduled for release today at the American Lodging Investment Summit in San Diego, says that revenue per available room will fall by 9.8% this year.

If conditions are as weak as expected, PKF estimates that nearly 20% of a sample of 1,500 U.S. hotels that it studied won't generate enough cash flow this year to cover interest payments on their mortgages, up from nearly 16% last year. This year's projection is on par with the most recent high of 20.7% in 2003 but still short of the 1991 recession's 25% tally, according to PKF.

U.S. hotels now carry roughly $250 billion in cumulative mortgage debt, according to Foresight Analytics LLC. Many hotel owners who can't generate enough cash to cover their debt service in this recession will avoid default and foreclosure by digging into their own or partners' resources to make up the shortfall or by negotiating a compromise with their lenders.

While the industry's fallout so far appears to be similar to that in previous downturns, "the difference this time comes from both the speed at which the industry fundamentals have deteriorated and the protracted nature of the current decline," PKF President Mark Woodworth said.

Exacerbating the industry's troubles is a flood of new rooms hitting the market because of development projects started during the real-estate boom of recent years. The estimated 125,000 net new rooms projected to debut in each of this year and 2010 amounts to a 2.5% annual increase in supply, according to Smith Travel Research. That's well above the 20-year average rate of 1.5% -- and it comes as demand for rooms is tanking.

Among commercial real-estate categories, the hotel industry rises and falls the most dramatically in reaction to economic cycles. That's because, unlike office buildings and shopping malls with long-term leases, hotel occupancy and rates change on a nightly basis as customers come and go at will. In a downturn, the fallout is significant; PKF expects the average occupancy among U.S. hotels to drop to 57.6% this year, falling by 3.2 percentage points, to its lowest level in the 20 years that Smith Travel Research has tracked the figures.

"The only word that comes to mind is 'unprecedented,' " said Bjorn Hanson, a lodging and tourism professor at New York University, referring to the speed and depth of the industry's decline in recent months. Still, Mr. Hanson projects a hotel delinquency rate of 5% to 6% this year, in line with the rates registered in 2002 and 2003 and nowhere near the 1991 delinquency rate of 14.2%.

Among the hotels that have fallen into delinquency or default on their mortgages during this recession is the 942-room Resorts Atlantic City casino-hotel in New Jersey, which is delinquent on $350 million in mortgages and facing foreclosure actions. Others late on their payments include the Marriott Courtyard Grand Cayman in the Caribbean, the 231-room Northland Inn near Minneapolis, and Westin hotels in Tucson, Ariz., and Hilton Head, S.C., according to credit-rating firm Realpoint LLC.

Write to Kris Hudson at kris.hudson@wsj.com
Printed in The Wall Street Journal, page B3