National Report–It’s far from an ideal situation, but it’s a reality of the industry today—many hotel owners will deal with a distressed property. After accepting this reality, borrowers must form a specific plan to maximize property value, minimize personal financial loss and move on. Depending on the particular loan situation, there are a variety of options borrowers need to consider.
The first step, according to Jim Butler, partner at Los Angeles law firm Jeffer Mangels Butler and Marmaro LLP, is to gather all relevant financial information—documents, deeds, correspondence, agreements, etc.—and create a comprehensive analysis. Figure out optimistic, middle and worst-case scenarios in terms of occupancy, average daily rate, revenue and expenses.
“The truth is you don’t know [what’s going to happen],” Butler said. “So you build the scenarios and lay out your cash and you place a value on everything. This is what consultants do. They look for anticipated revenue flows.”
The comprehensive analysis benefits borrowers by allowing them to take stock of the investment’s current and realistic value, and benefits lenders by showing them that the borrower is prepared for the upcoming conversation and difficult decision.
Workout
Workouts aid borrowers if they believe the property will rebound and show value given enough time and a new plan, and workouts aid lenders who more than likely do not want the property. The key to a successful workout is constant, constructive communication. So, borrowers should start talking to their lenders early.
Workouts can yield reduced fees, extension of maturity, reductions of interest rate and principal, and more that aids in an owner’s quest to keep a property and create value. Bringing in a consultant is a good way to help this process.
“A piece of advice in three words is ‘communicate with cash,’” said Steve Van, president and CEO of Prism Hotels & Resorts. “Because lenders and special servicers generally won’t be able to help much unless the owner can come up with cash that isn’t already there, and it’s hard to get around. But to get around that, communicate clearly and communicate consistently.”
Van said, depending on the property, lenders won’t be enticed into a workout for anything less than $100,000. For a $50-million hotel, that could go up to $1 million or more.
But that doesn’t mean lenders aren’t willing to work to reach a deal. According to Kirby Payne, co-president of HVS Hotel Management, many lenders are so averse to taking back a property that they will pay a consultant to facilitate a deal.
“In cases where the lender has paid to solve it, [the property] has never had to be foreclosed on,” he said.
Rather than contribute cash, specifically when the borrower does not want to retain the property, Butler said a borrower could offer services to the lender. This keeps the unwanted keys from both parties.
“Maybe the borrower will say, ‘I’ll put it on the market for you. I’ll do it for you like I’m working for you,’” Butler said. “That could be worth a lot to a lender to have the borrower cooperate and facilitate the sale or hold for the lender.”
These deals can add $10 million of value for the lender and often provide a service no one else can offer—that doesn’t come out of anyone’s pocket.
However, borrowers must remember that any deal forgiving debt has tax implications. The forgiven debt will be taxed, and as buildings depreciate, the basis gradually goes down as the tax liability goes up. The results of this tax can put the borrower in further financial distress.
“One thing that’s important as a borrower is to get with a tax lawyer and structure the foreclosure to minimize the taxes,” Payne said. An option in the workout plan could be a program that defers the recapture of items.
When dealing with a commercial mortgage-backed security loan, one of your first steps might be to miss a payment—intentionally or not—because there can be no workout until a payment is missed. And according to Van, CMBS loans have a longer workout process because of the need for special servicing.
“There’s not necessarily a difference [with CMBS loans], just a difference in process,” Van said. “Special servicers and lenders both want to preserve the value of the hotel and hotel loan.”
Default
Even though workouts to keep a property can be beneficial for both lender and borrower, in many cases it may be a complicated process that yields little value. Often, it may be prudent to simply default and give the lender the keys.
A deal that highlights this option is Sunstone Hotel Investors giving back the W San Diego in June. Sunstone did its homework, saw the writing on the wall and moved on—creating a blueprint for owners in a similar situation.
“Sunstone looked and saw they’d never get out of this hole,” Butler said.
This was nonrecourse debt, which makes up most of the CMBS loans from about 2000, according to Butler. The Sunstone model may become more prevalent based on those numbers.
Bankruptcy
For the most part, bankruptcy should be considered in two scenarios. First, if the borrower truly believes he has equity and that a new plan will turn the property around. Filing for bankruptcy will provide a temporary slowdown in loan payments, halt foreclosure and perhaps provide the cushion needed to implement a new plan and become profitable, Butler said.
Even in this scenario, bankruptcy isn’t preferred, Van said.
“Generally bankruptcy doesn’t accomplish anything,” he said. “That’s just my experience. It generally doesn’t better the position of the borrower and generally has lot of legal fees.”
Second, if a property has a long-term management contract, that contract devalues the property and hurts the lender’s proposition when trying to find a new buyer, which thus hurts the original borrower in a workout. The only way to break such a contract and create more value for the property is through bankruptcy.
“If you’re just trying to get rid of the hotel, that’s a tool I think will be used more frequently,” Van said.
