What Happens When a Massive Wave of Hotels Default?

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An enormously large number of U.S. hotel owners are at risk of defaulting on their mortgages, but experts say the banks holding those loans aren’t likely to usher in an era of mass hotel foreclosures across the country.

Hotels — at a nearly 24 percent delinquency rate at the end of the summer — are the biggest source of delinquent loans for commercial mortgage-backed securities, a group of mortgages pooled as one that hotel developers use to build new projects, reports data firm Trepp. Just over 1 percent of hotel loans were in default at the end of 2019.

More than $22 billion in hotel loans are in special servicing, a type of commercial mortgage-backed purgatory between default and foreclosure, according to JLL.

Not every hotel owner in the U.S. relied on commercial loans to build their property, but 50 percent of U.S. hotel owners claim they are in danger of foreclosure by their lenders due to the pandemic, according to an American Hotel & Lodging Association report.

There are fears, six months into the pandemic, banks are going to end the flexible payment terms and forbearance offered in March and April. Commercial mortgage-backed loans are harder to get modifications due to their pooled nature compared to a traditional bank loan.

But real estate attorneys and even lenders still question how many hotel foreclosures will actually materialize simply due to the high volume that would occur if banks or commercial loan servicers actually played hardball.

“I think a lot of the lenders learned some very good lessons in the last downturn,” said Clifford Risman, a Dallas-based real estate attorney at Foley & Lardner. “If the lender could foreclose and change a flag or management company and operate better or differently, yeah they would. But this is a problem that changing a flag and management company isn’t going to fix.”

When the Usual Tools Don’t Work

A global pandemic is an unprecedented problem for the hotel industry, and the usual demand-generating measures are unlikely to resurrect cratered occupancy and revenue. That is why many hoteliers haven’t offered deeply discounted rates, as experts caution a loss of pricing power will cause the industry to take even longer to recover.

Banks recognize this and note that revenue and occupancy are down so significantly across the industry that it would take far more than a new brand flag to recoup losses and meet debt service obligations, Risman said.

“I don’t think demand will drive this. Occupancy has been so low that a double-digit increase isn’t going to change whether or not someone can pay their debt service. That’s how bad it was,” he added. “I think a lot of the lenders have no interest in taking over a title.”

Foreclosure is often a last resort and not necessarily inevitable, even in a year shaping up to be the worst year financially for hotels.

“The banks at the end of the day don’t want to take these assets,” said Jeff Diener, a partner at DLA Piper. “They just want to get paid their interest and principal, month after month.”

But this doesn’t mean lenders are always looking to hold onto hotel mortgages, either.

“I don’t necessarily see foreclosures,” said ACRES Capital CEO Mark Fogel. “I see people buying notes at discounts and working something out with borrowers until demand comes back.”

ACRES Capital is a commercial real estate lender that offers bridge and construction loans to hotel developers in a variety of market segments. Rather than outright foreclosure, Fogel sees a wave of banks selling hotel notes to investors at a discounted price.

“If I buy at 70 cents on dollar, I have a discounted basis, can go back to the borrower, and work things out with a big cushion,” Fogel said. “Lenders and borrowers are generally saying we just have to live and fight to see another day.”

That discount gives the new lender more leeway to restructure debt servicing obligations to something that could work for the owner of a hotel with cratered occupancy and still get a decent return on investment. But the new deal could also come with new capital investment requirements or higher interest rates.

“Nothing is going to come for free,” Diener said.

Not a Total Foreclosure Avoidance

Foreclosures aren’t entirely off the table, despite the optimism for continued bank flexibility and alternative lending arrangements.

“Are we going to see mass foreclosures? It’s hard to give a yes or no answer to that, but I think it’s probably somewhere on the spectrum. There will be foreclosures,” said Meagen Leary, a Duane Morris partner whose clients include institutional lenders and commercial loan servicers.

Hotels less likely to make it out of the pandemic are those that were already struggling before coronavirus hit the U.S. Those include hotels with higher leverage or in struggling markets like Texas, where the oil business had declined in recent years.

But hotel owners in stronger markets and with generally good business before the pandemic may find better luck with their lenders, even commercial loan servicers. Further, just because a hotel loan goes into receivership following a default doesn’t always mean foreclosure is inevitable.

“Some hotels are performing well, and borrowers with good balance sheets and who are willing to have more skin in the game with longer-term work … Those have a stronger chance of being worked out,” Leary said.

More skin in the game includes cash management arrangements where a lender holds all the cash or excess cashflow to have added security, increased guarantee protections, and other cooperation covenants, she added.

But that is likely not enough to bail out certain hotels, especially those tied to conventions or heavily reliant on business travel to urban markets.

Wells Fargo in August sued Thor Equities for missing monthly loan payments since April on a $333 million mortgage at the 1,639-room Palmer House Hilton, Chicago’s second-largest hotel. The mortgage matured in June and has yet to be fully paid off, the foreclosure suit alleges.

“The big loans are on these 500-room or larger hotels in urban areas that have huge levels of operating costs, even if they’re shut down,” Fogel said. “There’s going to be an opportunistic play for someone willing to carry those hotels for the next year or two.”

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