Bankruptcy may provide opportunities for investors
NORTH BAY — While it’s no secret the hotel and lodging industry has taken a sharp hit during the recession, the rate of bankruptcy and default on loans within the industry has outpaced others in the commercial real estate market.
Although scores of hotels have defaulted or filed for Chapter 11 bankruptcy, opportunities abound for investors and buyers to purchase high-profile properties at favorable costs, particularly if the previous owners had sought bankruptcy protection, attorneys familiar with bankruptcy law said.
“There’s a lot of opportunity to take over hotels,” said Gary Kaplan, special counsel for Farella Braun & Martel, a San Francisco-based law firm with offices in Napa that deals with bankruptcy. “Things like getting rid of burdensome contracts, changing the terms of debt.”
A purchaser may be able to restructure the debt to the point where any money after operating costs goes to the loan, Mr. Kaplan said.
“You couldn’t do that outside bankruptcy,” he said. “It gives you more flexibility as a purchaser.”
The number of distressed hotels has increased dramatically over the past few years, and the difficulties facing the industry are multi-pronged. The projected number of delinquencies on collateralized mortgage-backed securities is expected to nearly double from current levels of 16.6 percent to 25 percent to 30 percent by 2012, according to the Fitch Report on hotels.
Compounding that stress, more than 75 percent of floating-rate hotel loans originated in 2006 and will mature in 2011 and 2012 at much higher fixed rates, the Fitch Report said. Additionally, the delinquency rate for the hotel and lodging sector of commercial real estate had the highest rate of default compared with other sectors, at a 17.3 percent default rate this year compared with 2.6 percent the previous year, according to a report from the New York data firm Trepp LLC.
“So even if you did have a performing loan, you’d find that the loan is fully matured very soon,” said Dean Gloster, a partner with Farella Braun & Martel.
The seasonal nature of hotels and subsequent uneven cash flow makes it all the more difficult, Mr. Gloster said, adding that given the economy, little lending is available as a reprieve for distressed hotels.
Other advantages in bankruptcy law, particularly section 363(f), allow an owner to sell a hotel “free and clear” of previous debt, which makes for a more attractive investment or purchase to prospective buyers, Mr. Kaplan and Mr. Gloster said.
Outside of bankruptcy, such a provision is unlikely, and costly litigation can arise over disputes between existing owners and would-be purchasers for potential interference with an existing contract in an attempt to negotiate more favorable terms of purchase.
Prospective buyers can also avoid substantial state and local real estate transfer taxes, which even if the tax is 1 percent of the property value can translate to millions of dollars, particularly for “trophy properties” that are more attractive for purchase than smaller, less luxurious hotels, Mr. Gloster said.
“A lot of people are interested to step in and buy for less and sell higher," he said.