Wave Of Distress Missing LA Hotels To The Delight Of Value-Add And Redevelopment Projects

The team marketing the Mart South hotel redevelopment in Downtown LA’s Fashion District noticed earlier this year that there was a big increase in interest in the property, a former office building entitled for hotel conversion.

In fall 2020, the property was averaging about three inquiries a month, but in January and February, when a buyer was selected, that shot up to 20 inquiries a month.

It surprised Cushman & Wakefield Executive Managing Director Mike Condon Jr. and Associate Bailey Dawson, who are leading the property sale, but Dawson said it seems indicative of the larger trend they’re seeing in LA.

"There's really been no massive wave of distress that's enabling people that are trying to prey on the downturn,” Dawson said. “We just haven't seen that.”

The Los Angeles hospitality sector was, like others across the country, deeply impacted by the coronavirus pandemic. However, a potential summer reopening is about two months away, and leisure travel across the state appears to be making a noticeable return. The absence of mass foreclosures in LA that many braced for has some in the industry wondering if the worst is behind LA.

That isn’t to say that hotels haven’t struggled. With most of the demand in the marketplace being leisure-driven, major markets across the country — most of which are dependent on business and group demand — continue to struggle the most, despite upticks in the last month, according to STR.

The hospitality data provider found that Los Angeles hotels’ total revenue per available room was down 77.5% in February compared to 2020 overall. That was on par with New York, and less of a drop than Orange County (80.8%), San Diego (84.4%) and San Francisco (90.9%).

But in the entire year of 2020 — a truly unique and terrible year for the hotel industry — only 15 notices of default were filed for California hotels, said Alan Reay, president of Atlas Hospitality Group, which tracks hotel defaults in the state. Reay said in a non-pandemic year, it’s not unusual to see 20 or 30.

In the first three months of 2021, Reay said Atlas has counted 25 California hotels with notices of default or bankruptcy filings, but he notes that the “vast majority” of those properties are part of larger portfolios connected to two borrowers, one of which was a subsidiary of Eagle Hospitality Real Estate Investment Trust, which filed for Chapter 11 bankruptcy protection at the beginning of the year.

“When people look at those and say, ‘Is that the start of the tidal wave [of bankruptcies],’ I don’t agree with that,” Reay said. “I think it is the exception to the rule.”

DBRS Morningstar Head of CMBS Research Steve Jellinek said that the delinquency rate for LA hotels is 15.1% — more or less in line with the national average of 15.77%.

“We’re just not seeing the bloodbath in hotel sales that we might have expected at the beginning of the pandemic,” Jellinek said.

Instead, many hotels were able to receive forbearances and modifications to their loans that allowed them to suspend payments or reduce them, or to tap into reserves that they otherwise use for capital improvements to make loan payments. Jellinek said all that seems to be working.

“I always ask myself, is this just kicking the can down the road, forestalling the inevitable?” Jellinek asked, but he said that Los Angeles has historically performed very well and that suggests that lenders will continue to work with borrowers who need help to continue weathering the storm.

Reay said it is the larger convention center hotels, which typically have high overhead and big mortgages, that will need the most patience from their lenders, as their bounce back is expected to take longer.

The Greater LA chapter of the Asian American Hotel Owners Association said many of its members, who are owners of smaller hotels, are struggling in a way that many of the more positive numbers don’t reflect. 

“Everyone is getting some sort of help,” said Bharat Patel, secretary of the AAHOA, though he said exact delinquency numbers or other indicators of distress were hard to pin down for the organization’s Greater LA arm, which stretches from Fresno down through Los Angeles County.

The question of how long that help will last is a big one for the hospitality sector. STR and CBRE had previously predicted that hotels wouldn’t see a full rebound until 2023 or 2024. And if Los Angeles sees another wave of Covid-19 cases, as is happening on the East Coast, that could push the reset button on burgeoning leisure travel and set everything back. 

But if the frenzy of distressed hotels fails to materialize in LA, Cushman & Wakefield’s Condon Jr. and Dawson are betting that other hotel deals — like the adaptive reuse office-to-hotel project in the Fashion District — will benefit. 

“People are now pivoting and starting to look at value-add or development deals, because that's the only opportunity to hit the same returns as a distressed asset acquisition,” Condon Jr. said.