IRVINE, CA-The number of California hotels in default orforeclosure increased during the third quarter, but an even biggerstory may be lurking in the shadows—the shadow inventory ofproperties that are in trouble but have yet to hit the defaultmarket. Alan Reay, president of Irvine-based Atlas HospitalityGroup, tells GlobeSt.com that his firm’s research suggests “a hugeshadow inventory of distressed deals that are yet to hit thedefault market” could be up to 1,000 hotels in addition to the 529in default or foreclosed already. California’s total hotel count isapproximately 10,000.

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A newly released Atlas survey of distressed hotels in Californiashows that the 529 in the state represent a 10.7% increase from thesecond quarter 2010 and 71.2% increase over the third quarter of2009. The 529 figure includes 119 properties that are inforeclosure, up 71.2% over the third quarter of 2009, and 410 thatare in default, up more than 58% from the third quarter of lastyear.

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The trends are not all downward, however. The number offoreclosed hotels selling to new buyers ticked up in the thirdquarter, a trend that Atlas expects to continue through the fourthquarter and accelerate into 2011.

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Reay cites two major factors causing the increase in sales offoreclosed hotels: Lenders are realizing the difficulties inrunning an operating business like a hotel, and are deciding tosell verses hold; and buyers are willing to pay higher prices thanbefore.

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In turn, Reay cites three major reasons that buyers are willingto pay more: the general consensus that we have turned the cornereconomically, RevPAR that is increasing in almost every singlemarket in California, and “the perception that we have hit bottomand now is the time to buy.” A secondary factor is that financingis coming back into the market, although it is not as readilyavailable as it once was.

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On the foreclosure front, Reay predicts that most of theactivity will be in the smaller and limited-service hotels asopposed to the large luxury resorts. “The luxury resorts lendersare absolutely loath to put the properties into foreclosure becauseit gathers a lot of bad publicity, and if the lender ends upforeclosing, they are hurting themselves because business intothose assets books two to four years in advance,” Reay says. Thelargest hotel in the state to be foreclosed on was the 512-roomHoliday Inn in San Jose.

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On the flip side, it’s very costly to maintain the small hotels,so lenders would like to sell the loans, but more of them arewilling to take the properties via foreclosure and put them on themarket now, Reay explains.

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Special servicers are moving a bit more aggressively in sellingoff their loans than the regional banks are, according to Reay, butthe banks now are finding that the forbearance agreements they havebeen working under with hotels for six months to a year aren’tsolving the problem. “That’s why we’ve seen an uptick in notices ofdefault, because these properties have reached six to 12 months ontheir forbearance agreements and the banks believe they need totake action,” Reay says.

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