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IRVINE, CA-The number of California hotels in default or foreclosed on jumped 125% in the last 60 days, according to a new report, and more than 500 have defaulted on their property taxes. Alan X. Reay, president of Irvine-based Atlas Hospitality Group, tells GlobeSt.com that the state now has 31 hotels that have been foreclosed on and 175 in default.

Reay says that the number of hotels that have defaulted on property taxes could be a harbinger of things to come because defaulting on taxes is often a precursor to a loan default. Some high-profile defaults, foreclosures and receiverships have already been in the news, such as the St. Regis Monarch Beach Resort near Dana Point, the W Hotel in San Diego and the Renaissance Stanford Court in San Francisco.

The total of defaults and foreclosures right now could look like a trickle compared to the flood that could be in store. Reay’s firm found that for the more than 2,500 hotel loans originated in California from 2005 to 2007, based on today’s market values, “We estimate that none of these hotels have any equity remaining.” Already, 75% of the hotels that are in default or foreclosure are properties that were financed during this period.

What will happen to the rest of the more than 2,500 California hotels that were financed during this period remains one of the big questions in the state’s hotel market, but there is no question that there will be “an unprecedented number of hotels in trouble,” Reay says. The 2,500 hotels are definitely at risk, but that doesn’t necessarily mean that they will default. How many of these go into foreclosure and become bank REO will depend on how much flexibility the banks have to rewrite the loans, and it also has to do with how many of the banks will be taken over by FDIC, the Atlas president points out.

If the banks don’t foreclose on the troubled loans, “We are still looking at thousands of loan write-downs,” Reay says. Whether it’s via REO or write-downs, “Either way, lenders are looking at taking a big hit on thousands of hotels,” he says. The 2,500 California hotels without any equity are part of about 10,000 nationwide that are in the same plight, Reay says, a situation that he terms “just unheard of.”

Another factor that will determine the fate of many of the hotels will be the actions of the investors who step in to acquire distressed hotel loans when many of the loans, inevitably and ultimately, end up in the hands of the FDIC as distressed assets for sale at a steep discount, something like 20 to 30 cents on the dollar. The first priority of those who buy the hotel loans “will probably be to restructure the loan and keep the borrower in there, as long as they can make a good return,” Reay says. “The last resort will be to foreclose.”

Non-franchised hotels account for a disproportionate number of foreclosures. They make up about 87% of the total. However, franchised hotels make up 59% of the defaulted properties.

Initially, the wave of distress in California was composed of mainly the smaller, non-flagged hotels in secondary and tertiary markets. “As the hotel economy worsened, we have seen it impact all property types,” Reay says.

No market or brand is exempt from the downturn. Atlas cites an unprecedented decline in room revenues, with California down 21.5% year to date, as one of the factors in the distress, combined with a jump in cap rates that has depressed values. It estimates that values are currently 50% to 80% lower than at the market’s peak in 2006 and 2007.

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