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SAN FRANCISCO- Millennium Partners this week acknowledged purposely defaulting on its two-year-old, $90-million CMBS loan for the 277-room Four Seasons San Francisco with hope of renegotiating the debt with the special servicer, LNR Property Corp., because the hotel, once valued at $135 million, is now worth less than is owed. The strategic move appears to be working for Millennium and others in California, which has industry experts expecting a lot more of it.

“What we are finding now is that–because on CMBS loans the companies cannot get any response from the master servicer–the only way of trying to renegotiate is to default because only a special servicer can modify the loan,” Alan Reay, president of Irvine, CA-based Atlas Hospitality Group tells GlobeSt.com. “My prediction is you are going to see vast majority of CMBS loans in California–probably throughout country–defaulting.”

At least a dozen hotels in California have employed the “default of convenience” strategy and are now in special servicing, according research by Atlas. Five of those hotels—a Hawthorne Suites and a Residence Inn in Sacramento; a Courtyard by Marriott and a Residence Inn in Oxnard; and a Marriott Courtyard in Riverside–were acquired by DLJ Real Estate Capital Partners in 2007 from Sunstone Hotel Investors for $150 million.

Another is the W Hotel in San Diego, for which Sunstone Hotel Investors chose not to make its June payment on a $65-million CMBS loan secured by the property. Sunstone said the voluntary move reflects a “significant and continuing deterioration in demand for luxury lodging.” Sunstone cited “a number of unique, market and hotel-specific factors” that drove its decision, adding that it might pursue similar options with certain of its other mortgaged hotels.

Most hotels that changed hands in 2006 and 2007 at the top of the market are now facing problems both because rate and occupancy assumptions are not coming to fruition, and because the drop in value is preventing refinancing. As a result, owners have to get aggressive in order to get their assets’ right side up again.

“In order to commence discussions with the debt holders of the Four Seasons Hotel in San Francisco, Millennium Partners has strategically withheld payment of debt service,” Millennium Partners said in a statement. “Conversations on restructuring the debt have begun, and Millennium Partners is hopeful that they will result in a positive outcome.”

The default by Millennium comes on the heels of another luxury hotel in San Francisco, the Renaissance Stanford Court Hotel, being taken over by a receiver. Funds of JER Partners paid approximately $93 million in January 2007 for the 393-room luxury hotel on Nob Hill and then spent $32 million completely renovating the eight-story property. Barclays Capital, the lender, says in court documents that the borrower, a pair of JER funds, defaulted on its $89-million loan for the acquisition, renovation and operation of the hotel and then essentially walked away from the asset.

A San Francisco Superior Court judge has thus far given Barclays some of the relief it sought, ordering last month the appointment of Douglas Wilson Cos. of San Diego as receiver and prohibiting the borrowers from interfering in the operation of the property. The man now overseeing the asset is Reint Reinders, a hotel and tourism executive who spent 21 years with Marriott and also directed the San Diego Convention & Visitors Bureau before joining Douglas Wilson Cos.

The hotel is currently hosting lots of guests but not achieving anywhere near the room rates expected prior to the recession. “It’s basically a brand new hotel; the whole thing has been redone, but rates have really suffered,” Reinders says. “First class hotels here are having to charge $120 per night to $130 per night [to maintain occupancy] when in a world-class city like San Francisco rates for such properties should be $200 or more.”

The property was expected to under perform through most of 2007 and 2008 due to the renovations. What wasn’t expected in 2006 was a deep recession that would cause the value of the hotel and room rates to decline precipitously. “Could anybody have foreseen in 2006 that we were basically at the top of the market and that three or four years later it would be worth 40% less? No,” Reinders says. “In fact, based on occupancy and rent trends the assumption was it would be 20% to 30% higher. Nothing grows to the sky, as we have found out.”

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