Vultures are swarming above Chicago, awaiting their chance to scavenge on the city’s struggling hotels.
Oxford Capital Group’s 228-key Hotel Felix in River North was snatched up last month by Monarch Alternative Capital through an auction of distressed debt. Weeks earlier, a group including Frontier Development and Hospitality squawked about the discount they received from Host Hotels & Resorts as the REIT unloaded a suburban Marriott for less than half the $30 million it claimed it was worth last year.
In July, Thor Equities was hit with an order of foreclosure on Chicago’s second-largest hotel, the 1,645-room Palmer House Hilton, after defaulting on a $333 million mortgage. The hotel’s value has dropped from $560 million in 2018 to $328 million today, according to ratings agency DBRS Morningstar.
The competition to scoop up hotels left in distress by the pandemic is just beginning. More auctions are set to be held by the end of the year for debt attached to poorly performing large hotels in both downtown and suburban settings. And buyers such as Michael Weinstock’s Monarch are waiting to seize cheap entry points into the lodging market.
Payments on $758 million worth of CMBS debt were at least 90 days delinquent in the Chicago metropolitan area as of the end of September, according to Romy Bhojwani, a hospitality market analyst for CoStar. Borrowers are delinquent on 39 percent of all CMBS debt issued against hotels in the Chicagoland market, and 58 hotels in the area are in special servicing.
Now interest rates are rising and winter is coming (literally and figuratively), a time when Chicago’s hotels are traditionally less busy, which will only mean further trouble for properties on the brink.
“Through the pandemic, [lenders] were more open and agreeable to letting the owners dip into things like the interest reserve, which is for just the purpose of seasonality issues, peaks and valleys of hotel performance,” Bohjwani said. “Owners haven’t fully replenished those reserves, so there’s not a lot of funds available.”
Surging interest rates now make refinancing unattractive or impossible. As loans approach their new maturity dates, lenders have little choice but to foreclose and sell assets to well-positioned buyers.
The only question is: How long will lenders and their special servicers keep buyers waiting?
Predators and prey
Lenders who pursue foreclosures on hotels might not be as motivated to auction them off right away, especially if they’ve been recently renovated and require minimal improvements.
“If the asset has been starved of capital, that can be a leverage point for the servicers to move quicker, because they don’t want to fund any type of capital improvements themselves,” said Chicago hotel broker Scott Kaniewski of HREC Investment Advisors. “You might have an asset in very good shape, and you might have a servicer saying, ‘I’ll sit here until things improve.’”
Bondholders in troubled CMBS debt look to be in a bigger hurry to move on from a few downtown properties, as they’ve set sales of distressed assets in motion that could occur before the end of the year.
Oxford’s Holiday Inn Express at 640 North Wabash Avenue is set for a foreclosure sale after more than two years of special servicing for nonpayment on a $23.5 million loan originated in 2013, according to a report by special servicer LNR Partners. The property’s appraised value slid from $36 million in 2013 to just over $12 million now, according to Morningstar.
An even more dramatic drop happened a few blocks north. Near the Magnificent Mile is the 345-room hotel at 198 East Delaware Place, which was once owned by Procaccianti Companies. The trustee for a $77 million loan issued against the property in 2015 filed a foreclosure action, and a sale is anticipated in the fourth quarter. The hotel’s appraised value is down 40 percent since the loan was issued, to $68 million, even less than the $72.5 million Procaccianti paid for it in 2005, according to Morningstar and public records. Procaccianti handed over the deed to the property rather than battle the foreclosure last year.
Not all disputes are being resolved without fights, even over relatively small amounts. Management of the South Loop Hotel’s capital improvement fund is a crucial factor in the ongoing foreclosure fight over the 231-room property at 11 West 26th Street, according to Vickie White, one of the owners being sued by Rialto Capital, servicer of the $7 million CMBS loan against the property.
Describing Rialto’s move to file a foreclosure complaint as “capricious, vindictive and deplorable,” in an Oct. 10 email, White claimed that the hotel is current on payments and missed only one during the pandemic. But Rialto and Wells Fargo, as trustee of the loan, are trying to “legitimize the confiscation of the capital improvement fund that has grown to over $1.5 million,” she said in the letter, adding that Rialto is “utilizing every sentence of the scrupulous mortgage agreement” that the property’s co-owner, Louis Dodd, solely negotiated. White accused the lender and servicer of playing favorites by offering forbearance to other borrowers but declining her request.
Lodging revenues are generally improving. But Chicago and other large cities with cold weather months are trailing the rest of the nation in pandemic recovery. These markets are more reliant on business travel, which hasn’t rebounded at the same pace as leisure travel.
“The current outlook for the lodging industry remains highly uncertain,” Host Hotels said in its latest quarterly report, made public weeks before its October sale of the 254-key suburban Downers Grove Marriott for just $14.5 million. Like other hoteliers, the company has been scaling back in Chicago and buying in warm weather markets.
Still, there’s a path forward for the sector’s recovery if business travel ramps up, and plenty of buyers are confident that’s on the way. Firms such as Massachusetts-based Linchris and Rhode Island’s Magna Hospitality Group are eyeing assets in markets reliant on these types of travelers, HREC’s Kaniewski said.
Some could be frustrated if loan servicers in charge of turning around distressed hotels opt to try to avoid the impact of high interest rates by holding onto assets until inflation is under control. Even if select lenders try to weather the storm, CoStar’s Bhojwani expects plenty of opportunities for buyers.
“It’s one of those once-in-a-cycle buying opportunities, particularly for well-capitalized investors and the ones that have raised distressed asset funds,” he said. “The distress that was anticipated through the pandemic, which never occurred, I think is going to occur in 2023.”