Bloomberg Law
Free Newsletter Sign Up
Login
BROWSE
Bloomberg Law
Welcome
Login
Advanced Search Go
Free Newsletter Sign Up

Hotels’ Distress Lays Groundwork For More Bankruptcies in 2023

Jan. 6, 2023, 10:30 AM

Hotels across the US are in line for a potential uptick in bankruptcies and out-of-court restructurings in 2023 as distress mounts from rising interest rates, staffing costs, and expectations of a mild recession.

Parts of the hospitality industry may finally be reaching a tipping point—even after managing to stay afloat over the last two years by weathering an unprecedented drop in business caused by the pandemic. Hotel owners and lenders across the country are now increasingly reaching out for help as new economic challenges, including rising interest rates and staffing costs, emerge.

As of December, close to $4.1 billion out of roughly $93 billion in outstanding lodging loans are delinquent, according to data from CMBS analytics firm Trepp Inc. It currently projects about $35 billion worth of those loans to mature this year.

“I’m getting a number of calls from clients who are in need of assistance,” said Deborah Friedland, a managing director at Eisner Advisory Group LLC, who specializes in hospitality. Many callers are worried about operational costs and shrinking profitability in the face of maturing debt liabilities, said Friedland. Some are simply asking whether they should file for bankruptcy.

Sign up for The Brief, a daily afternoon newsletter showcasing Bloomberg Law’s top stories.

Some notable hotels, like the world’s tallest Holiday Inn and the Crowne Plaza Times Square, were already forced into bankruptcy in 2022 after failing to fully recover from the pandemic and keep up with operational costs and debt service.

If the economy continues on a course into recession, “You’re going to see a tremendous amount of distress in the next 12 to 18 months,” Friedland said. “The hotels that were having issues pre-pandemic are going to have even more issues.”

Economic Headwinds

Like most other consumer-facing industries, the US hospitality industry limped along through the early days of the pandemic, relying on government-backed financial assistance and flexibility from its lending base. The industry suffered tremendously from loss of daily revenues over the course of several months.

A number of popular hotels in New York City filed bankruptcy in the first 12 months of a pandemic-driven drop in business, including the Williamsburg Hotel in Brooklyn and the Martinique in Manhattan. The 805-room Fairmont Hotel in San Jose, California, similarly was forced into Chapter 11 after suffering $19 million in losses in 2020.

“The full financial effect of it was felt stronger, more acutely and more devastatingly in the hospitality industry than perhaps any other sector,” the owner of the Iron Horse Hotel in Milwaukee said of the pandemic in court papers after filing for bankruptcy in June 2022.

While business travel has failed to catch up to pre-pandemic levels, many leisure destination hotels have rebounded with a surge of travel-hungry visitors since pandemic-related restrictions were lifted.

But the environment is changing quickly, as inflation pushes up operational costs and interest rate increases make debt payments and refinancing more difficult.

“Those higher interest rates are a killer,” said Mark Podgainy, a managing director at corporate turnaround firm Getzler Henrich & Associates LLP. “You’re between a rock and a hard place, at least for the time being.”

If predictions of a mild recession come true, any additional recovery will be delayed and “you’re going to see leisure travel coming down,” said Friedland.

Currently there are about 155 loans securing hotels that are in distress and about 160 hotel loans due to mature in the next two years, said Amrik Singh, associate professor in the Fritz Knoebel School of Hospitality Management in the University of Denver’s Daniels College of Business. Given the new economic reality, it’s likely that the amount of distress will grow primarily because of loan maturity defaults, Singh said.

“We are going to see an increase because the environment by which these hotels were securitized is changing,” he said. “These hotels are not going to be able to pay up.”

In an industry that in large part depends on cyclical travel, many properties could be forced to seek restructuring options sooner rather than later.

“People aren’t bullish on hospitality,” said Cohn Reznick LLP restructuring adviser Chris Creger, who has seen a considerable uptick in calls from hotel operators and lenders over the last two months.

Some hotels may not be adequately prepared for cash shortfalls in the near term. “I’m curious to see if that’s going to create a flood of filings,” Creger said.

Pressure to Spend

On top of facing maturing debt and a challenging environment for borrowing, operators of branded hotels are coming under greater pressure from brand owners to make capital improvements on the properties.

Many hotel franchisees were allowed during the pandemic to delay making improvements required under their brand or “flag” agreements. But there’s now increased demand to complete stalled projects like updating lounges and other hotel amenities, said Podgainy, who was hired to lead a bankrupt group that owns and operates the shuttered, five-star Wagner Hote in lower Manhattan.

“The flags have requirements,” he said. “The flags don’t want to have tired looking hotels.”

Brand owners have generally been taking a more aggressive stance on property improvement, which can require a tremendous amount of capital expense at a time when revenues appear likely to dip, said Friedland.

Worker demands for higher wages are also still affecting the bottom line at many properties, putting acute distress on hotels that require large staffs. The American Hotel & Lodging Association reported in October that 87% of its members surveyed are experiencing staffing shortages at a time when industry wages are at record highs.

New Ownership

A number of distressed hotel operators are hopeful they can turn their businesses around through a negotiated financial restructuring, including those running the bankrupt Holiday Inn Manhattan Financial District and Milwaukee’s Iron Horse.

The bankrupt owners of the Crowne Plaza in Times Square are pursuing a potential sale of the company’s assets or reorganizing by handing ownership over to the project’s mortgage lender.

But owners without deep pockets may have no choice but to step away due to higher interest rates and shrinking asset values, which correspond directly in an industry where lenders rely on loan-to-value ratios.

An increase in Chapter 11 filings or out-of-court restructurings could give lenders with collateral in hotel property “a real gut check” over whether they want to take over running a struggling hotel business in a climate of higher interest rates or come to another resolution, said Creger.

Amid growing distress, it appears likely that more hotel owners will have to walk away or sell to interested parties like private equity firms, opportunistic real estate investors, or hotel management and ownership groups.

“There are numerous parties that are out there, interested and well capitalized,” Friedland said.

There are also many situations where lenders have sold their loans at a discount, and the new debt owners may have their sights set on selling the property quickly or taking it over, according to Podgainy.

“This is their moment,” he said. “A lot of this waiting stuff is long in the tooth.”

To contact the reporter on this story: Alex Wolf in New York at awolf@bloomberglaw.com

To contact the editor responsible for this story: Maria Chutchian at mchutchian@bloombergindustry.com, Melissa B. Robinson at mrobinson@bloomberglaw.com