As the economy recovers, airlines are looking at clearer skies and cruise companies are sailing smoothly into 2010 and beyond. But the hotel industry has managed to keep itself down on the mat – mostly due to no fault of its own, and the situation has now reached a crunch-time stage.

Survivor

As far as occupancy and rates are concerned, there’s actually a bit of optimism, with the overall U.S. hotel occupancy rate projected to jump from 55% in 2009 to 59% this year. Room rates are expected to go up 4% next year.

This is about right and on track with the rest of the travel industry’s projected recovery. Then why is the hotel industry, as USA Today’s Gary Stoller puts it, still in survival mode ?

The biggest problem facing hotel owners – and one which isn’t going away on its own, is the steep drop in property values, which have dropped 50% from 2007 peak values.

15.7% of securitized hotel mortgage loans delinquent at the end of last month. In California, 330 hotels have defaulted on mortgage payments since 2009, with 76 having been taken over by lenders since 2008. Nationwide, 500 hotels have handed over the keys to their lenders.

These defaults and foreclosures are not the usual failed businesses about to shut down - most are thriving hotels facing a temporary revenue shortage. The main reason for all the defaults and foreclosures is that owners no longer see the percentage. 

First – revenues are not enough to cover both costs and mortgage payments. Second, even if the owner is capable of shelling out-of-pocket, the remaining balance on the loan for most hotels is now greater than the property value, which makes it a bad investment going forward. This is especially true for REITs like Sunstone, which has given up 13 hotels, including the W San Diego.

This is also where the ’survival mode’ kicks in for the remaining hotel owners who are too deep in to bailout. The only way to meet the mortgage payments under the new normal is to cut down on the costs and reduce services and freebies.

To make matters worse, just as the economy recovers, the hotel industry is being deluged by a flood of new hotel rooms due to projects which began in happier times. New York is facing a 5.1% increase in rooms, with 28 new hotels slated for opening this year and next. The 600 room Intercontinental Times Square is the biggest of the lot.

In Las Vegas, CityCenter’s massive opening has shaken up the entire ecosystem and Vegas is now praying hard for a recovery big enough to offset the impact of the new inventory.

To cut costs and keep rates from tanking badly, hotels are resorting to all kinds of gimmicks – including keeping entire floors boarded up, and even skipping daily printed menus at hotel restaurants and having servers explain the specials instead.

Hotels are also looking for cutbacks in payroll. 400,000 hotel employees have been laid off in the past two years. In addition to the reduced level of service offered to customers, this also creates new problems for the hotels, such as the massive protests faced by Hyatt in Boston for firing housekeepers. The Hyatt Regency Boston has just been sold by Hyatt to the Chesapeake Lodging Trust, probably in a bid to wash its hands off the matter.

Top this off with additional problems like the AIG Effect which pulled the rug out from under the meetings business for hotels nationwide. The St. Regis in Dana Point, which gained fame as the AIG party hotel, has itself been foreclosed.

All these issues have their roots in the mortgage crisis, and there are only two ways the hotel industry can get past it. First - more business and revenue flows large enough for hotel owners to be able to ignore the drop in real estate value. This looks to be a long way off.

Second solution is to reorganize the debt to make the mortgages more feasible for owners. This sounds especially attractive, if you consider some of the great deals that are going down on foreclosed properties and bankrupt projects.

Consider Carl Ican’s acquisitions of the Fontainebleau Las Vegas ($150 million deal on a $2.9 billion project, 70% complete) and the Tropicana Casino & Resort in Atlantic City ($200 million deal with debt cut by $2.5 billion). Or the proposed $905 million Extended Stay investment by Starwood Capital, which would reduce Extended Stay’s debt from $7.4 billion to $2.8 billion.

The hotels, companies and projects that emerge from bankruptcy, foreclosure or just a bit of debt reorganization are going to do extremely well – much better than others who are still carrying the pre-recession level of debt.

Either way, the hotel industry needs to get the real-estate monkey off its back, or there’s going to be a lot more surviving to do.

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