Sunstone's Loan Troubles: A Cautionary Tale

When the hotel business was hot, Sunstone Hotel Investors (SHO) was a ferocious buyer. From 2005 to 2007 the real estate investment trust snapped up $2 billion worth of properties, financing many deals with commercial mortgage-backed securities (CMBS). Now the travel industry is in tatters, and the large Southern California firm is scrambling to renegotiate its payments with lenders, which aren't making it easy. "Someone said that CMBS was a car meant to go forward fast," says Sunstone Chief Executive Officer Arthur L. Buser. "They don't do very well in reverse."

The standoff between borrowers and lenders, like those in the residential market, will only exacerbate the problems in commercial real estate. On Sept. 15 the U.S. Treasury Dept. and the IRS announced rules designed to give bondholders more flexibility to modify loans. But bondholders low down on the food chain still have little incentive to cut deals. If they do, they risk losing their entire stake since their investment is often wiped out first. The result is that negotiations often end in gridlock, or what some in the industry call "delay and pray." When they delay too long, borrowers can end up in foreclosure, which depresses the market further.

Buser has pulled every possible lever to cut the firm's debt, which stood at $1.7 billion at the start of 2009. The firm has sold two small properties: a Marriott hotel in Napa and another in Riverside, Calif., for $36 million and $19 million, respectively. But in this tight credit environment, Sunstone is having trouble finding buyers for other locales that carry higher price tags and mortgages. "Lenders are still not prepared to accept the kind of values that buyers are prepared to offer," says Jim Butler, a real estate attorney at Jeffer Mangels Butler & Marmaro.

Sunstone has had some luck with creditors. On Sept. 16 it announced an agreement with bondholders who control a $105 million loan on the Renaissance Harborplace Hotel in Baltimore. The creditors are letting Sunstone defer $6 million of payments for 30 months.

Other negotiations have been less successful. The bondholders on the W San Diego hotel and a Marriott in Ontario, Calif., wouldn't budge. So Sunstone simply handed the keys to the lenders. It has stopped making payments on another property, the Renaissance Westchester Hotel.

Still, Buser is optimistic. He's encouraged by an uptick in group bookings at the company's hotels in Orlando and Washington, D.C. "The economy will recover, values will go up," he says. "It's just a question of when."

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