Sunstone prepared to turn over W San Diego to bank

Sunstone Hotel Investors Inc. said Sunday it will default on the June mortgage payment for its swanky W Hotel San Diego property and turn over the 258-room downtown hotel to lenders, after failing to lower interest payments.

The real estate investment trust said Sunday its San Diego hotel has been hurt by "significant and continuing deterioration in demand for luxury lodging" as well as the opening of luxury boutique hotels, two additional Starwood-branded hotels and a 1,190-room convention hotel nearby.

Sunstone purchased the W San Diego in June 2006 for $96 million from developers including Starwood Hotels, Gatehouse Capital and Multi-Employer Development Partners. The hotel carries a $65 million, fixed-rate commercial mortgage-backed securities loan with a 6.14 percent interest rate, which comes due Jan. 1, 2018. The mortgage principal translates to more than $250,000 in debt per room.

San Clemente, Calif.-based Sunstone said its loan special servicer has declined the company's attempts at renegotiating interest payments lower. Since Sunstone feels the W San Diego is now worth much less than what it owes, the company would rather turn it over to the bank than have hefty interest payments continue to drain cash from its balance sheet.

"While the company maintains more than adequate liquidity to support or repay this mortgage, we believe a conveyance of this hotel in settlement of the debt would be in the best interest of our stockholders," Chief Financial Officer Ken Cruse, said in a statement.

Cruse said the move would deleverage Sunstone and add to its funds from operations — an industry profit measure — and credit profile.

Sunstone Hotel warned it could pursue similar options with a limited number of its other mortgaged hotels, but declined to identify any properties that might be in danger of default. Last month, Sunstone amended terms on some of its senior notes so that any default on less than $300 million worth of debt won't trigger noteholders to call in payment of their bonds. That would make it easier for the company to potentially shed other troubled hotels in the same fashion.

As of March 31, the company owned 43 hotels in the upper-upscale segment operated under brands including Marriott, Hilton, Hyatt, Fairmont and Starwood. It has been restructuring its credit facility and soliciting bids for new mortgage debt on several of its hotels.

Hotel real estate investment trusts have been hit hard by the credit crunch and by job losses which have curbed business and vacation travel. Analysts expect hotel margins will decline this year, given that hotels aren't cutting major services as they struggle to attract travelers.

Sunstone Hotel said that across its portfolio, revenue per available room — an industry performance measure known as RevPAR — slid 24.5 percent to $98.73 in the quarter ended May 31. That's nearly double the 13 percent drop it saw in the first quarter.

RevPAR for the month of May fell 24.4 percent and year-to-date is down 19.6 percent to $97.53.

"We continue to run our business with the expectation that 2009 will be one of the deepest cyclical troughs the lodging industry has endured," Arthur Buser, president and chief executive, said in a statement. "While we are generally pleased with our results thus far this year, as our recent revenue declines are largely the result of lower rate, rather than reduced occupancy, we expect margin control will become increasingly difficult."

Sunstone said the company has asked hotel operators to develop "zero-based" budgets and adjust staffing models for minimum business levels. The REIT plans to hold a conference call at 5 p.m. EDT Monday to update stockholders on recent business performance and transactions.