February 23, 2010
By Shawn A. Turner


2010 is shaping up as a good year to find deeply discounted debt, real-estate experts say.

Case in point: KSL Capital Partners’ reported acquisition of $380 million of La Costa Resort & Spa’s debt for $120 million. The resort is in Carlsbad, California.

“We’re at the dawn of a new cycle,” said Daniel H. Lesser, senior managing director-industry leader at CB Richard Ellis in New York.

KSL, according to a report in Commercial Real Estate Direct, acquired the debt on behalf of an investment fund it manages. The $147-million first mortgage and $233-million of mezzanine debt matured earlier this month. La Costa, located in the San Diego area, was purchased in 2007 for about $400 million from Kohlberg Kravis Roberts & Company and CNL Hotels & Resorts.

An outside spokesman for KSL would neither confirm nor deny the report of the buyback and said executives at KSL were not available for comment.

Lesser largely declined to comment on KSL’s deal. “They’re smart guys,” he said.

More deals

Alan X. Reay, president of brokerage and research firm Atlas Hospitality Group in Irvine, California, said he expects to see an increased amount of discounted debt purchases, particularly in the resort and luxury segments.

“Lenders in general are looking to sell these loans rather than go through the foreclosure process,” Reay said. “People don’t want to book meetings, weddings, if they hear (the luxury property) is in foreclosure.”

He added, “It’s less of a PR nightmare when they foreclose on a limited-service hotel.”

Poor operating performance has brought hotel values crashing down. For example, Commercial Real Estate Direct reported that La Costa Resort’s net operating income fell by 33 percent last year to $10 million, and is down at least 50 percent from 2007.

That’s in line with what Reay is seeing. He said that property values, as a whole, are down between 50 percent and 80 percent from peak values in 2007, which is likely to bring about even more bargain opportunities.

The average discount on loans Reay is seeing is 60 percent.

“The owners themselves would love to buy (the loans), but other people are coming to purchase those loans,” he said.

Money to be made

Kent W. Schwarz, senior managing director of PKF Capital in Miami, agreed that there are plenty of bargain-basement opportunities available.

“The answer is—unfortunately and fortunately—yes,” Schwarz said. “We will see more and more of that.

“It’s unfortunate because values have been reset; it’s just a matter of when it hits the books. The fortunate part is there are a lot of people who will make a ton of money. Fortunes have been lost and fortunes will be made.”

He said lenders are trying to avoid taking possession of the physical asset. He recalled a meeting with a special servicer who was late to a meeting with Schwarz because the servicer was out trying to raise money to meet payroll.

“That’s just not something you have to worry about with an individual building or an office building,” Schwarz said.

A new cycle

Lesser said the reported KSL deal reminds him of what has happened in past downturns.

“During past cycles, the smart money first out of the gate was buying distressed notes,” he said. “There’s definitely going to be a fair amount of this occurring. This will be the initial types of sales occurring …”

While there are some sales of properties happening now, he foresees that activity picking up more strongly by the middle of next year.

Sales of distressed notes are likely to be made across segments, the experts agreed. Lesser said he sees activity picking up from here.

“There’s only one way for it to go,” Lesser said, “and that’s up.”