Similar to what’s happening in the housing market, high interest rates are depressing the volume of hotel sales, which in San Diego County recorded their second biggest decline in 15 years.

BY LORI WEISBERG | FEB. 29, 2024 5:30 AM PT

San Diego made history last year when the upscale Inn at Rancho Santa Fe sold for a stunning $1.2 million a room — even as the volume of hotel transactions experienced one of the biggest declines the county has seen in 15 years.

The pricey sale of the 85-room inn belies a distressing trend seen not just locally but across the hotel real estate market statewide: a sharp downturn in sales fueled largely by high interest rates and a skittishness among lenders to finance costly transactions.

Last year marked the second steepest decline since 2009 for both the number of hotel transactions and overall dollar volume in San Diego County, according to a new statewide report released by the Orange County-based brokerage, Atlas Hospitality Group, which tracks sales throughout California.

The rising cost of financing is concerning enough that it has some experts — including Atlas Hospitality — warning about the looming threat of hotel foreclosures as large debt repayments come due.

While that’s already happened in some parts of California, San Diego County so far has been immune to the threat of default and foreclosure, according to Atlas CEO Alan Reay. The region also has some major selling points in its favor, including continued strong demand for leisure travel and convention and meetings business.

“The big news is that everyone is seeing a big decline in sales, and you’re also seeing it across all commercial real estate, but within California, San Diego County had the highest percentage increase in the price per room of hotel sales in any county,” Reay said. “That’s the biggest story for San Diego County.

“Yes we’ve seen a lot of hotels where the owners are having to give the keys back to the bank, but that’s more in San Francisco, Oakland, San Jose. We haven’t seen that in Orange County or San Diego.”

In 2023, San Diego County experienced a 23.5 percent decline in individual sales — from 34 in 2022 to 26 a year later — and a 42.3 percent decrease in total dollar volume, Atlas reported. Only in 2009, in the midst of the Great Recession, was there a steeper decline in sales volume, which fell 65 percent, Reay said.

Despite the impressive comeback of San Diego hotels following the punishing impacts of the pandemic, the sluggish sales of properties last year is not unlike what has been occurring in the residential and office markets as interest rates continued to climb in 2023 amid the Federal Reserve’s continued efforts to tamp down inflation, Reay pointed out.

“Interest rates really jumped up and completely impacted the number of sales and caused most other markets to decline in value,” Reay said. “There are a number of factors but the dominant ones are the quick acceleration of interest rates and second, the number of lenders who pulled out of the market.”

Reay noted that there’s also a disconnect between the purchase price that hotel owners think their properties should command and the dollar figure that buyers are willing to pay.

“As a seller, just as in the residential market, you’re looking at properties that sold, six, nine, 12 months ago, and you want to get the same price now, but you can’t get that because the cost of financing is so high,” Reay said. “And it takes a while for that to change. We saw that in 2009.”

Top 10 San Diego County hotel sales in 2023

Hotel	City	Rooms	Price	Price per room
Inn at Rancho Santa Fe	Rancho Santa Fe	85	$100M$100M$100M	$1,176,471
Pala Mesa Resort	Fallbrook	133	$53M$53M$53M	$398,496
Carlsbad by the Sea Hotel	Carlsbad	145	$44M$44M$44M	$302,759
DoubleTree San Diego Hotel Circle	San Diego	219	$44M$44M$44M	$200,228
Motel 6	Carlsbad	162	$20M$20M$20M	$124,074
La Quinta Inn	Vista	105	$17M$17M$17M	$163,810
Holiday Inn Express	Solana Beach	80	$16M$16M$16M	$193,750
Morgan Run Resort	Rancho Santa Fe	76	$15M$15M$15M	$192,388
1906 Lodge	Coronado	18	$14M$14M$14M	$773,611
Four Points by Sheraton	San Diego	225	$13M$13M$13M	$57,778

In all, 26 hotels accounting for 2,045 rooms sold for a collective $452.6 million last year, compared with 3,600 rooms that went for $784.7 million in 2022, Atlas reported. With the exception of the Inn at Rancho Santa Fe, which sold for nearly $1.2 million, almost every other sale, from Fallbrook to San Ysidro, was priced under $50 million, with many of the properties falling into the category of budget hotels and motels.

At least two of the sales — Hotel Primera San Ysidro and Palomar Motel Chula Vista — were sold in connection with local efforts to purchase properties for housing the homeless, Atlas confirmed.

Emmy Hise, senior director of Hospitality Analytics for the commercial real estate firm CoStar, covering the Western U.S., echoes Reay’s observations. Hotel transactions, she said, are simply harder to pencil out these days, given the high cost of financing. On top of that, while properties are performing pretty well in terms of revenue, they’re no longer experiencing the “crazy growth we saw coming out of the pandemic.”

Last year, for example, San Diego County saw fairly decent growth in average daily room rates and revenue recorded per room compared with 2019. But it was nothing like the 17 percent surge in revenue in 2022, compared to San Diego hotels’ financial performance during the last full year before the pandemic arrived.

Meanwhile, overall hotel room occupancy, while laudable compared to other markets, has yet to return to the levels seen in 2019.

“Top-line revenue growth stabilized in 2023, and most of that growth happened in the first quarter in 2023 and has slowed each quarter thereafter,” Hise said. “That’s because travel trends have normalized. You also have expenses increasing, which makes it harder to reach that higher net operating income, and you have more debt.

“I do think San Diego, though, is well positioned for investment activity. Other leisure destinations saw performance decline but because San Diego has a diverse travel base, where groups and conventions picked up the demand, hotels there are a less risky investment decision. As far as hotels going back to the bank, while there have been a few, there have not been enough to move the needle.”

Atlas Hospitality doesn’t specifically mention the potential for coming foreclosures in its year-end report, but Reay addressed it as a very real possibility in an interview.

The threat of foreclosures applies mostly to hotel loans arranged through commercial mortgage-backed securities he said. A wave of CMBS hotel loans — more than $25 billion — is expected to come due this year, which has prompted mixed opinions on the potential fallout.

Host Hotels & Resorts CEO Jim Risoleo noted in a recent Hotel News Now article that he’s not so convinced that major financial distress will necessarily follow, although his company, he said, will continue to track it.

Reay, however, points out that some of that distress already has materialized. Last year, the owner of two of downtown San Francisco’s largest hotels — the Hilton San Francisco Union Square and the Parc 55 — stopped making payments on its loans. And in Los Angeles, the 19-story Fairmont Century Plaza fell into foreclosure last year.

Even the venerable Hotel Del Coronado, which is in the final stage of completing a years-long $400 million makeover, has been placed on a commercial loan “watchlist,” based on data showing that the resort’s cash flow was coming in lower than what had been projected last year when the hotel refinanced its 2017 loan, said Hise.

The property’s new $950 million loan, which was taken out, in part, to help finance a capital investment of $166 million, carries an interest rate of nearly 10 percent, higher than its earlier 2017 loan of 7 percent, according to Costar.

Because the hotel is currently renovating its Victorian building, all 367 rooms are currently out of service and will remain so for more than a year, which will mean a loss of considerable income for a prolonged period.

“I can tell you that there are hundreds of hotels on the CMBS watch list,” Reay said. “The Hotel Del obviously has a lot of debt and a lot of rooms are out of service. But I don’t see the Hotel Del going back to the lender. The Del’s loan is almost 60 percent of what it appraised for. So that loan to value is not a high-risk loan.”

Given the possibility that distressed hotels could be coming onto the market his year and next, Reay said he’s seeing a lot of private equity groups raising money now so they’ll be prepared to snatch up properties at possibly discounted prices.

Pebblebrook Hotel Trust, a Maryland-based real estate investment firm that owns a number of higher end San Diego properties, including Paradise Point on Mission Bay and the Estancia in La Jolla, has been focused more on selling than buying over the past year and has no plans now to acquire properties, said Chief Financial Officer Ray Martz.

“Last year we sold seven properties, realizing $330 million of proceeds, with mostly all-cash buyers,” he said. “We continue to look at selling properties because we’re trading at a big discount. That way we can sell our assets at a dollar and buy back shares at 50 cents on the dollar. We think that’s the better use of capital because of current market conditions.”

No matter what the economic landscape looks like, though, Southern California urban markets are well positioned to weather any headwinds coming their way, Martz says.

“In 2024 San Diego will have a record convention calendar and there continues to be growth in the life science and biotech space in the La Jolla area, which is adding a corporate base, so of the coastal markets, San Diego is doing very well,” Martz said. “Boston and New York also are doing well as is Miami but San Francisco is in a different situation.

“Also what’s different about San Diego is it’s more an institutionally owned market where a lot of the hotels are owned by these hotel REITs, so when there are soft patches in the economy, it’s not going to affect them as much and they can get financing when others can’t.”