I have now heard this title more than once to describe the impact of current events on the hospitality industry. It makes sense as a way to rationalize 2001, but not necessarily as the overriding theme for the year. With the national recession actually starting in March of 2001, the slow down in corporate travel and resulting downturn in hotel profits, and the final blow on September 11 th , these all influenced what is now referred to as the “Perfect Storm” scenario.

Although most understand these events were for the most part the primary catalyst of our current economic slump within the hotel industry, regionally there were many other factors. Most notably were Boeings announcement of their move to Chicago combined with their massive layoffs, the dotcom implosion and their residual layoffs and the unprecedented rise in commercial vacancies in Seattle, Bellevue and Tacoma, currently 12.6%, 23.7% and 20.7%, respectively.  With all that is happening it is a wonder no one has yet made the reference to the early 80’s when we were asked… “the last one to leave Seattle, please turn out the lights.”

Although you can find many doom and gloom scenarios running rampant within our industry, locally we have been somewhat insulated from the substantial negative impact the “Perfect Storm” scenario has created. Prior to September 11 th , the Pacific Northwest was having another year of positive growth. Perhaps not the double-digit growth experienced in the past, but positive growth in RevPAR nonetheless. Profitability continued to rise, for the most part, and tourism dollars continued to poor in. The events of September 11 th will no doubt change that forever, however it is yet to be seen just what impact those events will have over the long term.

As we complete 2001 the future is still difficult to predict. The effects of a slowing U.S. economy are compounded by the continuing war on terrorism, which no doubt clouds the industries prospects for recovery in 2002. The Northwest economy, although slightly more resilient than the national economy, continues to feel the affects of the “Perfect Storm”. Nationally, expectations are that there will be little or no rate growth in 2002, as well as a drop in average occupancy.

Unfortunately, it seems that the Northwest markets will not go unscathed. Due to our reliance on, and concentration of, aerospace, technology and dotcom industries, recovery locally is not expected to occur until the fourth quarter of 2002. In fact, it is predicted that hotel performance (RevPAR & Profitability Percentages) will not return to 2000 levels until 2004.  According to Ernst & Young, Smith Travel Research and PKF, 2001 ended the decade long streak of increasing revenues and profits while 2002 marks the beginning of a slow and cautious turnaround.

Transactions

During the fourth quarter of 2001, there were eight significant transactions in Washington State, six of which sold for over $2 million. Fourth quarter trades represent single-asset and portfolio sales ranging in size from 35 to 404 rooms. The largest single asset sale for the fourth quarter was the Tacoma Express Inn for $3.7 million, or $26,000 per unit. This was the first significant trustee sale executed through a lender in 2001. It is expected that defaults in 2002 and 2003 will rise, however not to the same levels seen during the lender Real Estate Owned (REO) period of the early 1990’s.

Since the Westcoast Acquisition of the Red Lion chain from Hilton Hotels did not close until January 2, 2002, the largest portfolio sale for the quarter was the three-property Homestead Village trade for $18 million or roughly $45,000 per unit. This was not considered an arms-length transaction, but does represent current market value. The sale of the Skamania Lodge in Stevenson for $41 million, or $210,256 per unit in March continues to top single-asset sales for 2001. As of year-end 2001, 24 significant hotel trades closed at an aggregate value of approximately $148 million or $61,000 per unit, compared with 20 transactions valued at $108 million or $54,500 per unit, during the same period in 2000. Adjusting for the sale of the Skamania Lodge, 2001-trade volume represents approximately $107 million or $48,000 per unit. Year-end comparisons indicate the 2001 total sales volume, without the Skamania Lodge, was slightly lower than 2000, although the number of transactions is higher by 17%. As a result, 2001 experienced a decrease in value per unit of approximately $6,500 or 12% over 2000.

As economic conditions continued to worsen during the fourth quarter, occupancy declined in most markets in the Pacific Northwest. According to PKF, statewide occupancy declined 6.5% from 67.5% in 2000 to 63.1% in 2001. In fact, there was not a single market last year that PKF tracks in Washington, Oregon and Idaho that experienced positive occupancy growth compared to 2000.  

Occupancy for the Seattle CBD in 2001 was 70.0% vs. 73.8% during the same period in 2000. Statewide ADR remained, as expected, relatively flat. ADR dropped less than one percent from $99.71 in 2000 to $99.21 in 2001. As of year-end 2001 statewide RevPAR experienced a decline of $4.07 or 7%, compared to the previous year. Oregon experienced similar results, with RevPAR declining at an overall rate of 7.1% in 2001, compared to 2000. Idaho posted the only positive note in the region with the city of Boise increasing RevPAR by 2.5% over 2000 levels.  

It is difficult at best to predict the impact of the events of September 11 th and the continued war on terrorism. To date we have been fortunate that additional attacks on North America have not occurred. The greatest impact to date on the industry has been on property valuations. It is estimated that the events of 2001 had a negative impact on property value of 15-20%. Although this number seems high, the valuation discount experienced during the REO period of the early 1990’s was over 30%. The good news is that defaults and foreclosures are not happening at a substantial pace. Fortunately most lenders during the 1990’s tightened lending parameters by eliminating highly levered properties through lower LTV’s and thus circumventing the high default rate experienced in the early 1990’s. Most industry analysts anticipate that in the next 12 months the hotel industry will begin to reach normalization, primarily through stable travel patterns and increased spending on corporate and leisure travel.

Since the revenue side of the equation has had such a negative impact on value, operators continue to focus on the expense side of the operation to squeeze additional value out of operations. Cost containment, primarily through controlling labor continues to be the number one priority, as is controlling energy and utility expenses. Although most expect the first half of 2002 to show little if any sign of recovery, the good news is that new supply nationally and regionally is non-existent. Analysts continue to predict that new supply nationally will fall well below historic levels, primarily due to the lack of available debt in the market and the continued lack of Wall Street interest in the hospitality sector. Coupled with low inflation, low interest rates and an expected rebound in the stock market the national and regional economic outlook remains fairly positive.

As we move through the first part of the millennium we are faced with a challenge in our industry unfamiliar in recent history. With demand at all time lows it continues to be essential for operators to control costs while continuing to offer unparalleled customer service. Embracing new technologies, rethinking customer service and market strategies and re-engineering day-to-day
operations will allow us to prevail through this current downturn. Although we continue to find ourselves in a period of uncertainty, our industry is far better off today than decades before. Industry profitability continues to be at or near $20 Billion compared to negative profitability in the early 1990’s. Ten years has created a stronger, more resilient industry and one that will survive and continue to prosper for the foreseeable future.

Real Estate Exchanges Build Wealth
By Dennis P. Helmick

Exchanges under Section 1031 are the last tax shelter for real estate investors. A real estate exchange can deprive the tax man of what he wants most, a chunk of your wealth.

The Section 1031 Exchange lets you sell your investment property and reinvest in new investment property without paying any capital gains tax. Those dollars are reinvested intact without tax and can produce a dramatic increase in your wealth.

Any kind of investment property can be purchased to replace the investment property you sell.

As long as you buy new property of equal or greater value and reinvest all of your old property equity, there will be no tax to pay on the sale of your old property. The postponed tax works like an interest free loan from Uncle Sam. That gain will eventually be taxed if you sell, rather than exchange, the new property in the future. But in the meantime, those postponed tax dollars are compounding the growth of your real estate wealth.

If you don’t match value or equity, you pay tax on the difference. You could pay some tax by trading down or pocketing some cash.

You will need the assistance of an exchange facilitator company to handle the exchange. All of the exchange documents must be in place before the old property sale closes. The facilitator company must hold the money during the exchange. The facilitator company you select should be bonded for theft losses and insured for mistakes. At the end of the exchange, you should get the interest earned on the money that the facilitator company was holding.

There are two deadlines to meet: The 45 Day Identification and Designation Deadline and the 180 Day Closing Deadline. Both deadlines start on the closing of the old property.

The 45 Day Identification and Designation Deadline requires that you list your potential property purchases with your facilitator company within 45 days of the closing date of the old property. It is advisable to list more than one potential property in case your first choice doesn’t close. It is safest to list no more than 3 potential properties.

The 180 Day Closing Deadline requires you to close the purchase on your new property the earlier of 180 days from the sale closing of your old property or the due date of your tax return for the year of sale.

The facilitator company you select should assist you to meet the deadlines in the IRS rules.

It is best to contact a facilitator company early in the process to achieve your goal of a tax-deferred exchange.

The IRS 1031 rules provide a “Safe Harbor” for facilitator-assisted exchanges. These exchanges are a dynamic way to increase your real estate wealth.

Dennis P. Helmick is House Counsel and President of Exchange Facilitator Corporation, the first facilitator corporation in Washington State. His company has successfully completed over 5,000 exchanges throughout the United States.