Another restabilized San Diego County megaresort that was recapitalized this year, after previously changing hands via distress-related transactions, is the historic 757-room Hotel del Coronado.

Despite some lingering—and high-profile—distress situations, the U.S. resort market is reviving. Through August, U.S. resorts had sold more room-nights (25.9 million) than they had during the same period in 2008 and were running only slightly behind the 2007 peak of 26.3 million. In the luxury resort segment specifically, STR is projecting room demand to increase by another 3.5 percent in 2014. And, STR projects that the sector’s key benchmark, revenue per available room (RevPAR), is on track this year to pass its 2007 peak.

Markets featuring Disney theme parks, as well as the highest-profile destinations such as Waikiki Beach, have for the most part experienced the strongest rebounds to prerecession activity levels and beyond, says Matt Comfort, managing director of Jones Lang LaSalle’s Hotels & Hospitality Group.

Related: How the Government of Singapore Acquired Control of Four Historic U.S. Resorts

Investors and lenders active in the lodging sector generally consider the supply-restricted resort market more compelling over the longer term than the limited-service hotel sector in particular, Comfort says. While new destination-resort developments tend to be few and far between, developers can ramp up the supply of limited-service properties “quickly and cheaply” when capital flows freely, he notes.

However, three years into the recovery of the destination resort sector in the United States, the wayside remains littered with casualties from the previous boom-and-bust cycle. The primary culprit: the crushing debt that so many owners and buyers took on as the market was peaking—before it crashed hard during the Great Recession.

Overly optimistic investors tapped free-flowing debt to pay high prices for top-tier resorts, especially during the 2006–2007 bubble years. Even some of those with the deepest pockets ended up relinquishing title to creditors as the recession caused guest revenues to plummet.

As early as 2009, lenders were taking back and selling off beachfront playgrounds from Hawaii to Florida—along with plenty of popular ski lodges and casinos in between.

The resort distress ranged so far and wide that a significant chunk of the nation’s inventory has continued to undergo stressful recapitalizations, even as demand for luxury-class accommodations has recovered over the past few years.

Due to the dramatic swings in that demand over the course of an exceptionally steep economic cycle, destination resorts were hit disproportionately hard compared with other income-property categories that witnessed comparably aggressive lending and investing during the bubble era, says mortgage performance specialist Joe McBride, a research analyst with New York City–based commercial property analytics firm Trepp LLC.

“Large resorts were not as insulated from the recession as, say, multifamily or office properties,” McBride says. And as happens regularly after property bubbles burst, specialty private-equity opportunists have looked to profitably pick up the pieces as distressed owners have been forced to hand over keys.

Investment funds managed by Blackstone Group, KSL Capital, and similar firms have regularly snapped up struggling resorts “at significant discounts to outstanding debt balances and replacement costs,” often by purchasing distressed debt at marked-to-market pricing, notes Comfort. When financially strapped borrowers strive to stave off foreclosure actions, he notes, “these opportunists are well prepared for litigation.”

Values below Peak

As several recent transactions illustrate, however, routes to distressed-debt resolution these days are anything but homogeneous—in many cases reflecting that resort values generally remain far below their prerecession peaks, even this far into the recovery. The sector is still seeing some fresh foreclosure actions and challenging recapitalizations of still-struggling properties.

As Comfort explains, value recovery among resorts lags the general hotel sector rebound in part because conferences and other group travel upon which big resort properties rely have not bounced back to the extent seen with general leisure tourism. That valuation lag remains despite the fact that resort bookings and room rates have largely recovered to prerecession levels—as is the case with the domestic lodging sector generally. Indeed, the RevPAR metric averaged $131.60 among U.S. resorts through August of this year, just below the peak of $132.37 recorded during the comparable period in 2007, according to hotel research firm STR.

That is an impressive rebound over the cyclical low of $103.68 for those same months in 2009, when conferences and vacations had become luxuries few could still afford. By the 2010 summer travel season, roughly one in five securitized loans for hotels had become delinquent—well over twice the rate seen with commercial mortgages generally, according to Trepp’s data.

Given the lagging prices that buyers are willing to pay for destination resorts, many owners continue to grapple with the segment’s distressed-debt hangover, which stems primarily from the aggressive mortgages funded through Wall Street’s capital-markets conduits in 2006 and 2007. Despite the ongoing recovery in the hospitality sector, Trepp calculates that well over $5 billion in hotel mortgages are still delinquent—the vast bulk of them originated during those two years.

After the Workout Attempts

One lingering consequence is that some overleveraged ownership groups are just now ceding ownership to debt-holders after years of workout efforts. And that’s occasionally the case even in the stronger markets like Florida, where visits to beaches and theme parks have rebounded robustly.

For example, the experienced and well-capitalized owners of the landmark Hilton Daytona Beach Resort conceded in September that the $90 million–plus securitized loan financing their $142 million bubble-era acquisition remained too burdensome. Affiliates of Pyramid Advisors and GE Asset Management handed the resort back to debt-holder agents, who this fall were interviewing prospective sales brokers.

And even though the strategically located oceanfront property is outperforming the Daytona Beach marketplace generally, it is not expected to fetch much more than maybe half its 2007 appraised value of $150 million, according to Commercial Real Estate Direct reports.

In some cases, deep-pocketed players have been able to placate creditors and retain ownership during the toughest times and are now recapitalizing as the market recovers. These owners presumably infused additional equity into their resorts’ capital stacks, although they typically manage to keep such details confidential.

The Influence of Low Interest

As McBride points out, lenders are often willing to modify or otherwise restructure financings of higher-profile resorts if the owners have the financial resources and operational wherewithal to see properties through to recovery. He also notes that today’s prevailing low-interest-rate environment helps to pencil out debt restructurings “that may not have been available in previous years.”

Comfort concurs, adding that creditors realize that such properties tend to have solid longer-term upsides, given that high development costs limit the development of new competing resorts.

Consider one example: in July, computer mogul Michael Dell and partners secured $225 million in new floating-rate debt from Starwood Property Trust to help pay off their long-overdue mortgage secured by the sprawling Four Seasons Resort Hualalai on the island of Hawaii. The property’s appraisal last year still came in nearly 30 percent below the $503.6 million that Dell’s MSD Capital and Rockpoint Group paid for Hualalai in 2006—suggesting that the partners had to come up with more cash to satisfy holders of the nearly $325 million in original mortgage debt.

Improving liquidity—along with additional cash from the owner—likewise helped high-profile commercial and residential developer Sam Grossman hold onto the 640-unit Arizona Grand Resort & Spa in hard-hit Phoenix. The resort was purchased for $206 million during the bubble years.

Three years after Grossman interests negotiated a senior/junior “bifurcation” of their $190 million first mortgage, another recapitalization of the property (originally known as Pointe South Mountain Resort) was completed this past June—essentially wiping out holders of the junior debt. As research from Barclays Capital indicates, the fresh financing includes $67.3 million in senior debt from Prime Group’s Prime Finance unit and a $20.7 million mezzanine loan from Marathon Asset Management—along with unspecified new cash equity from Grossman’s team.

Veteran hospitality financial adviser Donald Wise suggests that financially strapped resort owners look to maximize revenues by supplementing traditional resort marketing strategies with social media communication targeting generation X and the millennials.

“Savvy capital players and managers who have picked management companies in tune with these dynamics” have the best chance of staving off “the foreclosure gods,” as the cofounder of Newport Beach, California–based Turnbull Capital Group puts it.

In other high-profile instances, properties returned to financial stability after foreclosures are being sold to new owner-operators optimistic about the resort sector’s upside. A noteworthy example is the famed 611-unit La Costa Resort and Spa in Carlsbad, California, which was acquired in June by Omni Hotels & Resorts as part of a five-property portfolio purchase.

La Costa’s seller was an investment fund managed by KSL Capital Partners, which took control of the property from Goldman Sachs real estate affiliate Whitehall Street in 2010 after purchasing some $380 million in mortgage debt at a deeply discounted price that reports have pegged at about $120 million. The Whitehall-managed group that relinquished the resort to KSL had secured the debt to finance its $400 million purchase of La Costa in 2007.

Another restabilized San Diego County megaresort that was recapitalized this year, after previously changing hands via distress-related transactions, is the historic 757-room Hotel del Coronado. The hotel’s previous restructuring came in 2011, when an affiliate of private-equity giant Kohlberg Kravis Roberts (KKR) saw its stake in the property reduced from 41 percent to less than 5 percent, and Strategic Hotels & Resorts’ stake diluted from 45 percent to 34.3 percent.

At that time, an affiliate of rival private-equity player Blackstone Group’s big real estate investment operation took majority control of the resort along Coronado Bay by converting $20 million in mezzanine financing into equity, and infusing another $100 million cash. Strategic Hotels & Resorts had become KKR’s primary partner in the venerable Hotel del Coronado, which had 679 rooms at the time, in a 2006 transaction valuing the property at $745 million.

Later that year, it would be encumbered with more than $620 million in mortgage debt. The amount of new debt that was secured last March from JPMorgan Chase Bank and Deutsche Bank was a more manageable $475 million, floating at 365 basis points over the LIBOR index.

Fighting for Control

Predictably in yet other cases, distressed owners have fought foreclosure actions through bankruptcy filings and other litigation. Indeed, the resort sector has witnessed no shortage of messy legal battles, often pitting various classes of creditors against each other as well as against debtor parties.

Perhaps the most noteworthy example is the $1.5 billion deal that closed earlier this year (see sidebar on page 60) giving Singapore’s sovereign wealth fund control of four well-known resorts that were subject to years of distress-related legal actions: Grand Wailea Resort Hotel and Spa in Hawaii; the La Quinta Resort and Club and PGA West golf course in southern California; the Arizona Biltmore Resort and Spa in Phoenix; and the Claremont Resort & Spa in northern California.

Meanwhile, the fates of other resorts still facing financial distress related to bubble-era transactions remain unknown. Permanent control of properties such as Carlsbad, California’s 329-room Park Hyatt Aviara Resort, and the 548-room JW Marriott Las Vegas Resort & Spa, is yet to be determined.

Aviara’s $186.5 million (original principal) loan was the largest securitized mortgage entering special servicing during the first half of 2013—the second time it was transferred to special servicing since having been pooled into a 2007 mortgage securitization. Time will tell whether owners Maritz Wolf & Co. and Broadreach Capital Partners can negotiate another modification allowing them to hang on as owners.

Likewise, the JW Marriott’s owners and creditors have battled for control of a property that is likely worth maybe one-third of its nearly $325 million appraisal in 2007—the year its long-delinquent $150 million senior mortgage was securitized.

While resolution routes vary, one common thread running through nearly all the remaining resort distress is Wall Street’s massive commercial mortgage securitization machine, which peaked to the tune of some $230 billion of commercial mortgage–backed securities (CMBS) issuance in 2007. Indeed, those very same former investment banks (Goldman Sachs, JPMorgan Chase, Lehman Brothers, and the like) that securitized all those shaky home loans likewise had a big hand in the resort sector’s severe financial woes.

“High leverage and optimistic expectations colored [mortgage] originations during the bubble era in all sectors of the CMBS market,” McBride says. He is quick to point out that bond-buyer losses related to soured mortgages have been, on average, far higher in the lodging sector than with office- and apartment-backed loans.

And as so many of the featured transactions illustrate, the same banks managed many of the aggressive investment funds that bought into resorts and financed them to the hilt during the peak period—and ended up losing billions during the equity-depleting downturn.

Indeed, according to data that Trepp analyzed for Urban Land, more than 17 percent (by principal balance) of the outstanding hotel mortgages securitized in 2007 were delinquent at the end of August 2013. Combined with outstanding 2006-vintage conduit debt (carrying a delinquency rate of nearly 11 percent), loans securitized during that biennium alone account for 84 percent of the $5.125 billion current balance of distressed lodging loans.

Yes, that is a considerable improvement over the peak hotel distress period in mid-2010, when the mortgage delinquency rate topped out at nearly 20 percent. That factored to nearly $13.5 billion in delinquencies among securitized mortgages—not including distressed hotel loans held by banks, life insurers, and other lenders.

All of this helps explain the distressed-debt hangover continuing to this day—despite the generally encouraging recovery in overall U.S. hotel occupancies and room rates. UL

Brad Berton is a Portland, Oregon–based freelance writer specializing in real estate and development.