Despite the fact that a new study conducted by the American Hotel & Motel Association (AH&MA) and PriceWaterhouseCoopers reveals that hotel-industry mortgage default rates have fallen steeply since 1992 - and remained at historically low levels since 1996 - market observers say that the troubled sector is certainly not out of the woods yet.

"I don't think you can make a sweeping generalization saying that the pressure is gone in the hotel sector," said Peter Kozel, a director at Standard and Poor's Ratings Services. "There have been recent defaults and there has been a lot of supply growth. But more importantly, it differs from region to region."

Although defaults have inched up slightly over the past two years, they have remained under two percent and are generally in line with other real estate products since 1995, according to the study.

Other findings in the study indicate that interest coverage for lodging properties has improved markedly since 1987 and is expected to stabilize over the next two years, financing through conduits has become the dominant form of lending for hotels, and hotels have not been as risky as other property types since the onset of the commercial mortgage-backed securities market.

Still, some recent larger hotel defaults points to the fact that weakness still exists within the sector.

"As far as delinquencies go, there have been some pools affecting our recent ratings and downgrades," added Jim Palmisano, an S&P analyst. "The underwriting standards are very stringent on these things, mainly because the hotel sector reacts to changing economies very quickly, so we always conservatively underwrite them; we hold them to a high standard."

It is this very factor of stringent underwriting that leads the recent study to conclude that the lodging industry is conservatively leveraged. Other factors contributing to this are strong earnings growth and the advent of low-leverage hotel real estate investment trusts. The Lodging Industry Mortgage Report - which reviews the industry's debt service, the life cycle debt requirements, and permanent mortgage providers - was commissioned to provide the first comprehensive picture of the hospitality industry's use of financial leverage.

The report, which was commissioned by Joel Ross, a partner at Citadel Realty, a New York real estate investment banking boutique, seems to bear out the theory that hotel loans are a much safer bet then they were 10 years ago.

But S&P's Kozel sees the situation as slightly more complicated than that.

"Clearly some markets in the south and southwest still seem overbuilt based on RevPAR (revenue per available room) and based on supply-demand numbers, and there have been some moderations in the pace of development," Kozel noted. "But you have to look at it more carefully. In places like Boston, San Francisco and New York, things seem to be very strong. There is still lots of supply coming, but in those places, the supply is being matched by demand, so there is less risk there."

Therefore, in places like Boston, there has been astronomical growth rates, and demand even exceeds supply.

But in those markets where there is a clear oversupply, then, there has been a moderation in the pace of development, which seems to be a good thing for the market. But whether that takes the pressure off the market ultimately depends upon the economy.

"As the economy expands at a good clip and corporate America doesn't get nervous and slash travel budgets, and there's no collapse in consumer confidence, then those markets will hold together," Kozel said. "There will be credit problems like there have been. But if there's a massive collapse in any of those factors, clearly those markets will be pretty vulnerable."

Still, people like Ross believe that the capital markets have let the troubles of previous real estate cycles bias their opinions of the hotel sector in the present day. Additionally, rating agencies also appear to consider hotels to be a dicey sector, requiring conduits to use much higher subordination levels for hotel loans than for those secured by other property types.

Nonetheless, according to the study, the default rate for the lodging industry is way down: about 1.5% last year, compared with 16% in 1992.

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