San Diego Business Journal

The year 2011 could rightly be called the Year of the Hotel in local commercial real estate circles. Trophy hospitality properties dominated the rankings of the year’s biggest deals based on sale prices, topped by Host Hotels & Resorts Inc.’s $570 million purchase of the Manchester Grand Hyatt.

Hotels, in fact, took seven of the top 10 spots on the San Diego Business Journal’s Top Commercial Real Estate Sales of 2011 list, according to data from CoStar Group. Contrast that with 2010, a year dominated by apartment and life-sciences real estate, when no hotels were to be found among the 25 largest deals.

“This level of activity in San Diego is something we’ve never seen in the 15 years we’ve been tracking these things, and we’ll probably never see anything like it again,” says Alan Reay, president of Irvine-based brokerage and consulting firm Atlas Hospitality Group.

The Right Conditions

Reay said the hotel rush of early 2011 was the result of a rare confluence of three factors: large real estate investment trusts flush with cash and competing to deploy it; a variety of lenders eager to finance purchases at low interest rates; and a high number of trophy hotel owners looking to sell.

Local deals also included Sunstone Hotel Investors Inc.’s purchase of a majority stake in the Hilton San Diego Bayfront for $475 million, and The Blackstone Group’s move to take a $354 million stake in Hotel del Coronado, as part of a larger refinancing of that property’s loans.

Acquisitions tapered off in the second half of 2011, as big REITs ran out of trophies to buy and retreated to the sidelines amid stock market volatility, and prices have since come closer to earth. For the first half, however, the San Diego region was California’s top market for hotel deals, beating out Los Angeles and San Francisco, and was second in the nation only to New York City.

More typical in 2012, Reay predicted, will be acquisitions by smaller private buyers, similar to the recent change in ownership at Estancia La Jolla Hotel & Spa, purchased in late November for $41.7 million. The buyer was Irvine-based Pacific Hospitality Group LLC, primarily a regional player that operates most of the hotels that it owns.

Room for More Deals

Robert Rauch, president of hospitality consulting firm R.A. Rauch & Associates Inc. in San Diego, foresees more deals in the $5 million to $25 million range in 2012, mostly by single investors and small investment firms.

Experts note that loan distress will play a diminishing role in the hotel marketplace, thanks to an improving economic climate and rising property values. Owners with otherwise good payment histories will see flexibility among lenders, willing to adjust terms or extend loan maturities if owners can come up with more equity to refinance.

“The lenders aren’t going to be in a hurry to foreclose,” Rauch said. “They don’t want to be in the hotel operating business.”

In other commercial segments, including office and industrial properties, observers say 2012 will likely be a continuation of trends seen in 2011. High-profile trophy acquisitions in the office category will remain rare, and leasing conditions in most submarkets will favor tenants seeking out the best deals from landlords competing to lure and retain them.

With new office construction at a near standstill, more property owners will be investing in upgrades to remain competitive, said Chris High, associate director in the San Diego office of brokerage firm Cushman & Wakefield.

He said the “flight to quality” trend will continue to be a factor, with life-sciences, high-tech and defense-related tenants continuing to absorb unused space to accommodate growth. Generally, corporate tenants seeking 5,000 square feet or less will have the most locations from which to choose.

“Larger blocks of space are going to be hard to find for some companies,” High said.

Bryce Aberg, a broker in the San Diego office of brokerage firm Cassidy Turley BRE Commercial, said the relatively limited supply of industrial space will continue to be in demand among government and military contractors. Those recently expanding locally, through leases and building purchases, have included Northrop Grumman Corp., Lockheed Martin Corp. and General Atomics.

“Manufacturing hasn’t come back that much, but we’re seeing a lot of those contractors taking manufacturing spaces to use for research and development,” Aberg said.

Even if military budgets get pared down in coming years, brokers said those defense-related firms currently have enough projects on their plates to keep space in demand in 2012 and beyond.