Starwood-Led Group Raises the Extended Stay Stakes By Lingling Wei and Kris Hudson Wall Street Journal 09-30-2009

Starwood-Led Group Raises the Extended Stay Stakes By Lingling Wei and Kris Hudson Wall Street Journal 09-30-2009

Starwood-Led Group Raises the Extended Stay Stakes
By Lingling Wei and Kris Hudson
The Wall Street Journal
September 30, 2009

In an escalating battle over the largest U.S. hotel bankruptcy, a group of creditors led by Starwood Capital Group is trying to wrest control of the bankruptcy of Extended Stay Inc., people familiar with the matter said.

The investor group -- including Fortress Investment Group LLC, D.E. Shaw Group and Five Mile Capital Partners LLC -- is proposing to buy Extended Stay's $4.1 billion first mortgage, which was carved up into commercial-mortgage-backed securities, or CMBS, for $3.5 billion, these people say. The offer calls for the group to put in more than $700 million in new equity and most of the existing bondholders to continue holding their debt, known in financial circles as "rolling" their positions.

Extended Stay properties would have a higher valuation under the Starwood-led proposal.
.The investors in the Starwood group are existing creditors in Extended Stay, with varying degrees of seniority, and are at risk of taking big losses under a reorganization plan proposed by the company.

By buying the first mortgage, the group would position itself to file a rival plan that could allow them and other creditors to recover more of their initial investments, the people with knowledge of the matter said.

The deal would need approval of the special servicer who oversees the bonds and any reorganization plan would need the blessing of the bankruptcy court. It also hinges on the willingness of bondholders to extend their positions.

In addition, when a company goes into bankruptcy, only the company itself has the right to propose a reorganization plan with the court during the "exclusivity" period, which usually can be extended for up to 18 months following the bankruptcy filing. So in this case, the investor group would still need to work with Extended Stay for an eventual restructuring plan, legal specialists say.

Representatives for the four firms and Extended Stay declined to comment.

The move by the creditors is another sign that savvy investors are looking to swoop in on distressed commercial properties as the capital markets begin to ease for big corporate and private borrowers. Starwood Capital, led by real-estate investor Barry Sternlicht, has closed a $2 billion private-equity fund to buy distressed hotel assets and recently launched a real-estate investment trust to invest in commercial-property debt by raising $950 million in new capital.

Commercial real estate increasingly is being targeted by opportunistic buyers even though the industry is still reeling from rising delinquencies, declining values and other stresses. For months, there was little activity because banks and other financial institutions holding assets were reluctant to sell.

But now some major distressed assets are coming to market just as financing is beginning to become available. For example, the Federal Deposit Insurance Corp. has received about 10 bids for the real-estate assets of the failed Corus Bank, one of the largest condominium lenders in the country, according to people familiar with the matter. The FDIC is expected to pick a winner in early October.

The Extended Stay chain, which has 680 properties catering to budget-conscious travelers, is being viewed as a major prize. It was acquired in 2007 by real-estate investor David Lichtenstein at the peak of the market in a highly leveraged $8 billion transaction. Besides the $4.1 billion first mortgage, the deal was funded with a $3 billion mezzanine, or junior, loan, which also was carved up into slices with different levels of risk and return.

The company filed for bankruptcy projection in June and proposed a plan that was supported by a small group of creditors including Cerberus Capital Management LP and Centerbridge Partners LP. That plan would enable senior CMBS creditors to get their money back, but would wipe out $4.8 billion in debt, hurting the majority of the existing creditors.

The Starwood-led deal is an effort by those creditors to strike back. Their $3.5 billion offer for the first mortgage may gain traction because it puts a higher value on Extended Stay than others that have emerged during the process. Upon its bankruptcy filing, the company estimated its value at $3.3 billion. An appraisal commissioned by the special servicer, TriMont Real Estate Advisors, pegged the value at $2.8 billion.

Still, big hurdles remain for the group to pull off its offer. According to a person familiar with the matter, any party making an offer for the mortgage must pay a 10% cash deposit and then close the purchase within 10 days.

Already, the Starwood-led proposal is getting support from some of Extended Stay's largest creditors, including Bank of America Corp., Wells Fargo & Co.'s Wachovia unit -- and the unlikely creditor in this case, the Federal Reserve, according to the people.

The Fed, through a fund called Maiden Lane, wound up holding about $900 million in Extended Stay debt after Bear Stearns's failure. Representatives at the banks and the Fed declined to comment.

The Extended Stay bankruptcy is being closely watched both for its size and because it is putting to the test the CMBS structure, which became a popular form of commercial real-estate financing over the past decade but has never been tested by a major real-estate downturn.

Many of the junior creditors cried foul when Extended Stay filed for bankruptcy protection, charging that the company cut a sweetheart deal with creditors including Cerberus and Centerbridge, at the expense of others.

The bankruptcy court on Monday appointed an independent examiner to delve into, among other things, the pre-Chapter 11 negotiations between Mr. Lichtenstein and some creditors.


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