Just in time for back to school, new swine flu fears have suddenly returned. And like the lingering infection itself, the H1N1 virus is one that just won't seem to go away.

In fact, according to a 68-page report released on Monday, about half of all Americans can look forward to a brush with the swine flu this winter, while 1.8 million will likely end up with a trip to the hospital from exposure.

That's the good news.

The bad news is that the new strain is so virulent that the author of the report, Dr. Harold Varmus, believes 90,000 Americans may eventually die from it.  That's three times the average number of flu deaths experienced each year.

"This flu could be extremely dangerous," Dr. Varmus said ominously. "It needs to be taken seriously."

Swine Flu Investments

As a result, swine flu fears are now running at a fever pitch of their own, with U.S. health officials planning to spend up to $2 billion on flu vaccines this year, purchasing nearly 160 million doses.

But while the fear engendered by the virus has been a big bonus for swine flu investments in pharmaceutical companies like Glaxo-Smith-Kline and Roche, the return of the flu promises to be nothing but a headache for the travel industry — especially hotel REITS.

Because let's face it; even if the swine flu projections fall short of Dr. Varmus's "plausible scenario," consumers aren't exactly going to be eager to jump on a plane full of sniffling strangers or check into a room full of germs from who knows where.

For most would-be travelers, it just won't be worth the risk.

That has the potential to disrupt the entire $770-billion-dollar U.S. travel industry at a time when it can least afford it. And if the SARS outbreak of 2003 is any guide, a swine flu scare may be enough to send parts of this industry into the abyss.

Because by comparison, SARS caused only $18 billion in losses to the industry, as travel to Southeast Asia fell by almost 70%.  Moreover, SARS caused "only" 774 deaths worldwide before rapidly coming to an end just four months later.

Meanwhile, with over 1,000 swine flu deaths already so far, we're only seeing the tip of the iceberg. . . The worst is yet to come, along with the requisite hysteria. 

Swine Flu Means Big Headaches for Hotel Stocks

That puts hotel REITS, like Starwood Hotels (NYSE:HOT) and Marriot International Inc. (NYSE:MAR) on increasingly shaky ground these days, since vacancies are already running well above average.  

In fact, according to Smith Travel Research (STR), occupancy rates for luxury hotels worldwide have dropped to 57 percent this year through July. That's down from 71 percent occupancy just one year earlier. 

Additionally, according to the group, the average daily room rate will drop by 9.7 percent, and revenue per available room (RevPAR) will be down 17.1 percent this year. As for 2010, STR projects further occupancy declines of 0.6 percent, and additional RevPAR declines of 4.0 percent.  Neither metric is exactly encouraging.

In the meantime, things have already gotten so bad in the industry that some hotel owners are walking away from their business entirely, handing the keys back to lender as they default.

In fact, Real Capital Analytics now classifies $18 billion in hotel loans as distressed, meaning they are either delinquent, in foreclosure, in bankruptcy, or have already been restructured. That compares with just $1.3 billion in distressed hotel loans a year ago.

And when you add in the prospect of a swine flu scare into this already toxic mix, it's easy to see why hotel REITs make good short sale candidates these days. 

As for Starwood Hotels and Marriott International, they already have the symptoms that could easily turn into something much more dire.

Swine flu or no swine flu, these stocks are headed for the teens.

Your bargain-hunting analyst,

Steve Christ, Investment Director

The Wealth Advisory

By the way, teetering hotel REITs are just the tip of the iceberg when it comes to commercial real estate these days. 

In fact, Goldman Sachs  recently came out with another bearish report on the sector that actually goes so far as to say REIT valuations are now "bubbly."  

According to the Goldman report:

While the worst of the current US recession appears to have passed, we caution that CRE trends are just starting to soften and will remain weak into 2011; as such, REITs should underperform the broader equity markets during the next stage of the recovery (6-9 months). In fact, we anticipate a decline in FFO of more than 10% for REITs next year, on top of the 15-20% expected decline in 2009.

Hence, 2011 should be the bottom with growth resuming thereafter. Over the next 12-24 months, we see the combination of rising CRE loan defaults, deteriorating fundamentals (similar to the 2001 downturn), and more stringent lending standards (50% LTV loans at higher rates) resulting in a "challenging road ahead" for REITs. (Editor's emphasis)

We believe investors should use the recent rally in shares (+42% since July 13) to reduce exposure to the REIT sector. REIT shares now trade at levels not seen since the "bubble years" in credit from 2004 to 2007, based on a current EV-to-EBITDA multiple of 14.3X, or an implied cap rate at the mid-6.0% level. In our view, the stocks are indicating one of two outcomes: (1) low cap rates are here to stay (similar to Europe and Japan) or (2) growth rates will be significantly higher than we have projected in the near term. We do not see either outcome as likely.

To learn more about how profit from Goldman's bearish call on REITs, click here.