Condominium hotels — lessons learnedImprovement in the <strong>global</strong> secondhomeand overall lodging markets,particularly in gateway and primaryresort destinations, combined withan updated regulatory framework iscausing a resurgence of interest incondominium hotels.Condominium hotels vary in structure andoperation throughout the globe. While inmost locations th<strong>ey</strong> physically resemble acondominium development, offering largeunits with kitchen facilities and little publicspace b<strong>ey</strong>ond a reception area, in otherlocations the asset resembles a typicaltransient lodging operation. This lattermodel became popular during the last realestate upcycle in the 2000s, particularlyin the US. In this model, the ownershipstructure is divided between a hotel lotowner, who owns the building’s publicspaces and ancillary revenue-generatingfacilities, and individual unit owners, who,if participating in an available rentalprogram, share in the revenues andexpenses associated with the rental of theirunits as transient lodging accommodations.This kind of condominium hotel features thepublic space, amenities and level of finishesconsistent with a hotel operated by theaffiliated brand.Regardless of the physical appearance oroperating structure, condominium hotels areoften considered attractive to developers,lodging operators and unit owners alike.In markets where traditional constructionlending was limited, the presale of units hadallowed developers to obtain constructionfinancing, aligning themselves with ahotel operator to gain pricing premiumson unit sales. Lodging operators benefitedfrom new inventory under managementand potentially earning a licensing fee onthe sale of the units. Unit owners oftenpurchased units assuming that values wouldcontinue to appreciate and that the incomegenerated from their revenue split wouldcover their costs of ownership.With the <strong>global</strong> economic decline, however,many condominium hotels, particularlythose located in the US, have facedlitigation, restructuring or bankruptcy,mostly due to issues surrounding control,income allocation and securities issues. Atthe core of the complexity has been theapplicability of securities laws to the offeringof condominium hotel units.The US Securities and Exchange Commission(SEC), in a 1973 release (SEC Release 33-5347) and in subsequent no-action letters,has addressed the issue of when the saleof condominium units constitutes the saleof a “security.” In brief, the SEC’s guidanceprohibits (a) the pooling of income, (b)emphasis of the investment aspects of thecondominium and (c) restrictions on useof the condominium (such as a mandatoryrental program). This issue affected projectstargeting both US buyers, a major sourceof <strong>global</strong> investment in second-home realestate, and international buyers, who,familiar with the concept back home, facedadditional complexity and risk.Global <strong>hospitality</strong> <strong>insights</strong>18
Most developers sought to avoid the costly and impracticalregistration process and set up procedures to avoid having toregister, or targeted non-US buyers, who were except from suchregulations. Th<strong>ey</strong> offered optional rental programs, avoidedsharing or discussing any information related to the economics andseparated the rental program and purchasing decisions. Incomeand expenses were individually allocated to unit owners whose unitparticipated in the rental program. This complexity was furtherexacerbated by the deal being put together prior to unit ownersbeing involved. For example, revenue and expense allocations mayhave made sense to the operator and developer but often did not sitwell with unit owners, who ended up sometimes facing higher thananticipated maintenance fees and capital expenditure requirementswith lower than expected revenue.The impact of avoiding SEC registration produced relativelyuninformed purchase decisions by the primary contributor ofcapital to the project, the unit purchaser. Buyers, not having beenprovided forward-looking income estimates, often overestimatedoccupancy and rate assumptions. Further, by splitting revenue, thehotel operation often struggled. Given the high prices paid for highlyamenitized units during this era, the revenue that a given unit couldproduce often calculated negative returns. Unit owners blamed thehotel brands and the developer for lack of financial returns despiteoften being in markets in which hotel performance may not havebeen feasible given the prices paid per unit.Given that the rental program participation could not be mandated,owners frequently rented their units outside the hotel operator’svoluntary program, with the unit guest unable to access thehotel operator’s services and amenities. Operators, strugglingwith managing inventory around owner usage and varying rentalprogram participation, also were required to address frequent unitowner calls for explanations, accounting for each unit’s income andexpenses separately, and carefully balancing rotation of units amongdeveloper and unit owner inventory.These issues, combined with a complex set of agreements that oftenwere unclear or inconsistent with the structure, led some projects tofail. And the <strong>global</strong> economic downturn exacerbated the situation.Recently, in the US, the Jumpstart Our Business Startups (JOBS)Act contained provisions that are being applied to condominiumhotels and serve to bring the structure more closely aligned withother <strong>global</strong> markets. This, and a resurgent <strong>global</strong> economy andreal estate market, may give new hope to branded condominiumhotels. In the JOBS Act, the new Rule 506(c) allows for greatergeneral solicitation and advertising as long as buyers are accreditedinvestors.If a condominium hotel is under the new rule, a developer couldthen pool revenues and expenses, mandate participation in a rentalpool and provide greater information that may emphasize economicbenefits. These new provisions serve to provide more information tothe buyer.While many questions remain regarding compliance with rulesconcerning securities sales, many <strong>global</strong>ly recognized lodgingoperators are weighing the pros and cons of managing condominiumhotels and/or have developed procedures to control risk (requiringa certain percentage of units to be dedicated hotel inventory, forexample).In the right markets, condominium hotels can be mutually beneficialfor all parties when interests are aligned and the details are carefullythought through, disclosed and documented.Top thoughts for <strong>2015</strong>19
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