Condo Hotel Boom: Far From Over

By Dan DiTieri

Over the past decade, condominium hotels have become a recognized segment of the hospitality industry, as the concept of “own and rent” became increasingly popular. However, the rapid increase in the number of “condotels” has raised concern about an imbalance of demand and supply and the possibility of a “bust.” However, Rick Davis, of the law firm of Greenberg Traurig, writing in the Hotel Yearbook 2007, takes a very optimistic view of the future of the new hospitality format, particularly those projects aimed not at the investment community but rather at individuals who see a condo hotel unit as a combination of vacation facility and real estate investment that can generate a modest return of rental income from a sponsored rental program.

Historically, contractions in the condo hotel business date back to the first boom in the 1970s and were almost entirely due to the failure to produce investment returns consisting with expectations. In contrast, today’s condo hotel is not aimed at the investment community but rather at a market that values more highly part-time use of the unit along with a share of rental income at least sufficient to offset holding and operating cost. Wealthy baby boomers also see benefits in having bragging rights to participating in a project in a major resort destination.

The modern approach of designing condo hotel projects so that offerings are not deemed securities under federal and state laws, as well as the use of disclaimers that are defenses against future claims of misrepresentations, make it unlikely, if not impracticable, for a project to unwind, says Mr. Davis. Even if a project proves disappointing from a rental revenue point of view, the continued availability of the unit to the owner and the potential of future appreciation remain attractive benefits to the owner.

One trend to watch is the creation of intermediary structures between the condo hotel itself and a new world of purchasers organized by entrepreneurs who see the opportunity to create ownership organizations and “clubs” by rolling up individual units that are purchased directly from the developers. The trend builds on the popularity of fractional condo offerings, destination clubs, and other forms of leisure ownership to attract an even broader demand for resort-type ownership. While some projects impose rules making such “roll-ups” difficult to achieve, many other projects have no objection to them. Alternatively, some developers design projects that include such a fractional program.

Mr. Davis discounts fears of extensive litigation, including class actions, resulting from the failure of rental income to meet owner expectations. He points out that the structuring and documenting of condo hotels over many years, guided by the need to comply with federal and state security laws, renders the likelihood of such actions extremely remote. Most condo hotel offerings are designed to avoid the application of security laws. For example, no representations are made about rental or investment returns, and buyers confirm in writing that no expectation exists of making a profit from a purchase of a unit notwithstanding participation in a rental program in which some amount of income might be derived.

This result is further supported by the fact that in most cases, participation in a rental program sponsored by the developer is voluntary, with the buyer having the option to rent the unit directly or through a real estate agent or not to rent at all (in those cases where local government regulations do not require that a unit be rented or made available to the public).

A significant new trend is the fractionalizing of condo hotels. This is done by offering a purchaser the opportunity to buy less than a full interest in a unit at a significantly lower price but with the same opportunity to participate in a rental program to the extent of a partial interest. Such an interest is a form of time-share or fractional ownership often regulated by statute. Marketing costs for fractional projects generally are higher than for full ownership units because more sales must be made. However, marketing costs have come down in recent years, and in many cases the extra costs are more than offset by the expansion of the available market, particularly in high profile resort destinations.

Once having made the decision to construct or convert and existing hotel to a condo-hotel, the developer must make a number of choices in addition to those mentioned above. These depend in part on whether the hotel will be 100 percent condo units (in which case it is a “hotel” only in the sense that the owner units are available to guests for a portion of the year) or will consist partly condo units and partly rooms solely for guests.

In some cases, local zoning laws may require the hotel to be partly hotel rooms so that more visitors will come to the area and so benefit local business and also because transient occupancy taxes (TOTs) often are an important source of municipal income. Another consideration for the developer is whether the location attracts a sufficient number of tourists to justify additional hotel rooms. If the decision is to have regular hotel rooms, the developer has a choice of several options with regard to the “hotel” part of the facility. The developer can retain ownership of the hotel, creating a long-term income stream, or sell the property for an immediate profit. If the developer retains ownership, a hotel management company is likely to be hired; this will require detailed negotiations with respect to fees as well as operating procedures.

Another significant issue relates to the common areas utilized by the condo units. Most often, the space is owned by a homeowners association (HOA). Many states have passed legislation governing HOAs and a developer must be careful to abide by the rules set forth.

Dan DiTieri is a senior manager in the Real Estate Practice in BDO Seidman’s New York office. He can be reached at (212) 885-8378.

The Hotel Yearbook 2007 is published by Wade and Company of Switzerland (yearbook@wadeandco.com).

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