Mr. Brewer III

Hospitality Law

Proceed with Caution: If Condo Hotel Market Cools, Litigation Could Heat Up

By William A. Brewer III, Co-Founding & Co-Managing Partner, Bickel & Brewer

Beyond the Big Apple

In August 2004, Elad Properties Ad Group Ltd. bought the Plaza Hotel for $675 million, a staggering $838,000 per room. Elad, a U.S.-based subsidiary of an Israeli company, is in the business of luxury condominium development, so it was no surprise that the company would plan to convert the Plaza.

In fact, condo hotels have attracted so much attention that the New York City Council recently introduced a bill to prevent hotel owners from converting more than 20 percent of a given hotel to condominium apartments. Meanwhile, extensive condo hotel development is happening all across the country. There are many companies providing hotel condo space in major markets throughout the United States. In fact, it was recently reported that more than 11 percent of all current hotel projects are condo hotels. At the end of first quarter 2005, there were more than 100 condo hotels moving through the industry's development pipeline.

What's behind this hot new market? For condo hotel developers, the answer is simple - a quick return on their investment. Capital is gained from the sale of condominium units, which often sell at prices that command attractive premiums when compared to traditional condominium residences. Due to this structure, these projects are advantageous in that they limit the amount of debt developers typically hold. For unit buyers, condo hotels can represent attractive real estate investments with attendant benefits that come with ownership. Demand is driven by the fact that most condo hotel properties tend to be upscale, such as the Fontainebleau Hotel in Miami Beach, Florida and the MGM Mirage in Las Vegas.

The Good

Of course, the key to success of a condo hotel project is the hotel component. The hotel operation must be efficient, attractive and profitable for the concept to work. The good news for many major developers is that this business model is relatively easy to identify, based on past experience and a good understanding of the local market.

The bad news is there is no shortage of potential issues that face condo hotel developers, operators and owners. A condo hotel project may be developed in a variety of configurations. For example, an existing hotel may be converted entirely to condominiums or only a certain percentage of the property might be converted. For resort properties, the configuration may include buildings that are solely dedicated to condominiums, with companion buildings that operate solely as a hotel.

An important consideration for the operator is available inventory. This will impact decisions on the configuration of the property and whether unit owners will participate in the hotel pool voluntarily or through a mandatory commitment. The potential permutations will impact hotel marketing, group bookings and ultimately the success or failure of the project.

The Bad

Of great concern to condo hotel developers are legal and regulatory issues. Under existing Securities & Exchange Commission ("SEC") rules, the sale of condominium units potentially can be classified as investment securities. If the units are marketed by the developer and its brokers for their investment appeal and rental pool arrangements, what would otherwise be a real estate transaction morphs into a security subject to SEC and state securities rules and regulations. Naturally, great care must be exercised to avoid forecasting investment returns to the buyers. The process of marketing units must be carefully managed and controlled to avoid the risk that buyers, in the next market turndown, will seek rescission of the sales contract or challenge the nature of the transaction as being a security.

The Ugly

There is more to consider than just securities issues. Given the hybrid structure involved in a condo hotel project, the structure may actually compound the legal risks for developers - especially those associated with chain brand management companies. Therefore, the potential legal issues normally related to individual condominium and hotel operations must be considered in tandem. For example, territorial exclusivity provisions in hotel management contracts should be evaluated to determine if the condo component of the property has any effect on the rights and obligations pertaining to any of the involved parties.

Another point of consideration will be the interests of the hotel manager and those of the condo unit owner; these interests will not always be shared. For example, responsibilities relating to common areas and their associated costs must be clearly defined. Unless these types of issues are well thought out and their remedies are clearly set forth, developers and operators face exposure to the effects of a down cycle.

The industry's key players should remember that any negative financial impact on hotel condo unit owners will likely spur litigation. It is imperative that all recall the lessons learned in the 90's regarding discharging fiduciary responsibilities. It is only in that way that returns will be in line with the risks.

William A. Brewer III is co-founding and co-managing partner of Bickel & Brewer, with offices in Dallas and New York. Under Mr. Brewer's direction, Bickel & Brewer has become renowned for its innovative handling of disputes within the hospitality industry. For the past decade, Bickel & Brewer has represented hotel franchisors, management companies, owners, developers and investors in the highest profile litigation in the hospitality industry. He is a member of various philanthropic organizations, including the New York City Partnership and the Board of Trustees of Albany Law School. Mr. Brewer III can be contacted at 214-653-4811 or wab@bickelbrewer.com Extended Bio...

HotelExecutive.com retains the copyright to the articles published in the Hotel Business Review. Articles cannot be republished without prior written consent by HotelExecutive.com.