Hotel Condominium Resurgence- Is it Smoke and Mirrors?

By Marc Stephen Shuster Partner, Berger Singerman | October 04, 2015

Co-authored by Barry D. Lapides, Partner, Berger Singerman

The crux of the hotel condominium concept is hassle-free ownership-condo owners have both a vacation home when onsite and an investment property that can generate an income stream when not in use by the owners. Hotel condominiums are also attractive to developers, lenders, and investors.

Developing a hotel is expensive especially with respect to rising land costs and the amenities that are required for high-end hotels or hotels that cater to Millennials such as room service, housekeeping, spas, health and fitness centers, fine dining, concierge services and more. Financing the development of a hotel with the use of traditional financing (e.g., low rates and reasonable covenants and restrictions) is still challenging; however, if a developer builds a hotel with a residential component, then that developer can finance the hospitality component from sales of the residential units, essentially outsourcing a sizable share of construction costs before breaking ground.

Developers are also lured to the hotel-condominium-hybrid real estate model because the hotel-amenity element has the capacity to generate anywhere from a 15 to 40 percent premium value over the per-foot sales price of similar units. Investors, especially baby boomers nearing retirement who are or will become enticed with the idea of amenity rich living in premier locations without the hassle of maintenance, will provide developers through condominium presales with the extra "equity" in their capital stack; this equity incentivizes the institutional lenders to provide traditional financing due to the transfer of some of the lending risk off of the institutional lenders and onto the mortgagees of the until owners.

A prudent analysis requires developers, lenders, and investors be mindful of the history of condominium hotels. Under the Securities Act of 1933, "securities" include not only stocks, bonds, and other easily recognizable instruments, but also "investment contracts", which the U.S. Supreme Court has interpreted to mean (1) an investment of money (2) in a common enterprise (3) with the expectation of profits solely (or "substantially") from the efforts of the promoter or third party. Prior to 2013, developers had to be extremely careful in marketing hotel condominium units because if the marketing and sales process was done incorrectly, the units could be considered a "security" thus bringing the Securities and Exchange Commission and its legal requirements into the equation and opening the door to potential liability that could kill a developer's chance of realizing profits.

Essentially, hotel condominium units are securities if they are marketed as such. The idea is pretty narrow-if one focuses on the return on the investment ("ROI"), which typically in the hotel condominium context is a byproduct of the rental program (whereby a developer or an affiliate hotel operator rents the condominium unit out for the owner when the owner is not using it, helping to defray investment and operating costs), the condominium is a security. The buyer is no longer simply purchasing real estate but rather is investing in a business enterprise where the expectation of ROI is tied to the developer or affiliate's managerial efforts. Ignore ROI and focus on selling the unit for ownership purposes so that the unit is not a security.

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The hotel industry has undertaken a long-term effort to build more responsible and socially conscious businesses. What began with small efforts to reduce waste - such as paperless checkouts and refillable soap dispensers - has evolved into an international movement toward implementing sustainable development practices. In addition to establishing themselves as good corporate citizens, adopting eco-friendly practices is sound business for hotels. According to a recent report from Deloitte, 95% of business travelers believe the hotel industry should be undertaking “green” initiatives, and Millennials are twice as likely to support brands with strong management of environmental and social issues. Given these conclusions, hotels are continuing to innovate in the areas of environmental sustainability. For example, one leading hotel chain has designed special elevators that collect kinetic energy from the moving lift and in the process, they have reduced their energy consumption by 50%  over conventional elevators. Also, they installed an advanced air conditioning system which employs a magnetic mechanical system that makes them more energy efficient. Other hotels are installing Intelligent Building Systems which monitor and control temperatures in rooms, common areas and swimming pools, as well as ventilation and cold water systems. Some hotels are installing Electric Vehicle charging stations, planting rooftop gardens, implementing stringent recycling programs, and insisting on the use of biodegradable materials. Another trend is the creation of Green Teams within a hotel's operation that are tasked to implement earth-friendly practices and manage budgets for green projects. Some hotels have even gone so far as to curtail or eliminate room service, believing that keeping the kitchen open 24/7 isn't terribly sustainable. The May issue of the Hotel Business Review will document what some hotels are doing to integrate sustainable practices into their operations and how they are benefiting from them.