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CONDO HOTELS – THE HOTTEST TREND IN HOTEL FINANCE By: Francis J. Nardozza, Chairman, REH Capital Partners, LLC "The Hotel Journal", May, 2005 Following the catastrophic events of September 11, 2001 and the ensuing US economic recession, sources of funding for new hotel construction, particularly luxury hotels was for the most part non-existent and most new hotel developments just simply didn’t pencil out under traditional hotel financing concepts. As history dictates, and what always seems to hold true, hotel developers will always find ways to develop, no matter what the circumstances or challenges. This time around, the solution was through the rebirth of the condo-hotel concept.
What is a condo-hotel and how does it differ from a residential condominium?
First off to dispel current notions, the condo-hotel concept is not new, in fact it has been around for decades. Generally speaking a “condo hotel” is a hotel whose guest rooms and facilities have been sub-divided into one or more condominium interests that are owned by one or more property owners, who have agreed by choice (not by mandatory dictate) to pool the rental of their units through a single hotel operator. Within many jurisdictions there are little if any property related differences between a residential condominium and a condo-hotel project. The real differences lay in the channels of marketing, the motivations of the target buyers, their usage patterns, and the way the property is overall operated.
Typical Residential Condominium Buyer Motivations (In order of priority):
n Use their units as a primary or secondary residence for extended periods n Appreciation in unit value over time n Occasional rental of units for some side income (mainly in vacation destinations)
Typical Hotel Condominium Buyer Motivations (In order of priority)
n Occasional vacation use of their units typically for under 120 consecutive days n Pool the rental and operation of their units as a “hotel” with professional management and a major hotel brand affiliation, to earn a reasonable investment return n Appreciation in value of their units over time
Why are hotel developers attracted to this concept?
What started out, as principally a way to finance the construction of new luxury hotels when funding otherwise was scarce, the sale of condo-hotel units has evolved into a primary motivation for developers to develop new luxury hotels. The first wave of new condo-hotel development was most prevalent in Southeast Florida in 2002 and 2003, and was viewed as a way to secure construction financing. This entailed pre-selling a sufficient number of hotel units (usually 55% to 60%) to establish a bankable capital base to secure bank loan construction financing, and then using proceeds from condominium sales closings to payoff the construction loan. The end objective was to have outside investors (unit buyers) owning the hotel room’s inventory, with the developer retaining the ownership and operation of the commercial space and hotel rental pool free and clear of any debt obligations. The reason this approach worked well, even when new hotel development otherwise wouldn’t pencil out under traditional metrics, was because units were sold at retail pricing rather than at developer’s direct cost.
In Southeast Florida where most of the early condo-hotel action took place, projects typically sold out at unit prices ranging from $350 to $500 per square foot. Now unit pricing has nearly doubled from earlier levels. This is due to residential and vacation real estate being such a hot commodity, mortgage interest rates remaining near their lowest levels in decades, and wider consumer familiarity with the condo-hotel concept. Now the huge profit incentives from sale of condo-hotel units far outweigh residual benefits to developers from on-going ownership and operation of the commercial space and hotel rental pool, and have become the primary motivation to develop new condo-hotels.
In addition to new development, many conversion projects are underway and not just for luxury hotels, but also for more moderately priced accommodations including conversions of all suites and extended stay hotels.
Although the condo-hotel concept in its newest reincarnation has been around for several years now, there are still a number of pending issues or considerations that remain to be more fully addressed, some of which are listed below:
Pending Issues or Considerations for Condo-Hotels
n Inadvertent developer actions causing the sale of hotel condominiums to be considered a sale of securities under state or Federal law requiring registration with the appropriate state agencies or the US Securities and Exchange Commission, (examples of triggering actions might include supplying revenue and return projections to prospective buyers, mandatory participation in a rental pool, and others matters for which legal advice should be sought) n State and local government jurisdictions attempting to reign in hotel condominium sales by limiting the number of days of consecutive owner usage, (either because of concerns of reducing the available stock of transient hotel rooms or concerns of usage as primary residence and impacts on area schools, roadways, and other infrastructure) n An evolving model for rental revenue splits and cost sharing that could change the risk-reward balance n Developer liability for unit defects, particularly for conversions n Impacts on sales and re-sales should interest rates climb significantly
Developers first viewed condo-hotels as a way to fund new hotel development when traditional financing approaches wouldn’t work. Now hotel condominiums have become much more mainstream as a funding structure of choice for new hotel development and as an accepted form of real estate ownership and investment for individual real estate buyers.
About the Author:
Francis J. (“Frank”) Nardozza is Chairman and CEO of REH Capital Partners, LLC, a national real estate and hospitality investment and advisory services firm based in Fort Lauderdale, Florida. He has over 28 years of diversified experience in real estate and hospitality investment, consulting, and transaction advisory services. He is recognized nationally and internationally for his work in the areas of mergers and acquisitions, real estate investment, and strategic advisory services, and has advised on over $15 billion in real estate and hospitality transactions. He is frequently called upon for expert witness testimony involving real estate and hospitality matters. Mr. Nardozza is the founding Chairperson of the “US Lodging Industry Investment Council,” and has previously served for three terms as Chairman of the “Market, Finance and Investment Analysis” Committee of the American Hotel & Lodging Association. He is a frequent author and lecturer on real estate and lodging topics. Prior to launching REH, Mr. Nardozza was the National and Global Real Estate and Hospitality Consulting Practice Leader for KPMG LLP and KPMG Consulting, Inc., where he completed a career with the two firms spanning over 25 years. Mr. Nardozza is active in advising on matters pertaining to condominium hotel development and conversions throughout Florida and the US.
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