Investment Analysis

Condo-Hotels Return

New SEC rules prompt another look at this niche property.

A series of complex legal issues and Securities Exchange Commission regulations have historically impeded the sale of condominium hotel units. New SEC rules adopted under the Jumpstart our Business Startups, or JOBS, Act of 2012 have loosened the legal structure and marketing process for condominium hotels, opening up a new opportunity for investors and developers. Going forward, selling condo-hotel units as securities is expected to become a more profitable — and more common — option.

Pre-Recession Problems

Prior to the Great Recession, any discussion of condominium hotels began with the premise that this product, which had gone from relative obscurity to wide-scale adoption in the space of about five years, had been a disaster for all involved. Along with high condominium unit prices, U.S. securities laws created complicated sales and marketing rules and imposed operational restrictions — resulting in the unavoidable sense of fitting a square peg into a round hole.

For unit purchasers, the failure of the average daily rate and occupancy to meet expectations, combined with the cost structure of maintaining a rental program consistent with brand standards, often resulted in significant buyer’s remorse. This, in turn, resulted in unit owners challenging and frequently attacking developers and hotel brands. Notwithstanding the careful disclosures set forth in properly drafted offering documents, unit owners dissatisfied with the economics of their purchase often became indignant over the relative lack of control provided to them within the condominium documents and other project covenants and restrictions. For their part, the brands became acutely aware that they had underestimated — and underpriced — the additional complexities involved in operating a condominium hotel.

Today’s Market Challenges

To be sure, business and investment memories can be short. But this does not fully explain the renewed interest in condominium hotels. Have developers and hotel brands learned their lessons? Have the factors influencing the prudence of condominium hotel development changed?

The answer to both questions, at least in part, is yes. Lessons learned from the last generation of condominium hotels are likely to influence market participants and enable them to avoid a number of mistakes. Today’s risk-averse climate minimizes such gambles as building condominium hotels in markets where even traditional hotels cannot survive; using the condominium hotel structure in projects with unsupportable real estate prices; and failing to carefully manage the balance between traditional and condominium hotel keys.

At the same time, there are significant contextual changes that may impact the viability of condominium hotels, both negatively and positively. On the negative side, unit financing is essentially nonexistent other than through personal lines of credit. On the positive side, the often mentioned JOBS Act and, in particular, new Rule 506(c) under Regulation D, which became effective in September 2013, provides a mechanism for selling condominium hotel units as securities through general solicitations. As a result, developers are permitted to require rental program participation, pool revenues among all units, and provide pro formas. Sales force licensing and securities law considerations relating to the resale of condominium hotel units offered as securities introduce new complexities, but these seem to be far outweighed by the economic and legal advantages available to developers under the JOBS Act.

While certain markets for condominiums are very strong, perhaps overheated, this is not true across the board. In many markets there is a degree of conservatism among purchasers. On the other hand, selling into overheated markets makes it difficult to deliver a reasonable return on investment through the rental program. For investors interested in parking money in a safe haven or with optimistic views toward capital appreciation, this situation may not present a problem, but this only applies in select locations.

Prominent hotel brands are looking at condominium hotels with a keen understanding of the problems that can arise but appear to be willing to at least experiment with carefully structured condominium hotels in appropriate markets and under appropriate conditions. In cases in which the brand is not necessary to facilitate real estate sales or fill beds, the unbranded model has the distinct advantage of greater flexibility concerning cost containment during difficult economic times.

It is difficult to predict what the ultimate impact of the JOBS Act will be on the condominium hotel market. There is growing interest in condominium hotels under the old (non-securities) structure. However, even though there have not yet been any condominium hotel units sold as securities under the JOBS Act, the opportunity to sell units as securities may eliminate several of the challenges of offering and operating condominium hotels — most importantly the risks pertaining to rooms inventory.

Andrew Robins is chair of lodging and lifestyle practice and Kenneth G. Alberstadt is chair of the capital markets practice at Akerman LLP. Contact them at andrew.robins@akerman.com and kenneth.alberstadt@akerman.com.

Recommended

Crowdfunding Capital

September.October.18

Here are the top three ways that real estate owners and investors can take advantage of crowdfunding and current trends in the sector to source capital, including choosing the right platforms.

Read More

Raising the Bar on Sustainability

July.August.18

 

Read More

Mitigating Circumstances

May.June.18

The 2017 tax act affects specific types of like-kind property exchange transctions. Throughout the negotiations for the Tax Cuts and Jobs Act of 2017, Internal Revenue Code Section 1031 like-kind exchanges had been at risk. Fortunately, exchanges of real estate property were saved from the chopping bloc

Read More

Full Speed Ahead

Mar.Apr.18

 

Read More