Developers Add Condominiums to Hotels to Increase Profits
Stymied by the increasing costs of building stand-alone luxury hotels, developers have turned to condominium hotels to allocate costs to a wider revenue base while creating another profit center. Hotel operators can charge premium prices for the condominium units in these projects, because condominium owners can take advantage of the hotels' services and amenities as well as receive an income when they aren't using their residences. By achieving a high profit on the condominium sales, developers offset the construction costs and achieve a quicker profit.
Development and Investment Strategies
The decision to develop this unique property type depends on the dynamics of the market in which the project is located. One approach is to develop the entire project as condominiums for purchase, such as the Fortune House in downtown Miami, which appeals to investors who aren't necessarily going to use the units; their main focus is return on investment. In this type of strategy, all of the units are the same size and similarly furnished, and the entire property operates as a hotel.
Another strategy involves building hotel rooms and condominium units separately but in the same building. The condominiums are used as supplemental hotel rooms, but the hotel's operation does not depend on the condominiums for its success. The condominiums are larger than the hotel rooms, and revenue from their sales offsets the high development costs. Four Seasons and Ritz-Carlton operators often use this strategy.
Condominium-hotel units appeal to certain buyers. For upscale projects such as Ritz-Carlton, Four Seasons, and St. Regis, the market comprises high-income couples and families who use their condominium investments as luxury vacation homes. Investors in more modest projects are often local middle- to upper-income individuals or couples who view the condominium as an opportunity to receive a return on their equity. In some of the resort destinations, such as Florida, the clientele is heavily Latin American and European. These frequent visitors see the condominium as both a vacation home and an investment opportunity. The buyer's market really depends upon the type of project and the location. For instance, a new downtown Denver condominium hotel is attracting buyers from within a 100-mile radius who see the city as a vacation experience because of its recent renaissance.
Even though the number of condominium-hotel projects quickly is multiplying, financing such projects remains complicated because of the juxtaposition of an operating business and fee-simple real estate sales.
Lenders typically allocate certain costs and values to a condominium-hotel development's separate components, relying on two underwriting values: the ongoing value of the hotel's real estate and operating business and the revenues derived from the condominium sales. Condominium pre-sales drive lenders' decisions on loan amounts and structure. Lenders conservatively underwrite these properties because of the continued uncertainty in both the condominium and hotel financing arenas. A few years ago, lenders required only 50 percent of condominium construction loans to be covered by non-refundable cash deposit pre-sales, but they now want 75 percent to 100 percent of loan amounts covered.
In addition, lenders demand stricter guarantees. Two personal or corporate guarantees usually are required: the loan guarantee, whereby the guarantor agrees to repay the entire balance of the loan with interest and penalties in case of a default, and a completion guarantee in which the guarantor agrees to deliver a fully completed project especially under conditions of a loan default. Depending upon how the developer negotiates with the contractor for the project, the lender may accept certain contract provisions as a part of the completion guarantee.
Mezzanine funding often is used to bridge the equity and debt gaps. While that amount can be expensive — in the 16 percent to 22 percent interest rate range — it completes the capital structure and allows developers to create value through the hotels' operation and ownership.
The condominium-hotel concept has spread like wildfire in recent years. In its inception, major luxury hotel operators, such as Four Seasons, Ritz-Carlton, Sonesta, Starwood, Trump, Marriott, Hilton, and Rosewood, integrated condominiums into their hotel developments in most of the resort destinations, such as Hawaii, California, Mexico, Florida, Arizona, and Texas. Development then moved into popular urban centers and included an expanded mixed-use concept in cities like New York, Chicago, San Franciso, and Boston.
The next wave of condominium-hotel projects included second-tier operators that simply wanted to take advantage of the condominium frenzy in certain markets. The most prominent of these is Florida, where condominium prices in these projects have set new records. Typical high-end units in choice locations in South Florida sell in the $800 per square foot to $900 psf range — sometimes reaching $1,000 psf — compared to luxury beachfront condominiums without the hotel component that sell for $500 psf to $600 psf. The majority of buyers in this region are from Latin America, which should keep the market strong, as many of those owners spend only a portion of the year in the United States.
However, sales have slowed in the $1 million to $2 million range in Miami-Dade County. The 46-month supply in first-quarter 2002 dropped to a 36-month supply this year, and absorption has slowed due to competition; however, several new projects have been announced recently that will add more inventory to the mix.
Other areas of the country experiencing strong condominium-hotel development include many revitalized downtown centers such as Boston, Washington, D.C., Las Vegas, San Diego, and cities dotting the southern California coast such as Santa Monica. Resort areas such as Hilton Head, S.C., and Texas' Gulf Coast also are seeing strong demand.
Despite their popularity, condominium-hotels' unique status as an operating business combined with fee-simple residential real estate sales may put a damper on developers' and investors' expectations. Even so, condominium-hotel units are profitable investments that allow owners to cover most of the costs of owning while enjoying first-class vacation homes.