Hotel Condominium Resurgence- Is it Smoke and Mirrors?
By Marc Stephen Shuster, Partner, Berger Singerman
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.
Developers were in effect forced to refrain from emphasizing a key selling point in hotel condominium units-the economic, profit or tax benefits of the investment, including rental revenue expectations-to prospective buyers, or risk being deemed a security subject to the regulations of federal securities laws. The need for developers to avoid coming under the scrutiny associated with "security status" of their hotel condominium projects prior to 2013 was twofold. On the one hand, if the real estate venture was a security, it must be registered as such under state or federal securities law, unless an exemption applies, and it is simply impractical to register with the SEC in light of the time requirements and associated expenses.
Alternatively, along with security status came a prohibition on using "general solicitation" to market hotel condominium units. This meant that developers could not broadly solicit the units in general advertisements, such as in newspapers, magazines, online, by mass email or other means typically relied on in the real estate marketplace and ostensibly, vital to the marketing and overall success of these hotel condominiums.
Now, however, the SEC has become more flexible with developers, providing leniency to market the hotel condominium as a security as opposed to real estate, even with private offerings. By adopting Rule 506(c) in response to the Jumpstart Our Business Startups Act of 2012, developers of hotel-condominiums can now "generally solicit" purchasers of hotel-condominium units as "securities" so long as all the purchasers of the securities are "accredited investors" and the issuer takes reasonable steps to verify the purchasers' accredited investor status. Accredited investors are those purchasers who either (a) earned income in excess of $200,000 per year (or $300,000 for a married couple) and reasonably expect the same for the current year or (b) have a net worth over $1 million (excluding the value of the person's primary residence). This regulatory change is monumental because it allows developers to call it like it is and market their project as a security to the public without the increased costs.
The current enthusiasm does not appear to be a bubble. According to a Bloomberg article titled "Homebuyers Avoiding Chores Fuel U.S. Condo-Hotel Revival": in the two highest lodging segments, the segments in which the majority of hotel-condominiums are constructed due to the "full service" nature of the demand, 130 hotels were under construction as of the end of 2007. In 2014, that number was 45 hotels. The real estate market itself, especially in prime areas, has made a full recovery. For example, in South Florida, of the 49,000 condominiums built during last decade's boom in Miami-Dade, Broward, and Palm Beach counties, the vast majority of these units have been sold, according to Condo Vultures LLC which tracks the South Florida condominium market. Part of this resurrection is due to better economic times, and part is due to a better regulatory environment in the enactment of Rule 506(c).
As the market continues to thrive, experienced developers have jumped back on board and are once again trying their hands at hotel condominiums. Among those leading the comeback are traditional hotel companies, such as Marriot, and traditional condominium developers, such as The Related Group of Florida. These experienced developers and their competitors are seeing the benefit of developing hotel condominiums and adding residential deposits to their equity component of their capital stack.
Most developers don't want or need to be reminded of the past, and taking consideration of the present, they want to know the trends for the future. The hotel-condominium market has thrived in Miami and is slowly coming to life in New York and Los Angeles; but, it is Las Vegas, arguably the city hit hardest during the recession, that solidifies the foundation of the hotel-condominium resurgence. In Las Vegas, sales have been steady and prices have gone up, contributing to overall confidence that the market has rebounded and that it is not too late to take advantage.
With that said, macro-economic factors such as the strong dollar, may counter balance the growth or create a healthy correction. Even in the hotel-condominium capital, Miami, developers remain wary of the future because many international buyers can no longer afford the same large down payments. The developers must now look for new potential domestic buyers. The foregoing doesn't even begin to address the impact of Airbnb, the poster child of the sharing economy, on the hotel business. Despite initial dismissal by traditional hoteliers as experiments at best, consumers have enthusiastically adopted the services of Airbnb, with these platforms creating new user behavior by providing cheaper alternatives. Although hotels not catering to business travelers are most vulnerable to competition from Airbnb, it is starting to catch on with business travelers as companies are trying to lower costs.
In turn, some hotel brands are adapting to the change in consumer demand in hopes of attracting the young-travelers market by rolling out extended stay boutique hotels located in urban locations, and offering more comfort-based amenities. Hyatt Hotels Corporation is taking another approach in responding to the sharing-economy trend by integrating its mobile app with Uber, the ride-sharing website, to provide hotel guests with online Uber reservation capabilities. While the accepted sentiment is that business travelers have not yet jumped aboard and embraced the sharing economy, Airbnb is undoubtedly re-writing the rules of the industry; the high end hotels in the industry should be immune from the effects of the sharing economy for the foreseeable future but only time will tell.
Overall, hotel-condominium market appears to be on the rise. With an improved economy, better regulatory scheme, and receptive market, there appears to substance behind this resurgence. Still, developers need to be cautious, keep the past in mind, and look toward future trends.
"The authors would like to acknowledge the assistance of Nicole S. Sohn, associate, who helped in the preparation of this article."
This article was co-authored by Barry D. Lapides. Mr. Lapides is a partner on Berger Singerman's Business, Finance & Tax Team and concentrates his practice in representing real estate developers and lenders in all aspects of commercial real estate transactions and financing arrangements. He represents developers, owners, investors, lenders and investment funds in connection with the acquisitions, financing, development, leasing and dispositions of hotels, shopping centers, apartment/condo/mixed-use complexes, vacant land and distressed properties as well as other various real estate projects throughout Florida. He also has extensive experience in the creation of condominiums (residential, commercial and mixed use) and homeowners' communities. In addition, he represents lending institutions in matters regarding consumer lending litigation and creditors' rights enforcement and has considerable experience in handling loan modifications, workouts, restructurings and foreclosures. He was appointed to the University of Florida Bergstrom Center for Real Estate Studies Advisory Board. Mr. Lapides can be reached at email@example.com or (305) 982-4063.
Marc Stephen Shuster is a partner in the Miami office of Berger Singerman, Florida’s business law firm. Mr. Shuster is a business attorney with extensive experience in commercial real estate transactions, both healthy and distressed, and corporate M&A deal work, with an emphasis on the hotel and hospitality industry. He advises both traditional hospitality conglomerates and Internet advertising sites serving the industry. Mr. Shuster he has served as counsel to a Florida-based emergency management/services conglomerate in negotiating for disaster relief work throughout the Caribbean. Mr. Shuster speaks and writes on novel issues affecting the hotel and hospitality space, serves on various community boards, and has been recognized with numerous awards and accolades. Mr. Shuster can be contacted at 305-982-4080 or firstname.lastname@example.org Extended Bio...
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