Hotel Online  Special Report
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The Global Hospitality Advisor

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How to Make a Condo
Hotel Deal — Part II


by Jim Butler & Guy Maisnik, June 2005

This is Part II of a two-part series. Part I appeared in the March 2005 issue of the Global Hospitality Advisor. This article by Jim Butler and Guy Maisnik was originally published in the February 2005 issue of Urban Land Magazine by the Urban Land Institute (ULI),© 2005. ULI is the copyright owner of the article. This article is reprinted with the permission of ULI.

Challenges for the Hotel Operator

The hotel structure needs to be designed to handle the specific operator's particular market segment in a given location. The hotel operation needs an adequate supply of rooms on a predictable basis.

  • First and foremost: how many of the condominium units will be available as hotel rooms and when? 
  • Will an adequate number of rooms be available to handle large group meetings, usually booked 12 to 24 months in advance?
  • How much meeting space will be needed?
  • How many seats are in the restaurants and lounges? 
  • Is there a sufficient and stable supply of rooms to efficiently maintain needed staff and service levels for everything from front desk to maintenance and room service?
  • Will there be enough hotel business derived from rental of rooms to support traditionally unprofitable or less profitable hotel operations that condominium owners expect or demand, such as food and beverage? 
  • How can cost allocations be kept flexible enough to meet experience and evolution, while protecting the reasonable expectations of the condominium owners? 
  • How can the operator be assured that capital will be available for the maintenance required to provide uniform room quality at required levels to satisfy hotel guests? 
  • How does the operator deal with a large number of condominium unit owners on issues requiring owner consent?
  • How does the operator fairly allocate room rental allocations among condominium owners and placate unhappy unit owners who find that their units are less desirable or produces less income than they hoped?
If the condo hotel structure cannot provide the operator with sufficient rooms and profit potential, the operator may exercise a termination right. Termination by the operator may mean that condominium owners and the lender find that the units cannot be put to productive income-producing use, and the project will fail. However, if the operator can manage the property reasonably well, then there are fewer of the typical operator concerns in a traditional hotel project that must accommodate owner exit strategies, such as termination on sale of the hotel or upon other specified events. In fact, condominium unit owners and lenders may be more concerned about having the operator "locked in" to protect their respective interests and property values for long periods of time than in other models.

Challenges for the Developer

The natural tug of interests between a hotel owner and an operator in the context of a traditional hotel provides certain checks and balances on the power of each, that may not be present if the developer has no ongoing permanent stake in the project. Developers will want to go into the deal with the following issues on the table:

  • Does the condo hotel developer expect to make all of its profit on the front-end sales of the units, or is it expecting to have value and cash flow from the residual hotel? 
  • What support, if any, will the developer lend to the project if cash flows in the cyclical hotel business run short, or if capital is needed to maintain the property? 
  • What capital calls and limitations are the homeowners associations (HOAs) subject to in order to support the project? 
  • What balance of hotel operator concerns and unit owner freedom maximizes the value and profit of the condominium program? 
  • Will unit owners be more inclined to sign up for the voluntary rental management agreement with the right operator if their use of their unit is limited, or does the value of having the potential for an income stream offset the inconvenience of limitations?
  • Has the developer balanced the legitimate interests of the condominium unit owners and the operator in negotiating the form of hotel management agreement?
Challenges for the Condominium Unit Owner

Managing and satisfying the condominium unit owner's expectations will be a challenge, particularly given the securities law restrictions on information that can be provided to purchasers. A buyer who pays a huge premium for a condo hotel over the price of a comparable "ordinary" condominium may be in for a rude surprise when the resale value of the property is disappointing or the owner's share of hotel revenues, after the operator's share, furniture, fixtures and equipment or FF&E reserves, and other carrying costs, is insufficient to cover debt service, insurance, HOA assessments and other costs of ownership, much less provide a reasonable return on investment. Sophisticated condominium buyers will want to know the following:

  • How will developers and operators keep an inappropriate speculative fever from breaking out, with unrealistic expectations of cash flow and profit from placing units in the hotel rental management program?
  • Will the unit owners or the HOAs have the right balance of power and wisdom to effectively work with operators in the joint cooperative effort needed for the project to succeed? 
  • Can purchasers regard their condominium as an investment in real estate that may appreciate over time and that may not provide the return the investor would like on a near-term basis?
  • Will the investor get good financial advice on realistic cash flow possibilities, and the capital expenditure or CapEx requirements of using units as hotel rooms? 
  • Will the investor learn what hotel investors have known for years—namely, that the typical FF&E reserves of 4% to 5% of gross income may be enough to cover routine costs of maintaining a typical new hotel property, but over the long term, the capital required is substantially greater and comes in spikes at certain stages in the hotel's life cycle? 
  • How will the condominium owner control an inefficient operator or one who does not maintain the property well? 
  • What can be done to ensure fair rotation of available condominiums rented to hotel guests? 
  • Who will asset manage the operator when there is no single owner of the hotel property, but only individual unit owners and HOAs possibly lacking in hotel expertise? 

Jim Butler is Chairman of the Global Hospitality Group of Jeffer, Mangels, Butler & Marmaro LLP, a full-service business law firm with more than 160 lawyers in Los Angeles and San Francisco. The Global Hospitality Group has handled hundreds of transactions spanning the globe, representing $35 billion in total acquisitions, sales, developments and financings of hospitality properties and companies. Their experience ranges from individual properties to billion-dollar portfolios. Jim can be reached at 310.201.3526
 
The Global Hospitality Advisor ® is published four times a year for the clients, business associates and friends of Jeffer, Mangels, Butler & Marmaro LLP.

The information presented in this newsletter is intended as general information and may not be relied upon as legal advice, which can only be given by a lawyer based upon all the relevant facts and circumstances of each particular situation.

  • Our experience ranges from individual properties to billion-dollar portfolios.
  • Large or small, routine or complex, if a legal matter has your attention, it deserves ours too.
The Global Hospitality Group® is a registered trademark of Jeffer, Mangels, Butler & Marmaro LLP
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For more information:
Jeffer Mangels Butler & Marmaro LLP
1900 Avenue of the Stars, 7th Floor
Los Angeles, CA 90067-4308
Attn: Jim Butler
310.201.3526 • 310.203.0567 fax
jbutler@jmbm.com
http://www.jmbm.com

The premier hospitality practice
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Also See: Avoiding The Pitfalls of Condo Hotel Structuring; Steps To SEC Compliance / Peter Connolly / June 2005
The 2005 Lodging Industry Investment Council Top Ten; LIIC's List of Major Hotel Investment Opportunities and Challenges / May 2005
Copyright Laws Applicable to Hotels / Jim Abrams / March 2005
Condo Hotels - How to Make Them Work / Jim Butler and Guy Maisnik / February 2005
The Condo Part of Condo Hotels; A Primer on How to Create a Common Interest Development / David Waite, JMBM / The Global Hospitality Advisor / February 2005
Catching the Buzz on Condo Hotels, A Roundtable Discussion / The Global Hospitality Advisor / JMBM / December 2004 
Outlook 2005: Hotel Industry Fundamentals, Where have we been? Where are we going? / The Global Hospitality Advisor / JMBM / December 2004
How to Master Your Next Disaster Protect your guests, educate your employees, and limit your liability / Julia L. Rider / JMBM / October 2004
Wage & Hour Class Action Lawsuits: Hospitality Employers Caught in the Cross Hairs / Marta Fernandez / JMBM / September 2004
Adopting Pet And Service Animal Policies To Avoid Lawsuits from Disabled Hotel Guests / Marty Orlick / JMBM / September 2004
Politics Over, New ‘Overtime’ Law Takes Effect; The Significant Changes / JMBM / September 2004
Hotel Franchise Agreements: Opportunities And Pitfalls / JMBM / September 2004
ADA Lawsuit Alert: Beware the Internet Surf-by; A new twist on the ADA drive-by lawsuit / JMBM / September 2004
Hotel Unions Challenging Work Rules Found in Hotel Employer / The Global Hospitality Advisor Handbooks; Claim Interference with Employees’ Rights to Organize / JMBM / October 2003
Wage and Hour Lawsuits and Audits Continue to Sweep the Hospitality Industry / The Global Hospitality Advisor / JMBM / October 2003
Prepare NOW for an ADA Attack; Myths and Tips on How to Minimize Exposure / The Global Hospitality Advisor / JMBM / October 2003
Sarbanes-Oxley Update / The Global Hospitality Advisor / JMBM / Arpil 2003
Equal Public Access or Access to Deep Pockets? The Hospitality Industry Remains a Target of Lawsuits by Disability Rights Groups Under the Americans with Disabilities Act / The Global Hospitality Advisor / JMBM / March 2003
Outlook 2003: A Roundtable Discussion / The Global Hospitality Advisor / JMBM / Dec 2002 
Time Bomb Waiting to Explode: Wage & hour Claims Over Exempt Employees / The Global Hospitality Advisor / JMBM / Oct 2002
I'm Mad as Hell, and I'm Not Going to Take it Anymore! / The Global Hospitality Advisor / JMBM / Oct 2002
Settlement Procedure Available to California Hotels Plagued by Prop 65 Cases - The Global Hospitality Advisor / April  2002 
Top Ten Investment Challenges Facing the Lodging Industry / Lodging Industry Investment Council / April 2002 
Decertifying a Union? The Employer’s Bill of Rights / The Global Hospitality Advisor / JMBM / April 2002 
Outlook 2002: A Roundtable Discussion /  Bruce Baltin, Bjorn Hanson, Randy Smith, Jack Westergom - The Global Hospitality Advisor / January 2002 
New Rules for Hotel Workouts: REMICs for Dummies / The Global Hospitality Advisor / JMBM / December 2001 
Living in the Wake: Predictions & Practical Implications / The Global Hospitality Advisor / JMBM / December 2001 
Avoiding Liability for Lay-Offs / The Global Hospitality Advisor / December 2001
The Worker Adustment and Retraining Notification Act: Impact on the Hotel Industry / JMBM 
When is an Apartment a Hotel ... and Who Cares? / The Global Hospitality Advisor / JMBM / September 2001 
The 'Perfect Storm' / The Global Hospitality Advisor / JMBM / September 2001 
Richard Kessler's Grand Theme Hotels - Interview with GHG Chairman  Jim Butler / March 2001
Stephen Rushmore's  Industry Trends / Top Markets, Predictions & Opportunities  / Jan 2001
Outlook 2001: A Roundtable Discussion The Global Hospitality Advisor / Jan 2001
Perspectives on Hotel Financing in 2001; Jim Butler, JMBM's Global Hospitality Group Chairman, Interviews Two Active Players in Hotel Finance / Jan 2001 
Robert J. Morse: Millennium’s New President / Interview with GHG Chairman Jim Butler / Nov 2000 


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