Hotel Online  Special Report
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The Global Hospitality Advisor

Five Keys to Successful
Condo Hotel Regimes


“Ask the Hotel Lawyer” 
providing practical insight into timely legal issues
October 2005

GHA “It seems like everyone is doing a condo hotel project. Do they all work?”

Jim Butler: The latest reports show that 90,000 condo hotel rooms are in the pipeline. As a hotel lawyer and the leader of a team of condo hotel specialists that has been working on these projects for some time, it sometimes feels like we have talked to the developers of every one of those condo hotels in the pipeline (and a few more). Of course that is not true, but we do get about five-to-10 calls per week just on condo hotels. Some of these proposals will work, but many of them won’t. We look at five key factors to assess the viability of a condo hotel project. 

GHA: What are those five keys?

Jim: In a nutshell, the five keys to a successful condo hotel project are: (1) economic fundamentals, (2) the condo hotel program’s design, including expense and income allocations, (3) a condo hotel regime that will ensure adequate hotel room inventory, (4) structure and documentation to assure appropriate and consistent quality and (5) not locking down the structure until you have a viable regime design.

GHA: Then let’s start with economics. What are you looking for in a condo hotel project?

Jim: First and foremost, we want to know whether the condo hotel can operate profitably. A condo hotel may help liberate trapped capital, but it’s not a cure for a sick hotel that can’t generate an operating profit. If it doesn’t work as a hotel, it’s not going to work as a condo hotel. We want to be comfortable with the economic fundamentals—demand and supply, the all-in project cost (acquisition, construction or conversion), operating costs and achievable revenues. We want to be comfortable that the condo hotel is in a good location in a good market ... that it has the right brand and operator, and that the physical facilities and amenities are competitive and suitable for the target market. On the condo side, it must tap into an appropriate consumer demand and provide the right product at the right price point. Part of the economic equation is determining if the cash flow generated will cover operating expenses and provide some return on investment. 

GHA: Is this where the “right” program design and allocations come in?

Jim: Yes. This is not a “one size fits all” situation. The program design and allocations have to be right for each particular project. In working with condo hotel developers over dozens of projects, we have found that the early revenue splitting formulas (e.g., 60 percent to the hotel and 40 percent to the unit owner) really were clumsy efforts to cover otherwise unallocable expenses—and these allocation formulas don’t work very well. So we work with the developer to tailor design the condo hotel revenue and expense allocation for each project and each project component. The allocations must be fair to the condo unit buyers, but must also assure significant cash flow to cover hotel operating costs. And as you would expect, the program design must be implemented throughout the condo documents, hotel management agreement and the rental program agreement.

GHA: With so many individual unit owners in the rental program, how is it possible to manage the hotel room inventory?

Jim: Adequate and predictable room inventory is a critical issue for a successful condo hotel project. Getting a workable solution typically involves an intelligent use of carrots and sticks, and it can be a bit tricky. To ensure hotel room inventory, you need enough unit owners to sign long-term rental management agreements. But, you must go about this in a way that avoids having the project labeled as a “security” by the Securities and Exchange Commission—an important issue we have covered in previous issues of the Global Hospitality Advisor®. It’s crucial for a condo hotel to have an adequate and predictable supply of rooms available for the normal flow of hotel guests and for advance bookings, such as large groups and conferences that tend to book 12-to-24 months out. So, you have to give the unit owners incentives to participate in the rental management program and disincentives—like reasonable charges—if they don’t. A viable condo hotel regime will have about 80-to-90 percent of the condo units participating in the rental management program.

GHA: Can you really maintain the quality of the units belonging to individual owners?

Jim: Yes—if the condo hotel program and regime documents are properly structured. The condo documents must legally obligate the unit owners to maintain their units, and the hotel operator must have effective means to enforce those obligations. A good condo hotel has to deliver a consistent and appropriate quality of service, room furnishings and other physical elements for its particular brand or market segment throughout all rooms and the rest of the property. The regime must be crafted so that this particular level of quality is legally enforceable. Anyone in the hotel business knows that there may be times when the owners will be required to dig into their wallets to cover hotel operating shortfalls and to cover capital expenditures, FF&E upgrades and replacements. But, a traditional hotel only has one owner, while in a condo hotel there may be several hundred owners—and you have to coordinate and enforce each of those obligations.

GHA: The last factor you mentioned was not locking down the structure until you have a viable regime design. What do you mean by that?

Jim: For better or worse, most of the elements critical to the success of the condo hotel—appropriate cost and revenue allocations, mechanisms for obtaining and managing the necessary room inventory and providing adequate revenues, and means of enforcement to meet condo unit owners’ obligations—get “baked in” or locked down in documents that are difficult or impossible to change once implemented. So they better be right the first time. These documents include the condo documents—the CC&Rs, HOA agreements, and HOA management agreement—and the rental program agreement and the hotel management agreement with the hotel operator. 

We have been called in after-the-fact many times by developers who have been given unworkable condo documents drafted by expert condo lawyers. The problem is that they were experts in condos, but had scant experience with hotels, and no experience with condo hotels. Unfortunately, the best way to fix bad documents at the outset is to throw them away and begin again from scratch. Condo hotel deals are far too complex to try and bandage bad documents. But once they are in place, you may have to live with them for a long time, even if they are terrible.

GHA: Any final words of advice for those considering a condo hotel? 

Jim: Our clients’ number one concern is typically minimizing legal liability. While there are no “magic shields” to ward off all liability, it can be managed to reasonable and acceptable levels by following some common sense approaches used successfully by residential developers who have coped with these issues for many years. First, happy people don’t sue. You want to sell a good product and you need to structure the project so that it works well for everyone—the condo buyer, the lender, the operator and the investor. Second, take SEC compliance very seriously and recognize that in this area, “good faith is not good enough.” Third, prepare for the inevitable construction defect lawsuit at the start of the process. Make sure you have good construction, contractors, documentation of the construction process, inspections and insurance.

GHA: Is there anything else?

Jim: There is so much more I could say on the subject, because condo hotels are complex creatures. But my job as a hotel lawyer is the same for a condo hotel project as it is for a traditional hotel—to guide our clients through the crucial issues to maximize profitability and minimize problems.


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 more than 1,000 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 or jbutler@jmbm.com.
 
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
.

 
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
in a full-service law firm
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Also See: Americans With Disabilities Act Update: the Hospitality Industry, A Consistent Target of Abusive ADA Litigation, May Get Some Relief from Abusive Lawsuits / Marty Orlick / October 2005
Labor Wars: A Hotel Survival Guide - Watch Out For Neutrality Agreements / Marta M. Fernandez / September 2005
How to Make a Condo Hotel Deal - Part II / Jim Butler and Guy Maisnik / June 2005
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
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Prepare NOW for an ADA Attack; Myths and Tips on How to Minimize Exposure / The Global Hospitality Advisor / JMBM / October 2003
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I'm Mad as Hell, and I'm Not Going to Take it Anymore! / The Global Hospitality Advisor / JMBM / Oct 2002
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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 
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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
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