|By David Sudeck, Hotel & Timeshare Lawyer | JMBM
Global Hospitality Group®
In prior economic downturns, the developers of timeshare, fractional
interest, and private residence club properties -- referred to in this
article as "vacation ownership product" or "VOP" -- were fortunate to see
the industry continue to grow. A diverse buyer base and strong demand,
due in part to effective selling methods implemented in the industry, were
among the reasons industry fundamentals stayed strong. But the scope of
the current financial crisis and credit freeze has not spared VOP developers
from the adverse forces affecting development and consumer demand worldwide.
What are the 6 biggest challenges facing our
Vacation Ownership industry?
3 Keys to Survival -- How does a VOP developer
meet these challenges so as to avoid foreclosure and bankruptcy?
Scarce and expensive receivables financing. When a financial giant
like Textron Financial Corporation announces that it will limit new originations
in its Golf Finance and Resort Finance divisions (as it did in its October
2008 Form 8-K), developers should take stock of all current and future
development. Without reliable receivables financing, there may not be working
capital for operations, debt service, or the origination of more seller
financing. Wall Street financing that has supported the largest branded
timeshare companies has also dried up.
Construction loan problems. Developers may be looking at a maturing
loan or an inability to fund project construction loan interest reserves
as a result of construction cost overruns, construction delays, slower
than projected absorption, reduced sales prices, or a combination of all
Increased marketing and sales costs. Bluegreen Corporation reported
its sales and marketing expenses increased from 55% during the three months
ended June 30, 2007 to 62% during the three months ended June 30, 2008.
Many projects are facing higher selling and marketing expenses (as a percentage
of gross sales) due to increases in the cost of incentives and less productive
Downward pricing pressure. The industry is experiencing deterioration
in sales prices for a number of reasons, including reduced consumer confidence
as well as reduced savings, lost home equity and unemployment resulting
in fewer qualified buyers. Sellers are experiencing increases in the cost
of providing seller financing (if any) and increased competition from whole
ownership and other vacation ownership opportunities.
Looming owner financing defaults. While default rates remain low
in the timeshare industry compared to other industries, including car loans
and other real estate products, this could change as some owners are likely
to face financial difficulties and need to make decisions with respect
to the allocation of limited funds.
Owner maintenance fee defaults. If a homeowner's association fails
to collect adequate maintenance fees needed to maintain the quality of
a physical vacation ownership property or its operations, it could adversely
affect ongoing sales or cause owner dissatisfaction resulting in increased
interval loan defaults.
Ask and answer the right questions -- a 3-pronged approach to survival
A vacation ownership project developer facing any one or more of these
challenges must act quickly and decisively to limit downside risk and avoid
project foreclosure and bankruptcy. This requires a comprehensive analysis
of the circumstances affecting the project.
The following issues must be understood and addressed in order to undertake
a successful vacation ownership property workout:
1. Understand the interests of all stakeholders
The primary stakeholders in the project will generally include
the developer, the VOP owners, the property manager, and the lender. Open,
strategic, and regular communication with all stakeholders will be key
during a workout.
2. Evaluate the product - identify problems and opportunities
The VOP owners: If VOP sales in a project have closed escrow, these
owners should be primarily concerned with their ability to use, enjoy and
exchange their intervals. Hopefully, the sales staff was trained so as
not to create an improper expectation on the part of the VOP owner of appreciation
or rental income (unlike some condo hotel purchasers, who may have purchased
with an expectation of benefitting from a successful rental program); if
improper representations were made by the sales team, then the developer
should consult with counsel at JMBM familiar with hospitality and securities
laws to understand and address the potential issues surrounding these purchaser
In any case, the developer should closely monitor whether existing VOP
owners are satisfied with their purchase: have all promised amenities been
completed and is the property being maintained and operated to their reasonable
satisfaction? If not, the developer should attempt to understand and address
their concerns. Legal counsel should be consulted to analyze potential
claims and defenses.
The property manager: If a third party management company is involved
with resort operations -- and particularly if the management is coupled
with the resort's branding -- then the management company will be concerned
about the condition of the property and possible damage to its reputation
resulting from the failure of the developer to complete and maintain the
project. The manager may be in a unique position to advise the developer
regarding the problems with a property's physical plant, operations, and
owner relations. If the management company continues its services for the
project, then it should be a key player in assisting the developer in its
efforts to rework the project and its relationship with the project's owners.
However, the developer should be aware that if a project is not completed
or if funds are not made available by the developer for maintenance and
operations, then under the management contract, the manager may have rights
and remedies which may include termination and the right to pursue damages.
The lenders or equity partners: The VOP developer should keep its project
construction lender(s) and investors apprised of the challenges facing
the project. If these stakeholders have been apprised of the efforts made
by the developer to work through these challenges, there may be more flexibility
if and when it becomes necessary to renegotiate project financing. If third
party purchase money lenders have been providing financing to end users
or if the developer has an open receivables financing line that requires
extension, then the developer should determine what assurances the lender
will need in order to continue making loans in support of project sales.
Developers should carefully evaluate their product with the
assistance of an experienced consultant and attorney and determine if a
workout strategy should be implemented.
3. Determine if a loan workout or restructuring is necessary and possible
Non-loan-related workout strategies may include: (a) project rebranding;
(b) replacing property management; (c) changing the sales and/or marketing
teams; (d) modifying the VOP product offering; or (e) selling the project.
To identify an appropriate solution, the developer and its consultants
will need to work through the answers to a myriad of questions, including:
Does the developer still control the project and the condominium association?
If not, do the project documents provide the developer with the ability
to make changes to the project, its branding, management, and/or remaining
Can the project's flag/brand be changed without substantial expense?
If so, is the brand the right brand for the property, or would a different
brand lead to higher profits? Certain brands have achieved consumer recognition
and sales price premiums. However, the introduction of a new flag to a
property can also significantly increase the costs of marketing and operations.
Replacing an existing brand, if any, may also require a detailed analysis
of termination rights or a negotiated termination.
Is the property being managed effectively? Are there deferred maintenance
issues? Are maintenance dues current? Does the manager have an effective
public relations capability to assist the developer with effective communications
with the owners? Should the property manager be terminated? Can the property
manager be terminated? The developer, an experienced consultant and experienced
legal counsel should carefully address these issues. Employing an experienced
property management company that can provide the developer and the owners
with an accurate and reasonable budget, keep accurate accounting records
to determine budget compliance, work within the approved budget, and collect
maintenance assessments in a timely manner, is critically important.
Is the sales and marketing team effective? Do the marketing and sales
teams have experience working under difficult market conditions? Are they
employing creative and effective strategies to encourage tours, offers
and closings? Have they analyzed the local, national and international
competition to determine what product is selling and what strategies may
be working? If not, are they capable of doing so? If not, then an outside
consultant or a marketing and sales team with the appropriate knowledge
and background should probably be retained to undertake a complete review
of the market, the marketing and sales strategy, and the product(s) offered
Would modifying remaining unsold inventory help increase sales pricing
or absorption? Would greater use flexibility (e.g., fixed to floating,
a points-based system) help with sales? Is it possible to reduce product
pricing without reducing profitability (e.g., annual to biennial, increasing
the number of intervals per unit through smaller fractional interests)?
Is there any market going-forward for the product offered or is a conversion
of the project appropriate (fractional ownership percentage to timeshare,
from timeshare to hotel, etc.)? For example, a fractional interest community
offering a 1/10th interest (allowing 5 weeks or more of usage per year)
for a purchase price of $150,000 may be very attractive when area condominiums
or homes are selling for well over $2 million.
However, if these area properties lose value, then the relative value
of the fractional interest may be less compelling or a prospective consumer
may opt to purchase the whole ownership property. This may compel the project
developer to consider offering a lower-priced product, possibly in the
form of a smaller fractional interest allowing for reduced usage time,
but it may involve a complete restructuring of the offering. This would
require a modification of the project's documentation and an amended registration
with the regulatory authorities. If interests in a project have already
been sold, then there may be a host of other legal issues to resolve when
considering a modification of the product being sold. Non-legal considerations
would include whether, for example, a luxury fractional interest property
can function efficiently as a different product type (e.g., timeshare)
when the project's amenities are expensive to maintain and may result in
homeowner assessments that are incompatible with the product offered.
Should the project be sold? Should the developer sell the remaining
unsold inventory in bulk or as part of the sale of a mixed-use project?
Is there a logical and ideal buyer the property? Can the universe of buyers
be expanded and improved by undertaking one of the workout strategies discussed
In short, the developer must undertake an analysis of the highest and
best use for the property and determine the costs and limitations involved
in re-positioning or selling the property. There is no one solution to
the challenges facing VOP projects, and any of these solutions will require
the involvement of a project's stakeholders as addressed above.
Open, strategic, and regular communication with all stakeholders will
be key during a workout.
For a VOP project in trouble, a workout with the project lender may
be its only chance for survival. Issues may include an upcoming maturity
date, interest reserves that are inadequate based on modified sales price
and/or absorption schedule projections, or project cost overruns that cannot
be met through additional loan or equity funds.
It is important to work with experienced counsel to establish realistic
goals for a workout and a strategy for accomplishing these goals. Considerations
will include whether guaranties are in place, whether the property is part
of a mixed use project, and how foreclosure or bankruptcy may impact the
reputation of the developer.
Because vacation ownership properties are special assets, with an operating
business and ongoing sales, most lenders lack the expertise and experience
to effectively operate an asset of this type. Therefore, if the lender
feels that the borrower has the expertise, financial resources and desire
to maintain the asset, and if regulatory considerations do not prevent
the lender from engaging in a workout, then the lender is much more likely
to provide some relief, in the form of improved loan terms, that will provide
the developer with the time and flexibility to work through the other issues
facing its project.
If the vacation ownership property is part of a mixed-use project and
if the hotel, office, multi-family residential or other income component
in the project serves as security for a CMBS (Collateral Mortgage Backed
Securities) loan, then there are a host of additional complex considerations
relating to prepayment and foreclosure that must be considered before attempting
to negotiate a workout with the loan servicer.
If your project is in jeopardy, act now!
If a vacation ownership project is facing challenges that may put the
project in jeopardy, then the developer should seriously consider retaining
a turn-around specialist or other consultant to visit their project, assess
the situation and offer suggestions for improved performance. If the developer
elects to pursue any of the suggested workout strategies or if the developer
may be facing claims relating to prior sales, then consultation with legal
counsel experienced with the hospitality industry and workouts is a must.
David Sudeck is a member of JMBM's Global Hospitality Group® - a
team of 50 seasoned professionals with more than $50 billion of hotel transactional
experience, involving more than 1,000 properties located around the globe.
David joined JMBM after most recently running a condominium development
company as well as a real estate brokerage company. As a result of his
combined business and legal experience, David brings to JMBM and to his
clients his legal expertise, his finance, entitlement and development knowledge,
and his extensive relationships with investors, lenders, brokers, developers,
and service providers. At JMBM, David primarily focuses on the formation
and registration of condominium, timeshare and fractional interest regimes,
the negotiation of hotel, spa and restaurant management agreements, and
the development, acquisition, sale and leasing of hotels and restaurants.
David has assisted timeshare and fractional interest developers (including
one of the largest independent timeshare owners in the country) with the
preparation and registration of their project documentation.
David can be reached at firstname.lastname@example.org
or 310-201-3518. Look for David's timeshare and vacation ownership articles
on HotelLawBlog.com under the "Timeshare" TOPIC or go to www.HotelLawBlog.com/timeshare/.