Hotel Online  Special Report
---
The Global Hospitality Advisor

.
Regulating Condo Hotels

Bad Condo Hotel Municipal Ordinances
Will Discourage Good Projects

.

This article first appeared in the May 2006 issue of Urban Land, published by the Urban Land Institute (ULI). ULI is the copyright owner and this article is reprinted with permission.

by Catherine DeBono Holmes, June 2006

With the increasing demand for condo hotel building approvals around the country, municipal governments have scrambled to develop zoning ordinances that will allow high quality condo hotel developments, while at the same time preserving the transient occupancy tax (TOT) revenues that are so important to municipal income, assuring an adequate supply of transient hotel rooms for tourists, as well as for business and leisure travelers (to support tourism, and municipal facilities such as convention and conference centers); and controlling additional costs for and burdens on local infrastructure such as schools and city services.  

Cities in hot markets like California, Florida, New York and Nevada have looked at examples from some of the early adopters of condo hotel zoning ordinances, while some cities have sought help from local attorneys aimed at further refining the approval requirements for condo hotel developments.  

Developers need to review carefully these detailed ordinance provisions, as they may, in some cases, be counterproductive to the sale and operation of a condo hotel.  In addition, developers must be cautious about their own involvement in the adoption of municipal ordinances, as they run the risk of converting the offering of their condo hotel units into an offering of �securities� under federal securities law. This dreaded event can be disastrous for developers. In dealing with municipal ordinances concerning condo hotels, the unwary should take heed of the following dangerous traps. 

Restrictions on Unit Owner May Jeopardize SEC Status

Overly restrictive use and rental conditions in an ordinance on owners of condo hotel units could, under certain conditions, result in the units being characterized as securities under federal and/or state securities laws. In the past, through a series of �no action� letters, the Securities and Exchange Commission (SEC) has permitted limited zoning restrictions�including prohibitions on the use of a condo hotel unit as a permanent residence and requiring unit owners to make units available for rental�without finding that these restrictions caused the condo hotel offering to convert into a �security.�  However, developers need to be aware that the SEC's no-action letters are not binding on the courts, and the SEC can change its position depending on the facts of each offering or upon changes in the SEC's views in general. Therefore, developers cannot rely on previous no-action letters as protection against any potential securities claims by regulators or purchasers.

The SEC recently advised informally that it will examine the totality of all restrictions and requirements on unit owners, including those imposed by zoning ordinances, in determining when condo units will be deemed securities. Therefore, developers should not assume that any restriction on unit owners contained in a zoning ordinance will automatically be acceptable to the SEC or other authorities in their determination of whether the condo units are securities.
 
Standards for Hotels and Hotel Operators  May Be Unreasonable

One recently proposed ordinance would have required every condo hotel to be operated under a �brand� included in the �upscale segment� or �luxury segment� defined by J.D. Power and Associates, and upon completion, to meet the published requirements to receive a rating of no less than a Mobil 4-star or AAA 4-diamond designation. While these designations may sound like a reasonable assurance that every approved condo hotel will meet the highest quality of operational standards, they may impose undue restrictions upon the developer and create unrealizable expectations. 

Many condo hotel developers, as well as potential purchasers of condo hotels in future years, may prefer to be managed by an owner rather than by a "brand.� In addition, most hotels that are regarded as luxury hotels, and that are commonly spoken of as Mobil 4-star or 5-star hotels or AAA 4-diamond or 5-diamond hotels, are not in fact holders of the actual designation from Mobil or AAA. The higher luxury hotel ratings (e.g., 4- and 5-diamond or star ratings) involve some very subjective and elusive qualities, and even if a hotel achieves such a rating, the rating might be lost on technical grounds without a noticeable reduction in quality. However, in either event, the developer�s hotel could fail the test and be in violation of the municipal ordinance. 

It is preferable that zoning requirements speak in terms of hotels being operated as �upscale� or �luxury� hotels, without specifying either that they are required to be operated by a "brand" or that they maintain a particular Mobil or AAA ranking. 

Common Area Ownership

One recently proposed ordinance required that the common areas of a condo hotel be owned by the developer or an entity other than the condo hotel unit owners. Apparently, it was designed so that the homeowners association (or HOA) would not own the common areas of the hotel. However, the condominium regulations of some states require that common areas are owned by an HOA, or at least that their ownership might be transferred to an HOA, should certain events occur. In addition, some state laws do not allow cities to determine who owns property, requiring that ordinances be limited to restrictions on the use of property. 

Hotel Management Agreements

Another proposed ordinance required that a condo hotel HOA enter into an agreement with a hotel manager that would last at least five years. However, the condominium regulations in some states limit the duration of contracts that an HOA may enter into. In this case, the proposed ordinance would be in conflict with state law. Some hotel operators may not agree to enter into a management agreement with an HOA, although they might agree to one with the developer and the individual unit owners. The ordinance could then deny the developer the right to enter into a management agreement with a desired hotel operator. 

Budgets and Other Operating Matters

Some ordinances require the developer to submit a budget to the condo hotel HOA for the maintenance of the hotel.  Such an ordinance assumes that the HOA will be responsible for maintaining the hotel, which is not always the case. In fact, the standards for the operation of condo hotels, including the budgeting process and other operational matters, are undergoing significant changes, as developers around the country experiment with various types of operational models. Cities should allow for this process and not micromanage condo hotel operational matters.

Beware of Developer Participation in the Ordinance Process

Some developers understandably want to work closely with city building authorities to craft ordinances that the developers believe will provide necessary flexibility and will solve certain hotel operating issues by limiting owner use and occupancy rights. But this can prove dangerous. A developer who is overly active in an ordinance process that results in restrictions on the owners� use and rental of their condo units could place the condominium offering at risk of being converted into a securities offering. The SEC has said that limited restrictions on the condo hotel owner�s use imposed by a preexisting ordinance will not cause a project to become a security. 

However, if a developer uses the ordinance process to create material restrictions on an owner's use, the SEC (or a court) could decide that restrictions on the owner�s use imposed by ordinance were in fact caused by the developer's own actions, and thus renders the condo offering a security. 

In general, developers should limit their participation in the ordinance drafting process. They can probably work to reduce municipally imposed restrictions on developers and owners as to use and management of a condo hotel, but these issues normally should only be brought to the attention of municipal officials in a conceptual way. In fact, the entire interaction with the city in the ordinance process must be carefully guided to avoid running afoul of important SEC considerations.

Municipalities Should Regulate with Care

Municipalities have legitimate reasons to regulate condo hotels, but they must do so carefully. Overregulation strips value from the condo hotel real estate and makes justifying the skyrocketing costs of construction more difficult. Undue restrictions also can deter purchasers from buying units and present operational issues that drive away high-quality operators that are essential to a successful project. 

Finally, overly restrictive municipal regulation of condo hotels could create insurmountable SEC problems for developers by causing the condo hotel units to become securities---either by overly burdensome restrictions on owner use and rental of condo units, or by involving developers too heavily in the ordinance process. Either road can lead to disaster and may convert the offering of condominium real estate into an offering of condominium securities. 

Most important for cities, bad ordinances with unnecessary and ill-conceived restrictions will discourage good projects that would otherwise benefit cities, developers, buyers of residential units, and the traveling public.



Catherine DeBono Holmes is a senior member of JMBM�s Global Hospitality Group® and a partner in the firm�s Corporate Department. Catherine assists clients with hotel management and franchise agreements, purchase and sale transactions, and condo hotel regime structuring. For example, Catherine provides national representation for a large hotel owner�s hotel management and franchise agreements. She recently assisted a client with a 1,500+ room convention hotel in successfully concluding a complex RFP process involving all the major hotel brands and negotiating a favorable management agreement. She devotes a significant part of her practice to advising condo hotel clients on many important business and legal aspects condo hotel regime structure and condo hotel documentation, including CC&Rs, HOA docs, unit management agreements, shared facilities agreements, rental management agreement programs, and securities compliance matters (structuring, documentation and training). Catherine can be reached at 310.201.3553 or [email protected].
.


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
[email protected]
http://www.jmbm.com

The premier hospitality practice
in a full-service law firm
 --
Also See: Union Withdraws Complaint Against Hotel; NLRB Concludes Owners Do Not Have to Re-hire Workforce / Marta Fernandez / Global Hospitality Advisor / June 2006
American Indian Gaming Fuels Opportunities for Hospitality Industry / Global Hospitality Advisor / June 2006
Jim Butler on Condo Hotels / The Evolution of Rental Revenue Splits and Expense Allocations / March 2006
The Labor Pains of Hotel Closings; Optimal Strategies for Full or Partial Hotel Closings / Marta Fernandez - JMBM / March 2006
A Developers Nightmare: How Municipal Ordinances Can Make Condo Hotels �Securities� / JMBM / February 2006
Condo Hotels and the Americans with Disabilities Act: A Case of Mistaken Identity? Is your condo hotel a �residence� or a �place of public accommodation�? / JMBM / February 2006
Outlook 2006: GHA Hospitality Roundtable / JMBM / December 2005
The Condo Hotel Boom - What Does it Mean for the Hotel Industry / JMBM / December 2005
Ask the Hotel Lawyer� / New Business Uncertainty: Jury Trial Waivers Struck / December 2005
Five Keys to Successful Condo Hotel Regimes / �Ask the Hotel Lawyer�  / October 2005
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
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 


To search Hotel Online data base of News and Trends Go to Hotel.Online Search
Back to Hotel.Online Press Releases
Home | Welcome! | Hospitality News | Classifieds | Catalogs & Pricing | Viewpoint Forum | Ideas/Trends
Please contact Hotel.Online with your comments and suggestions.