Developers of upscale properties in key markets are back in the development game, thanks in part to recent legislation impacting the sale and marketing of the units.

Condo-hotels are back in the development game, thanks to positive new SEC laws, strong destination markets and the ever-present search for financing.

Developers of upscale properties in key markets are increasingly returning to the condo-hotel concept for new projects, thanks in part to recent legislation impacting the sale and marketing of the units. And at a time when development capital is still scarce, hoteliers are finding that the ability to pre-sell condo units for a proposed project can make all the difference in getting investor approval.  

Condo-hotels—properties where individual hotel room units are sold to investors, who may live there part time and also place the units in a rental program—were a hot commodity up through the mid-2000s, then plummeted with the recession. But recently they’ve made a healthy return in markets such as New York City, Miami and Los Angeles, with several more high-profile projects in the early stages.

“The concept is definitely reinvigorating,” said Greg Hartmann, managing director for Jones Lang LaSalle Hotels’ strategic advisory and asset management team. “It was very large and active in decades past, dropped off the map, didn’t happen post-downturn, and that’s what’s sort of revitalizing now.”

Pivotal new laws

The key words being, “sort of”: The condo-hotels under development are structured differently from those in the past.

Recent changes in Securities Exchange Commission laws now enable individual condo-hotel units to be sold as investment securities, which has a huge impact on the ability to market and sell these properties.

“You cannot, in my view, compare the risks associated with (new) offerings to the risks that were taken on any past condo-hotel that was offered as a non-security,” said Andy Robins, lodging and lifestyle practice chair at law firm Akerman. “It’s just far and away a cleaner structure.”

Some developers have already gotten on board, particularly in South Florida. In Miami, the LeFrak Organization is developing 1Hotel & Homes South Beach with Starwood Capital (and might build another in Los Angeles). Related Group of Florida has four projects underway, including the $150-million, 300-unit Beachwalk hotel-residential development in Hallandale Beach, set for completion in 2015.

The West Coast is warming, too. Among others, Beny Alagem’s Oasis West Realty is planning two Waldorf Astoria condo towers adjacent to its Beverly Hilton property. In Hawaii, Pacrep is planning a second, $160-million condo-hotel next to its existing Ritz-Carlton Residences, Waikiki Beach.

The investment perspective

But why do it at all? For starters, experts say the value is in the ability to pre-sell units to investors before the project has even broken ground (and if the property is branded, that may also mean an early exchange of franchise fees). When underwriters are reviewing the project, those presale numbers are often the deciding factor.

“It’s how you finance them,” explained Mike Marshall, president & CEO of Marshall Hotels & Resorts, which has been involved in various condo-hotel projects over the years. “If you can get enough pre-sells and you can finance them, you don’t have to do a lot of personal guarantees, and you can get a construction loan, because you’ve got commitments to sell the units.”

However, that’s where the trouble often starts. During the last phase of condo-hotel development, some builders were reportedly convicted of defrauding investors, by padding pre-sell numbers in order to access capital. Many projects were also far too costly on a per-foot basis to end up offering the kinds of returns investors were promised, leading to lawsuits.

“It’s not ‘if’ you’re going to get sued; it’s ‘when’ you’re going to get sued,” Marshall said. “People have to understand that you’re probably not going to make very much money on this thing, and you have to treat it as a second home and hope that you offset some of your expenses with any income you might get. For those people who are buying it as an investment, they’re the ones that end up getting mad and suing.”

The rules have changed

In the past, there was also conflict arising from varying standards of upkeep performed by each unit’s owner, as well as owners’ choice of whether or not to place properties in the operator’s rental pool, hampering the available cash flow at the property.

These limiting factors have changed with the latest incarnation of the condo-hotel concept, in which owners often are required to maintain the property to a specific standard, while it is common for the owner to be permitted to only stay in the unit up to 120 days per year, and 29 consecutive days maximum. The units are placed in the rental pool by default when not occupied by the owner.

“Being able to now offer projections if you are so inclined, being able to pool revenues from all of the units, and most importantly, being able to mandate participation—in the developer’s or the brand’s rental program, no less—we looked at that and said, ‘game changer,’” Robins said. “The next question becomes: It’s better than before, but is it good enough to justify developers today going into this structure? I think the answer is a qualified ‘yes.’ I actually think it’s an absolute yes, but it’s conditioned on certain factors.”

Those factors hinge largely on the market where the condo-hotel is built, as well as its brand positioning. Major urban markets such as New York City, Miami, Los Angeles, San Francisco and Boston—where demand is high and there is strong tourist and global appeal—have emerged as key locations for condo-hotels, with upscale and boutique brands largely dominating the space. Resort markets have been slower to return, but may do so in time.

“(The new laws) change the playing field significantly, which you would think allows the game to change significantly. Now, instead of the legal concerns you might have had, now it comes to market concerns,” Hartmann said. “There are some markets that can handle it and are doing quite well, and there are other markets that haven’t gotten there yet and are risky and won’t do as well. …

“I think now it’s going to be something that’s more thoughtfully developed but a little more consistent in its delivery.”