For anyone involved in the condo hotel market, the April 5-6 Weekend Edition of the Wall Street Journal could not have brought many smiles. The article ‘Rooms With a Bubble View’ eviscerated the state of condo hotels, with an opening paragraph that offered a welt-raising slap in the sector's face: ‘For many investors, the condo hotel may go down as the Pets.com of the real estate bubble.’
While the Wall Street Journal reported doom and gloom in the condo hotel market, hotel and housing industry experts who are familiar with this niche market recalled Mark Twain's oft-repeated aphorism regarding exaggerated reports of one's death.
‘I think the Wall Street Journal predicted 12 of the last three downturns,’ jokes Jim Butler, founding partner of Jeffer, Mangels, Butler & Marmaro LLP and chairman of the Los Angeles law firm's global hospitality group. ‘It's a fine publication, and one of our favorite ones, but sometimes they get a little carried away.’
Butler points out that unlike other areas of the real estate industry, condo hotels are something of an anomaly; linking its situation with other residential sectors is a mistake. ‘It's like painting everything with the same brush,’ he adds. ‘You can't do it.’
The condo hotel concept first appeared in the 1970s with the promise of offering a luxurious and low-maintenance alternative to timeshares and traditional vacation homes. Although limited primarily to high-traffic resort areas and a few major cities, condo hotels, the Wall Street Journal reports, represent about 10% of all hotel rooms currently under construction, and a higher percentage in Florida, Las Vegas, and other popular tourist areas. Major hotel chains including Trump, Hilton, Marriott and Four Seasons operate these properties.
{OPENADS=zone=7} As Secondary Marketing Executive first reported in October 2006, the units' rental income (typically 50% of income minus the management fee) made them attractive as investment properties. They were targeted at a wealthier clientele, and many lenders offered jumbo loans (some as high as $3 million) to finance these properties. But in that October 2006 article, it was noted the sector was already showing signs of softening – and this was when the housing industry as a whole was considered to be on sound footing.
For Patrick S. Duffy, principal with Los Angeles-based MetroIntelligence Real Estate Advisors and author of The Housing Chronicles Blog, the early weakness in this niche market was not unexpected.
‘It was a very risky proposition, unless the property was flagged under an international luxury hotel brand such as the Ritz-Carlton, Mandarin Oriental or Four Seasons,’ he says. ‘Not just due to oversupply but to a complete lack of transparency on pricing and potential income from renting out these units through the hotel. When developers deliberately hide information such as this from appraisers and consultants – which was a fairly common occurrence at Las Vegas high-rise projects – and forced us to pretend to be buyers, it's hard to believe they were being honest to buyers regarding actual income from joining the rental pool.’
The situation in Nevada's gambling capital is of particular interest to Duffy. ‘In the case of Las Vegas, it was a case of oversupply. I'd be very interested to see any demand studies that were conducted, and the assumptions made on visitors who would be interested in buying a condo hotel unit versus something they could rent out on their own,’ he adds.
Duffy adds that because condo hotels were widely seen as investment properties, rather than traditional second homes, the appeal of immediate and considerable revenue returns checkmated legitimate concerns on financial viability.
‘These were also highly speculative purchases,’ he continues. ‘Not only were buyers speculating on rising values, but also on the presumption of achievable rents and occupancy. With no real track record to gauge, everything boiled down to guesswork and hope – sort of like Pets.com! Moreover, condo hotel units tend to be smaller and pricier than traditional units, so the minute the music of hope stops, the first pillars to fall are condos, speculative homes, pricey vacation homes and something without a track record – all categories in which condo hotels reside.’
The feeble (and, in may cases, nonexistent) return on investment that many condo hotel buyers experienced is being heard in Washington: the Wall Street Journal's recent article notes some unhappy buyers who lost substantial money on their condo hotel units are in talks with the Securities and Exchange Commission, requesting investigations into securities fraud.
{OPENADS=zone=15} Yet Jared H. Beck of the Miami-based Beck & Lee Business Trial Lawyers points out the premature softening and current problems within the condo hotel sector is due to the sector's distinctive nature, particularly when compared to traditional condominium projects.
‘I think it has to do with the use restrictions that are typically part of buying into a condo hotel and signing the management agreement for the unit,’ he explains. ‘Based anecdotally on conversations I've had with many of my clients, I can tell you that a great number of people who speculated in 'plain vanilla' condos, especially in Florida, often believed that if they weren't able to resell the unit before closing, or if the unit didn't appreciate in value, at the very least they would have acquired a nice second or vacation home in a beautiful climate. In this way, the dream of owning a second home helped fuel the housing market craze.’
Yet Beck notes the sector had its own unique limitations that helped weigh it down. ‘Condo hotels have always been a tougher sell, because once the unit enters the rental program, the owner doesn't have control over the unit in the same way that he or she owns a regular condo or other residential property,’ he says. ‘So it is no surprise to me that the condo hotel market softened earlier.’
Yet today's condo hotel market does not appear to be contracting. In fact, it appears to be quite the opposite situation. New projects are still being announced with great fanfare: last month saw the announcement of a $40.6 million construction financing agreement for the Residences at Point Breeze, a luxury condo hotel development on Cape Cod's Nantucket Island, while the always-camera-ready Donald Trump personally cut the ribbon on his new gold-plated Trump International Hotel & Tower in Las Vegas.
‘These projects are all huge, so with their lengthy construction schedules they really don't have a choice but to open when they're finished,’ observes Duffy. ‘With the right location, branding and price, I'm sure there's still a market, although it's probably much smaller than it was in the past.’
Anthony Dadlani, president of the New York-based A Plus Capital Management and author of The Creating Wealth Blog, notes the continued activity in this sector could be better served with an improved marketing and public relations campaign, particularly in view of the negative Wall Street Journal article.
‘The market needs to get good word-of-mouth from investors that this product can provide positive cashflow,’ he says. ‘As an investor, I would buy this product as long as I can get a return and have occasional use of it for my family.’
Butler concurs, stating the Wall Street Journal's focus on problematic condo hotel projects and dubious developers has warped the bigger picture. ‘Focusing on one particular category is not representative of the product,’ he says. ‘It's like picking the bad apple and saying all apples are bad. These abuses are not industry-wide – they're less than the tip of the iceberg.’
In the face of the current market, how should financial institutions approach condo hotel lending today without getting a sense of jittery apprehension?
{OPENADS=zone=13} ‘If they are not doing so already as part of their due diligence process, financial institutions should be taking a hard look at whether a given condo hotel developer has crossed the line into making an unregulated securities offering,’ cautions Beck. ‘The reality of the market now is that those developers which have crossed this line or come too close are going to be facing the largest number of lawsuits from unhappy buyers, and such projects are probably also the ones which unreasonably raised the expectations of buyers. Minimizing litigation risk and managing expectations are keys to a successful project these days, and financial institutions should take this into account when deciding whether to finance a given project.’
Duffy adds that a continued period of economic lethargy will not help this sector. ‘I'd be very surprised to see any construction loans at the moment for condo hotel projects due not only to the market downturn, but also the slowing of the overall economy,’ he says. ‘For mortgage loans, I'd expect the financing bar to be raised with higher down payments and a more realistic, confident assessment of what these units can command in rents and occupancy levels from the developer. Clearly, the days of crossing fingers and hoping are over.’
Yet Butler notes the industry will continue to thrive in the years to come, and lenders should not be apprehensive. ‘Lenders need to realize these are more complex projects – they're mixed-use projects, and you should not go into that type of lending without the right expertise or analysis,’ he says. ‘But lenders shouldn't have a particular fear of them.’