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Condo Hotel Splits — Allocating Costs Fairly and Consistently

Author of www.HotelLawBlog.com
8 November 2006
Condo Hotel Lawyer on “The Splits.” A few days ago, in a posting called The “Splits” — One size does not fit all, I emphasized the importance of achieving fair and realistic “splits” of revenue among all the stakeholders in a condo hotel or other hotel mixed-use property. These stakeholders might include condo hotel unit owners, timeshare or fractional owners, pure residential unit owners, and retail or commercial unit owners (e.g. the owners of the spa, waterpark, restaurant, parking operator or sundries store).

The key to getting the right splits and a viable condo hotel regime structure is a fair and reasonable allocation of all expenses and revenues involved in the project. As a starting point, you might allocate expenses on the basis of square footage use, revenues generated or other rational basis. But what items should be allocated to whom? How do accomplish a fair allocation?


Unit maintenance agreements

Before splits are determined, costs have to be reasonably charged against income, and properly allocated through an array of different document or regime elements. Some costs may be allocated through the condo docs. Others may be charged through management agreements or through voluntary or mandatory “unit maintenance agreements.”

In most cases, our hotel developer clients determine that residential and condo unit owners should be required to meet consistent quality standards of appearance and upkeep, and to pay designated fees and costs that enable the hotel operator to provide the services necessary to assure that the standards are met. We often specify the services that will be provided by the hotel operator to the residential and condo unit owners in “unit maintenance agreements.” These agreements might state that the hotel operator will be responsible for all housekeeping, repair and maintenance of the unit and specify the charges the unit owners will pay for these services — whether or not the units are put into the hotel rental program. Participation in the unit maintenance program (as opposed to participation in the rental program) can be required as a condition to buying a condo unit.

As most people understand, requiring participation in a maintenance agreement is not the same as requiring a condo unit buyer to participate in a rental program. Requiring such participation, or even inappropriate discussion of such a rental program prior to sale, could create a big SEC problem — turning the sale of the condo units into a sale of “securities.” See, Why does the SEC care about condo hotels?

Shared facilities

When structuring a hotel mixed-use project — particularly with one or more residential components — we often create something called “shared facilities” which are usually owned by the developer with costs assessed to all who use or benefit from the facilities. The “shared facilities” typically include many of the facilities that might otherwise be common areas in a pure residential condo. They also include non-revenue producing facilities that are necessary for the hotel or condo operation such as the bell desk and property security. For consistency, hotel operational issues, quality control, safety and a host of other reasons, these facilities are not owned by the homeowners association but by the developer, operator or other third party.

Still other expenses may be deducted before the “splits” (and may be in the hotel management agreement or homeowners association’s management agreement) or absorbed by one party or another from their “splits.” The more upscale and complicated the property, the more there is to take into account. And of course, this whole structure is also affected by restrictions imposed by the state real estate regulators, the SEC, entitling agencies, operator standards, cash flow models, competition and other factors. Yet it is one of the most important aspects of structuring a successful condo hotel project and deserves all the time and attention it requires — particularly as some parts of it may be “baked in” to the CC&Rs and other documents that are difficult to change once the first condo unit is sold.

Get the best guidance available

Developers should get help from an experienced advisor who has seen all the approaches to allocation issues, worked through the problems and rationales, and understands the evolution of expense allocations or splits in today’s complex environment. This is not an area where you want your professionals to learn on your job, at your expense!

If the allocation of expenses is not worked through carefully, the developer can be vulnerable to “gaps” that leave financial exposure to significant expenses that are uncovered. Developers could also become vulnerable to legal exposure for violation of state law governing condominiums.

Finally, poorly conceived assessments and rental revenue splits can result in unsustainable hotel operations that disappoint the expectations of everyone, including unit buyers. Lawsuits and serious financial problems often follow angry consumers — a scenario that can be avoided by smart planning on the front end.

If you are interested in condo hotels, or hotel-enhanced mixed-use, you may find these articles helpful:

Condo Hotel Fundamentals

Condo Hotels: Program Design is Key

Condo Hotels: Room Inventory is Vital

Condo Hotels: Standards Must Be “Built In”

Not so fast! Locking Down the Condo Hotel Structure

Condo Hotels’ Enduring Legacy: Hotel-Enhanced Mixed-Use

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Our Perspective. We represent developers, owners and lenders. We have helped our clients as business and legal advisors on more than $50 billion of hotel transactions, involving more than 1,000 properties all over the world. For more information, please contact Jim Butler at jbutler@jmbm.com or 310.201.3526.

Jim Butler is one of the top hotel lawyers in the world. GOOGLE “hotel lawyer” or “hotel mixed-use” or “condo hotel lawyer” and you will see why.

Jim devotes 100% of his practice to hospitality, representing hotel owners, developers and lenders. Jim leads 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.

Jim and his team are more than “just” great hotel lawyers. They are also hospitality consultants and business advisors. They are deal makers. They can help find the right operator or capital provider. They know who to call and how to reach them. They are a major gateway of hotel finance, facilitating the flow of capital with their legal skill, hospitality industry knowledge and ability to find the right “fit” for all parts of the capital stack. Because they are part of the very fabric of the hotel industry, they are able to help clients identify key business goals, assemble the right team, strategize the approach to optimize value and then get the deal done.

Jim is frequently quoted as an expert on hotel issues by national and industry publications such as The New York Times, The Wall Street Journal, Los Angeles Times, Forbes, BusinessWeek, and Hotel Business. A frequent author and speaker, Jim’s books, articles and many expert panel presentations cover topics reflecting his practice, including hotel and hotel-mixed use investment and development, negotiating, re-negotiating or terminating hotel management agreements, acquisition and sale of hospitality properties, hotel finance, complex joint venture and entity structure matters, workouts, as well as many operating and strategic issues.

Jim Butler is a Founding Partner of Jeffer, Mangels, Butler & Marmaro LLP and he is Chairman of the firm’s Global Hospitality Group®. If you would like to discuss any hospitality or condo hotel matters, Jim would like to hear from you. Contact him at jbutler@jmbm.com or 310.201.3526. For his views on current industry issues, visit www.HotelLawBlog.com.