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Condo Hotel Lawyer: The “Splits” — One size does not fit all

Author of www.HotelLawBlog.com
6 November 2006
Condo Hotel Lawyer on customizing the “Splits” for your project. As hospitality lawyers and business advisors, my partners and I spend a lot of time with our hotel developer clients determining the appropriate “splits” for their condo hotel projects. How to split — or divide — revenues earned from renting a condo unit between the unit owner, the hotel operator, and other stakeholders, is critical to a condo hotel’s success. So let’s look at some of the considerations.


What are “splits” all about?

Let’s say that Bill and Joan Morgan are looking to purchase unit 201 in your newly developed Paradise Hotel & Residences. And let’s also assume that the Morgans would put unit 201 into the hotel rental program. The “splits” refer to how much of the rental income the Morgans would receive as a unit owner, and how much is kept by the operator or other stakeholders. The guest staying in the Morgans’ unit may pay $1,000, but the “splits” refer to how much of that the Morgans actually receive. The Morgans, as the owner, expect to receive cash through the rental program, and that cash has to satisfy their reasonable expectations.

At the same time, the hotel operator must have enough money to operate the hotel at the level of service that the people buying the units expect, depending on its brand or market position. A guest at a five-star property will understandably expect more than a guest of a four-star property, so the splits received by the operator will have to adequately cover the costs of meeting guests’ expectations.

Obviously, if the operator collects too little, the hotel cannot be maintained at the expected level of quality and service, and the operator cannot afford to lose money for very long. But, if the operator gets too much, unit owners will feel unfairly dealt with and will have less money to defray their costs of ownership.

In many multi-use properties, splits involve more than operators and unit owners. In complex properties, there are a number of potential players — the owner of traditional hotel rooms (if any), residential unit owners, condo hotel unit owners, timeshare or fractional owners, and retail or commercial unit owners (e.g. the owners of the spa, waterpark, restaurants, parking operator or sundries store). For these multi-use properties, the formula for achieving fair and adequate splits can become quite complicated.

No standard formula

In the earlier days of condo hotel development, there was often a simplicity to the “splits” issue. Typically, condo hotels simply divided room rental revenues between condo unit owners and the operators — usually somewhere in the range of 50%-50%, but possibly ranging from 40%-60% to 60%-40%. These splits were an inexact way of dealing with expenses and were generally based on guesses as to future expenses and revenues. Too frequently, operators collected too little revenue to cover the expenses, and sometimes they collected too much.

Now that condo hotel developments have evolved into complex mixed use developments, we have to decide what expenses should be included in assessments charged to all unit owners, versus what expenses should just be charged to unit owners in the hotel’s rental program. Only the expenses charged to unit owners in the rental program will be reflected in the decision on the rental income splits. However, even though we don’t reflect all expenses of the project in the rental revenue split analysis, we have to keep in mind the unit owners’ total expenses of owning a unit — including their assessments and the amount of the rental income retained by the hotel owner — when we decide how much of the rental revenues to share with the unit owners. If we don’t share enough of the rental revenues with the owners, they will wind up having to write checks every month to cover their assessments, and they will not be happy about that. The goal of any rental revenue split arrangement should be to allow the owner to at least cover their assessments.

The only way to fairly allocate expenses and income is to work with actual numbers, and charge each party a fair share of the expenses. The allocation requires both a micro view of all the usage and benefit of each part of the hotel or resort facility, and a macro assessment of the financial viability of the regime suggested by allocations. In both assessments, the goal is to strike a fair balance of allocations that will assure proper maintenance of the physical and service standards and appropriate rewards.

Although it sounds straightforward, the allocation process can get fairly complex and really requires an individualized assessment of each property, its facilities and usage — not to mention what will happen on future expansion. JMBM’s Global Hospitality Group is fortunate to have my partner Catherine Holmes to assist clients in working through the many thorny business and legal issues involved. (Her contact information is below.)

How costs are allocated is critical, and this process will be the subject of an upcoming blog entry.

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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 cholmes@jmbm.com.

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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.