24 November 2008
Even the ARDA Conference in Washington, DC last week reflected the gloomy financial crisis when our timeshare guru, David Sudeck, was there. The usually ebullient crowds were more subdued than normal. In fact, one gentleman in the elevator commented that he considered wearing a noose rather than a tie around his neck at the conference. Ironically, the demand for all flavors of timeshare, fractional, vacation ownership and clubs seems remarkably resilient given the current situation, but the wholesale absence of financing does present some serious problems.
If you missed David’s last report (See Hotel and Timeshare Lawyer insights on special implications of “the downturn” for Vacation Ownership), this is the critical follow-up on how vacation ownership developers can protect themselves.
Time share Lawyer — Three “Keys to Survival” for Vacation Ownership Developers in Challenging Times
By David Sudeck, Hotel & Timeshare Lawyer | JMBM Global Hospitality Group®
This article is the third in a series that will discuss Timeshare, Fractional Interest, Private Residence Club, and Vacation Club properties (sometimes collectively known as “Vacation Ownership” or “Shared Vacation Ownership” properties). This article talks about three keys for developers facing some major challenges now facing the industry.
In prior economic downturns, the developers of timeshare, fractional interest, and private residence club properties — referred to in this article as “vacation ownership product” or “VOP” — were fortunate to see the industry continue to grow. A diverse buyer base and strong demand, due in part to effective selling methods implemented in the industry, were among the reasons industry fundamentals stayed strong. But the scope of the current financial crisis and credit freeze has not spared VOP developers from the adverse forces affecting development and consumer demand worldwide.
What are the 6 biggest challenges facing our Vacation Ownership industry?
- Scarce and expensive receivables financing. When a financial giant like Textron Financial Corporation announces that it will limit new originations in its Golf Finance and Resort Finance divisions (as it did in its October 2008 Form 8-K), developers should take stock of all current and future development. Without reliable receivables financing, there may not be working capital for operations, debt service, or the origination of more seller financing. Wall Street financing that has supported the largest branded timeshare companies has also dried up.
- Construction loan problems. Developers may be looking at a maturing loan or an inability to fund project construction loan interest reserves as a result of construction cost overruns, construction delays, slower than projected absorption, reduced sales prices, or a combination of all of these.
- Increased marketing and sales costs. Bluegreen Corporation reported its sales and marketing expenses increased from 55% during the three months ended June 30, 2007 to 62% during the three months ended June 30, 2008. Many projects are facing higher selling and marketing expenses (as a percentage of gross sales) due to increases in the cost of incentives and less productive tours.
- Downward pricing pressure. The industry is experiencing deterioration in sales prices for a number of reasons, including reduced consumer confidence as well as reduced savings, lost home equity and unemployment resulting in fewer qualified buyers. Sellers are experiencing increases in the cost of providing seller financing (if any) and increased competition from whole ownership and other vacation ownership opportunities.
- Looming owner financing defaults. While default rates remain low in the timeshare industry compared to other industries, including car loans and other real estate products, this could change as some owners are likely to face financial difficulties and need to make decisions with respect to the allocation of limited funds.
- Owner maintenance fee defaults. If a homeowner’s association fails to collect adequate maintenance fees needed to maintain the quality of a physical vacation ownership property or its operations, it could adversely affect ongoing sales or cause owner dissatisfaction resulting in increased interval loan defaults.
Non-loan-related workout strategies may include: (a) project rebranding; (b) replacing property management; (c) changing the sales and/or marketing teams; (d) modifying the VOP product offering; or (e) selling the project.
3 Keys to Survival — How does a VOP developer meet these challenges so as to avoid foreclosure and bankruptcy?
It is important to work with experienced counsel to establish realistic goals for a workout and a strategy for accomplishing these goals.
Ask and answer the right questions — a 3-pronged approach to survival
A vacation ownership project developer facing any one or more of these challenges must act quickly and decisively to limit downside risk and avoid project foreclosure and bankruptcy. This requires a comprehensive analysis of the circumstances affecting the project.
The following issues must be understood and addressed in order to undertake a successful vacation ownership property workout:
- Understand the interests of all stakeholders
The primary stakeholders in the project will generally include the developer, the VOP owners, the property manager, and the lender. Open, strategic, and regular communication with all stakeholders will be key during a workout.
- Evaluate the product – identify problems and opportunities
Developers should carefully evaluate their product with the assistance of an experienced consultant and attorney and determine if a workout strategy should be implemented.
Non-loan-related workout strategies may include: (a) project rebranding; (b) replacing property management; (c) changing the sales and/or marketing teams; (d) modi
fying the VOP product offering; or (e) selling the project.
To identify an appropriate solution, the developer and its consultants will need to work through the answers to a myriad of questions, including:
the developer must undertake an analysis of the highest and best use for the property and determine the costs and limitations involved in re-positioning or selling the property.
- Does the developer still control the project and the condominium association? If not, do the project documents provide the developer with the ability to make changes to the project, its branding, management, and/or remaining unsold inventory?
- Can the project’s flag/brand be changed without substantial expense? If so, is the brand the right brand for the property, or would a different brand lead to higher profits? Certain brands have achieved consumer recognition and sales price premiums. However, the introduction of a new flag to a property can also significantly increase the costs of marketing and operations. Replacing an existing brand, if any, may also require a detailed analysis of termination rights or a negotiated termination.
- Is the property being managed effectively? Are there deferred maintenance issues? Are maintenance dues current? Does the manager have an effective public relations capability to assist the developer with effective communications with the owners? Should the property manager be terminated? Can the property manager be terminated? The developer, an experienced consultant and experienced legal counsel should carefully address these issues. Employing an experienced property management company that can provide the developer and the owners with an accurate and reasonable budget, keep accurate accounting records to determine budget compliance, work within the approved budget, and collect maintenance assessments in a timely manner, is critically important.
- Is the sales and marketing team effective? Do the marketing and sales teams have experience working under difficult market conditions? Are they employing creative and effective strategies to encourage tours, offers and closings? Have they analyzed the local, national and international competition to determine what product is selling and what strategies may be working? If not, are they capable of doing so? If not, then an outside consultant or a marketing and sales team with the appropriate knowledge and background should probably be retained to undertake a complete review of the market, the marketing and sales strategy, and the product(s) offered for sale.
- Would modifying remaining unsold inventory help increase sales pricing or absorption? Would greater use flexibility (e.g., fixed to floating, a points-based system) help with sales? Is it possible to reduce product pricing without reducing profitability (e.g., annual to biennial, increasing the number of intervals per unit through smaller fractional interests)? Is there any market going-forward for the product offered or is a conversion of the project appropriate (fractional ownership percentage to timeshare, from timeshare to hotel, etc.)? For example, a fractional interest community offering a 1/10th interest (allowing 5 weeks or more of usage per year) for a purchase price of $150,000 may be very attractive when area condominiums or homes are selling for well over $2 million. However, if these area properties lose value, then the relative value of the fractional interest may be less compelling or a prospective consumer may opt to purchase the whole ownership property. This may compel the project developer to consider offering a lower-priced product, possibly in the form of a smaller fractional interest allowing for reduced usage time, but it may involve a complete restructuring of the offering. This would require a modification of the project’s documentation and an amended registration with the regulatory authorities. If interests in a project have already been sold, then there may be a host of other legal issues to resolve when considering a modification of the product being sold. Non-legal considerations would include whether, for example, a luxury fractional interest property can function efficiently as a different product type (e.g., timeshare) when the project’s amenities are expensive to maintain and may result in homeowner assessments that are incompatible with the product offered.
- Should the project be sold? Should the developer sell the remaining unsold inventory in bulk or as part of the sale of a mixed-use project? Is there a logical and ideal buyer the property? Can the universe of buyers be expanded and improved by undertaking one of the workout strategies discussed above?
In short, the developer must undertake an analysis of the highest and best use for the property and determine the costs and limitations involved in re-positioning or selling the property. There is no one solution to the challenges facing VOP projects, and any of these solutions will require the involvement of a project’s stakeholders as addressed above.
Open, strategic, and regular communication with all stakeholders will be key during a workout.
- Determine if a loan workout or restructuring is necessary and possible
For a VOP project in trouble, a workout with the project lender may be its only chance for survival. Issues may include an upcoming maturity date, interest reserves that are inadequate based on modified sales price and/or absorption schedule projections, or project cost overruns that cannot be met through additional loan or equity funds.
It is important to work with experienced counsel to establish realistic goals for a workout and a strategy for accomplishing these goals. Considerations will include whether guaranties are in place, whether the property is part of a mixed use project, and how foreclosure or bankruptcy may impact the reputation of the developer.
Because vacation ownership properties are special assets, with an operating business and ongoing sales, most lenders lack the expertise and experience to effectively operate an asset of this type. Therefore, if the lender feels that the borrower has the expertise, financial resources and desire to maintain the asset, and if regulatory considerations do not prevent the lender from engaging in a workout, then the lender is much more likely to provide some relief, in the form of improved loan terms, that will provide the developer with the time and flexibility to work through the other issues facing its project.
If the vacation ownership property is part of a mixed-use project and if the hotel, office, multi-family residential or other income component in the project serves as security for a CMBS (Collateral Mortgage Backed Securities) loan, then there are a host of additional complex considerations relating to prepayment and foreclosure that must be considered before attempting to negotiate a workout with the loan servicer.
The VOP owners: If VOP sales in a project have closed escrow, these owners should be primarily concerned with their ability to use, enjoy and exchange their intervals. Hopefully, the sales staff was trained so as not to create an improper expectation on the part of the VOP owner of appreciation or rental income (unlike some condo hotel purchasers, who may have purchased with an expectation of benefitting from a successful rental program); if improper representations were made by the sales team, then the developer should consult with counsel at JMBM familiar with hospitality and securities laws to understand and address the potential issues surrounding these purchaser expectations.
In any case, the developer should closely monitor whether existing VOP owners are satisfied with their purchase: have all promised amenities been completed and is the property being maintained and operated to their reasonable satisfaction? If not, the developer should attempt to understand and address their concerns. Legal counsel should be consulted to analyze potential claims and defenses.
The property manager: If a third party management company is involved with resort operations — and particularly if the management is coupled with the resort’s branding — then the management company will be concerned about the condition of the property and possible damage to its reputation resulting from the failure of the developer to complete and maintain the project. The manager may be in a unique position to advise the developer regarding the problems with a property’s physical plant, operations, and owner relations. If the management company continues its services for the project, then it should be a key player in assisting the developer in its efforts to rework the project and its relationship with the project’s owners. However, the developer should be aware that if a project is not completed or if funds are not made available by the developer for maintenance and operations, then under the management contract, the manager may have rights and remedies which may include termination and the right to pursue damages.
The lenders or equity partners: The VOP developer should keep its project construction lender(s) and investors apprised of the challenges facing the project. If these stakeholders have been apprised of the efforts made by the developer to work through these challenges, there may be more flexibility if and when it becomes necessary to renegotiate project financing. If third party purchase money lenders have been providing financing to end users or if the developer has an open receivables financing line that requires extension, then the developer should determine what assurances the lender will need in order to continue making loans in support of project sales.
If your project is in jeopardy, act now!
If a vacation ownership project is facing challenges that may put the project in jeopardy, then the developer should seriously consider retaining a turn-around specialist or other consultant to visit their project, assess the situation and offer suggestions for improved performance. If the developer elects to pursue any of the suggested workout strategies or if the developer may be facing claims relating to prior sales, then consultation with legal counsel experienced with the hospitality industry and workouts is a must.
The hospitality lawyers at JMBM’s Global Hospitality Group have a great library of free resources on dealing with troubled hotel loans. Go to top of the home page at www.HotelLawBlog.com, click on the “HOTEL LAW TOPICS” tab, and then sel
ect “Workouts, Bankruptcies & Receiverships.”
JMBM’s Global Hospitality Group® includes an experienced Distressed Assets Team that mobilizes quickly to address the complex issues surrounding distressed hospitality properties and stalled developments. Whether it is a solution to a lender’s troubled loan or the response to a buyer’s opportunity, we work quickly to preserve value and increase cash flow.
Timeshare and Vacation Ownership resources
You can access David Sudeck’s articles on timeshare and vacation ownership under the “Timeshare” HOTEL LAW TOPIC — one of the tabs at the top — at www.HotelLawBlog.com. You can also just go to http://hotellaw.jmbm.com/timeshare/.
- Global Hospitality Advisor®: Opportunistic investment alert! What to watch for when buying distressed debt on timeshare, fractional and vacation club developments
- Vacation Ownership Properties 101: What are they? How do they work? How are they regulated?
- Hotel and Time Share Lawyer Insights on special implications of “the downturn” for Vacation Ownership
- 3 Keys to Survival for Vacation Ownership Developers as the Financial Crisis bites deeper
- Hotel & Timeshare Lawyer: Does the timeshare exit strategy or repositioning your property create ADA problems?
If you are, or are considering, developing a timeshare, fractional interest or condominium hotel project or if you are considering modifying the project documentation of an existing project, please contact David Sudeck, a senior member of JMBM’s Global Hospitality Group®. David can be reached at firstname.lastname@example.org or 310.201.3518. Look for David’s timeshare articles under the “Timeshare” HOTEL LAW TOPIC tab at the top of the home page on HotelLawBlog.com.
This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We’ve done more than $50 billion of hotel transactions and more than 100 hotel mixed-used deals in the last 5 years alone. Who’s your hotel lawyer?
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 email@example.com or 310.201.3526.
Jim Butler is one of the top hospitality attorneys 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. In the last 5 years alone, Jim and his team have assisted clients with more than 100 hotel mixed-use projects — frequently integrated with energizing lifestyle elements.
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.