10 November 2008
Hospitality Lawyer — What does the Financial Crisis mean for vacation ownership projects?
As you may have read in a previous article or press release, David Sudeck recently joined JMBM’s Global Hospitality Group as a hotel lawyer to head up our timeshare and vacation ownership practice. He is a real veteran on the team for these issues. (See “Hotel & Timeshare Lawyer Joins JMBM’s Global Hospitality Group® team“).
David has started writing and posting his own series of articles on vacation ownership. You can access these timeshare and vacation resources under the “Timeshare” TOPIC — one of the tabs at the top — at www.HotelLawBlog.com. You can also just go to https://hotellaw.jmbm.com/timeshare/.
Vacation ownership products (including timeshares, fractional interests, and private residence clubs) have an increasingly important role in the development and repositioning of hotels and resorts, but as the Financial Crisis has gone global, there are some special implications for the industry which David writes about in this timely article.
Special implications of “the downturn” for Vacation Ownership: Strengths and Vulnerabilities You Should Consider For Your Project
By David Sudeck, Hotel & Timeshare Lawyer | JMBM Global Hospitality Group®
This article is the second 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 the special implications of the Financial Crisis on the industry.
there is healthy demand for timeshare and other vacation ownership product, but the lack of financing and reduced consumer confidence is chilling sales absorption numbers
Time for more time share or fractional product in your project?
Our clients with hotels or hotel mixed-use projects that are not yet completed and open, or that have unsold residential components, are increasingly stopping to take stock of the situation. Most of them are re-evaluating whether a change in the mix of uses would improve absorption in light of rapidly changing consumer travel, purchase, income, and savings patterns. We are working with our clients to optimize product mix and modify the legal structure of their projects accordingly.
Where appropriate, we are still encouraging clients to incorporate a for-sale vacation ownership component in their projects. Studies by ARDA (the American Resort Development Association), the Washington-based trade association representing the vacation ownership and resort development industries, show that the long-term success of the vacation ownership industry is virtually assured by great demographics, strong consumer demand for vacation ownership product and the variety of new products being offered by a sophisticated industry to satisfy a broad range of consumer desires. However, in the near-term, we see that all real estate and leisure products will be affected by the Financial Crisis, with its impact on the economy, available financing, and consumer confidence.
Is the Vacation Ownership industry immune from the downturn?
Howard Nusbaum, President of ARDA, recently addressed the state of the timeshare industry in this turbulent economy. In his open letter for September/October 2008, entitled “Timeshare, Recession Resilient?” Mr. Nusbaum observed that while the entire hospitality industry may be negatively affected by the economic downturn, there are a number of reasons why timeshares in general should be better situated than other real estate product, and even hotels.
But in his November/December open letter, Mr. Nussbaum was less optimistic. He said, “I don’t have to tell you that our vacation ownership industry is feeling the pain from this credit market crisis, but only as victims and not as part of its cause. And remember that during previous downturns, our resort occupancies have outperformed hotels and our sales have outperformed traditional second home and condo sales–and we can work toward that same outcome this time, too.”
Other than a near-term shortage of receivables financing, all other factors that have sustained the timeshare industry for years continue unabated.
What happened to the short-term outlook for vacation ownership?
“Financing. Financing. Financing.” – Although it has fared better for a longer time than other hospitality and real estate products, the vacation ownership industry has finally been hit by the global credit freeze. Receivables financing has become increasingly scarce and much more expensive. This is the financing — the liquidity lifeblood — that allows resort developers the funds needed for operations, payment of debt service and the origination of more seller financing. It is secured by the paper taken back by the developer-seller from timeshare interval purchasers for the portion of their interval purchase price over their cash down payment.
A case study with Textron. Textron Financial has been one of the leading providers of financing for timeshare resort properties for more than 18 years. Textron Financial’s website says that the company “provided more than $810 million in new financing to vacation ownership and hospitality industries in 2007.”
Even at The Lodging Conference in Phoenix in late September, Textron executives said that they were “still in the market and very active.” However, Textron Financial Corporation’s most recent Form 8-K filed with the SEC in October 2008, showed a dramatic change. It said:
“In recent weeks, volatility and disruption in the capital and credit markets have reached unprecedented levels. In light of current market conditions and in order to reduce Textron’s short term funding requirements, on October 13, 2008, the Board of Directors of Textron approved the recommendation of management to downsize Textron’s commercial finance business, Textron Financial Corporation, (“TFC”). Under the approved plan, TFC will exit its asset based lending and structured capital divisions . . . In addition, TFC will also limit new originations in its … Golf Finance and Resort Finance divisions. [emphasis added]”
Textron’s statement that it will limit new receivables financing lines is troubling, and other smaller sources of receivables financing are following suit, or charging higher premiums for the much-needed financing. The availability of on-site approvals and ready seller financing has been a critical ingredient for the success of the timeshare industry. Anything that significantly reduces this availability is bad news for unsold projects without established financing commitments. Those with existing lines have been, for the most part, successfully renewing and extending their credit facilities.
Sales slowdown from dearth of receivables and seller-financing for vacation ownership product
As the withdrawal of Textron and other receivable financing sources restricts or closes down seller financing, the industry is likely to look to third party financing from sources willing to lend directly to the consumer — the buyer of a timeshare interval. But even in better economic times, only a few lenders understood and were comfortable with vacation ownership product financing. Until someone fills “the gap,” there will be slower absorption as potential buyers are forced to self-finance (pay all cash or draw down on their home equity lines), wait to purchase, or purchase on the resale market at a lower price point where they can afford to buy using cash rather than debt. Slower absorption is likely to result in downward pricing pressure and, in some cases, lender workouts.
To that end, our next article will discuss workout strategies for timeshare, fractional and other vacation ownership projects.
during previous downturns, our resort occupancies have outperformed hotels and our sales have outperformed traditional second home and condo sales
10 Reasons that Time Share keeps going and going like the Energizer Bunny
Other than a near-term shortage of receivables financing, all other factors that sustained the timeshare industry for years continue unabated. As soon as liquidity is restored and financing returns for timeshare and fractional receivables, we expect that the traditionally resilient timeshare and vacation ownership industry will rebound quickly.
Ten factors supporting the industry’s impressive strength include:
- Active Sales Force/Manufactured Demand – The vacation ownership industry has not historically been cyclical because the industry has been able to successfully manufacture demand through an active selling process (rather than relying on passive demand) that includes inducing the consumer to visit the property and educating the consumer to purchase the product.
- Baby Boomers – The demographics drive time share sales. Approximately 76 million baby boomers (ages 42-62) are entering retirement. Baby boomers are drawn to the appeal of owning a flexible vacation product that allows them to travel with their family and stay in fully-appointed accommodations at a predictable and pre-paid price. Despite many years of robust sales, time share is still early in market penetration with only approximately 6 percent of the U.S. population having purchased. That means there are millions of potential customers in the prime target market likely to purchase timeshare.
- Diverse Buyer Base – According to a recent ARDA survey, the buyer profile of the average timeshare buyer has become increasingly diverse. While baby boomers and empty nesters have been the leading purchasers of vacation ownership products over the past few years, the study showed:
- 17% of recent buyers are single
- 31.4% of recent buyers and 24.9% of all owners have children under 18
- The average age of recent buyers is 52
- The median income is $74,000 for recent buyers and $81,000 among all owners
This diverse buyer base suggests that there has been robust demand amongst a healthy variety of prospective buyers, and prior to our recent global market meltdown, the industry was showing signs of continued growth. Again, this probably means that when the financing comes back, additional prospective buyers will come back as well.
- Relative Affordability of Timeshare Compared to Whole Ownership. The origin of timeshare in the United States was based in part on the reduced consumer spending habits associated with the oil crisis of the early 1970s (see Vacation Ownership Properties 101: What are they? How do they work? How are they regulated?). Consumers looking to spend less money than would be necessary to purchase a whole ownership condominium unit may still instead want to purchase a timeshare or fractional interest, and not everyone requires third party financing for their purchase. Particularly in the high-end fractional and private residence club market segment, many purchases have been made in cash, and the purchase price of a 1/8th interest in a multi-million dollar residence will still be perceived as a good value by a high net worth individual comparing it to purchasing a whole residence.
- Investment in Future Vacation Enjoyment. The vacation ownership industry sells a product based on the future enjoyment of a property or an exchange. The perceived value comes from its use rather than an expectation of financial return. Vacation ownership properties allow a segment of the population who could not otherwise afford a whole vacation condominium or home to become vacation property owners.
- Financial Responsibility. According to ARDA, over the boom period, there were not many acquisitions of vacation ownership products made for the purposes of “flipping,” and few in the vacation ownership financing market participated in risky sub-prime lending practices. Instead, the industry’s portfolios of consumer loans have primarily included fixed interest rates with short term loans based on strict underwriting criteria. This means that the default rate amongst vacation ownership purchasers should remain comparatively low.
As traditional receivables financing lines remain unavailable, we suspect that developers will begin to bulk sale their receivables to traditional banks, which should begin making loans again as TARP money is funded
- Community and Governmental Support. Securing development rights nationally is more of a challenge than ever, but local communities and local government have typically welcomed timeshare development because of the resulting economic benefits. Not only do timeshares and fractionals typically generate transient occupancy taxes (where the period of stay remains under that used to trigger the tax – typically 30 days), but they also can generate all of the taxes associated with the sale of a real property interest. These taxes are more important than ever to local government as they face growing budget deficits. As the beneficiaries of a prepaid vacation, vacation ownership product owners also historically have spent more money while traveling than those staying at hotels, lending greater support to local businesses.
- Resale of Foreclosed Intervals. While defaults are still relatively low, if a timeshare consumer does default on a purchase-money mortgage that was financed by the seller/developer, then that seller/developer often is in a unique position to make effective use of the foreclosed interval, particularly if developer sales are continuing at the resort. When a bank or traditional lender is forced to foreclose on a house or condominium, it often deals with having to repair damaged property, finding a management company to operate the property, finding a realtor to sell the asset, and then selling the asset in competition with other area inventory sold at pricing that is outside of the lender’s control. A timeshare developer which provides seller-financing does not deal with much of these issues in connection with a foreclosure because a defaulting timeshare buyer rarely damages the property, and the developer typically already controls the management of and maintains the resort. Furthermore, the developer is in a unique position to sell the foreclosed property using its existing sales team (assuming the developer is still selling its initial inventory) and resell interests at prevailing market pricing for new inventory by offering incentives that are only associated with other product sold by the developer (e.g., the ability to convert a future stay to points only if the interest was purchased from the developer).
- Cash Purchase of Vacation Ownership Products. Some consumers purchase lower-priced timeshares using cash rather than borrow at the relatively high interest rates that have been offered by timeshare developers. With respect to a timeshare interval, this means that the cost of ownership would typically include only low annual assessments and property taxes. As referenced above, purchasers of high-end fractional or private residence club products have also frequently used cash or equity lines of credit from their homes to purchase the higher-priced product. That being said, potential purchasers may feel less compelled to use large portions of their cash in this uncertain market, and home equity loans are increasingly difficult to secure (if there is equity left to draw upon!).
- International Demand. Vacation ownership companies have successfully tapped into international markets, including Asia, where rising incomes have resulted in an increasing middle class and increased demand for luxury and other leisure products. These markets may provide opportunity not only for the development of new product abroad, but the sale of product in U.S. destinations desirable to international citizens. However, as the world’s markets become increasingly volatile (evidenced by article titles like “World stocks tumble on recession fears despite European interest rate cuts”, which posted a few days ago), it is increasingly difficult to predict short-term spending habits internationally as well.
Where do we go from here?
The availability of on-site approvals and ready seller financing has been a critical ingredient for the success of the timeshare industry. Anything that significantly reduces this availability is bad news. The data demonstrates that there is healthy demand for timeshare and other vacation ownership product, but the lack of financing and reduced consumer confidence is chilling sales absorption numbers. As long as it lasts, the credit freeze will adversely affect sales and the industry as a whole.
As traditional receivables financing lines remain unavailable, we suspect that developers will begin to bulk sale their receivables to traditional banks, which should begin making loans again as TARP money is funded, enabling banks to handle large write-offs of bad loans. In the mean time, there is a lot of money sitting on the sidelines waiting to invest in performing assets, and timeshare industry defaults are lower than credit card, car loans and other consumer debt. Therefore, for those developers with staying power, financing help hopefully will be on the way soon.
The availability of on-site approvals and ready seller financing has been a critical ingredient for the success of the timeshare industry. Anything that significantly reduces this availability is bad news
Does that mean that the vacation ownership industry will avoid the loan workouts that other real estate product types are facing? We hope so, but in this game of musical chairs, poorly-conceived and/or unfortunately-timed projects with vacation ownership components may have been caught “without a chair” as the music stopped. Unfortunately, waiting for a return of liquidity can be expensive, and some lenders will be unwilling to extend their matured loans to wait for improved conditions.
As an owner, developer or lender, please contact us if you need assistance with your vacation ownership or hotel mixed-use project. We have a team of attorneys with extensive experience in hospitality law and loan workouts. See our Resource Library for Workouts, Bankruptcies & Receiverships.” or go to https://hotellaw.jmbm.com/workouts_bankruptcies_receiver/.
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 https://hotellaw.jmbm.com/timeshare/.
Articles include:
- Global Hospitality Advisor®: Opportunistic investment alert! What to watch for when buying distressed debt on timeshare, fractional and vacation club developments
- 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?
Thank you to ARDA for serving as a source of information for this article. JMBM is a proud member of ARDA. The open letters from Howard Nusbaum, president of ARDA, can be viewed at www.arda.org.
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 dsudeck@jmbm.com 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 $87 billion of hotel transactions and more than 100 hotel mixed-used deals in the last 5 years alone. Who’s your hotel lawyer?
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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 $125 billion of hotel transactions, involving more than 4,700 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 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 $87 billion of hotel transactional experience, involving more than 3,900 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.
Contact him at jbutler@jmbm.com or 310.201.3526. For his views on current industry issues, visit www.HotelLawBlog.com.
