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?
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:
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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 firstname.lastname@example.org or 310.201.3526. For his views on current industry issues, visit www.HotelLawBlog.com.