Restructuring distressed condominium hotel projects and
workouts of defaulted condo hotel loans for profit opportunities now.
Hotel lawyer on failed condo hotel turnarounds, workouts, bankruptcies and opportunistic investment.
20 December 2008
there is no single “silver bullet”
Hotel Lawyers on restructuring distressed condo hotels. Restructuring distressed condo hotel projects and loans secured by them is moving to the top of the list for many lenders, owners and investors. Condo hotel deals are so complex and varied that there is no single “silver bullet” to take care of all problems. Combining JMBM’s legal and business experience in advising on more than 100 condo hotel and hotel condo deals with a veteran condo hotel expert, here is a 3-part article to explain: Part 1: the background and structure of the typical condo hotel, Part 2: critical differences between condo hotel restructurings and those with traditional hotels, and Part 3: a unique approach to working out some troubled condo hotel projects.
The hotel lawyers at JMBM’s Global Hospitality Group® have a rich library of free information on dealing with distressed hotel and hotel mixed-use projects. See “Workouts, Bankruptcies & Receiverships,” under the “HOTEL LAW TOPICS” tab at the top of the home page at www.HotelLawBlog.com.
The condo hotel structure is a long-term viable part of the hotel mixed-use landscape
First, let me clearly state that JMBM’s hospitality lawyers believe that condo hotels have earned an enduring place in hotel mixed-use development. They are viable. They make sense. They will continue to be very useful. Damning failed condo hotels in the current downturn is like bashing single family residences in the housing bust.
There is nothing fundamentally wrong with this type of property — when it is structured properly and built in accordance with sound economics of supply and demand. Yes, there are a lot of poorly conceived and executed condo hotels that deserve their fate, but many sound projects are suffering now too.
in early 2007 . . . there were slightly over 200 condo hotel projects in the U.S.
A landscape littered with distressed condo hotel opportunity (and danger)
Although there is nothing wrong with the condo hotel concept, the landscape is littered with stalled condo hotel sales construction projects frozen in the financial deep freeze. Construction lenders, like Lehman, have reneged on binding loan commitments, and end-user financing has virtually disappeared. Many great projects are now in deep distress. Most condominium buyers are hiding under the bed at home, saving their money and hoping they don’t lose their jobs. Most lenders are ignoring even great projects because they are hoarding capital to cover their capital depletion from derivative losses, no documentation home loans and investments with the likes of Bernie Madoff.
As the optimist said, “Somewhere in here there has to be a pony!” The question is: Can you find it?
Peter Connolly and I will take this on in 3-parts:
Restructuring distressed condo hotels – Part 1
What to do when the hotel is performing
but the condo structure is dragging it down
Jim Butler and Peter Connolly
condo hotels have earned an enduring place in hotel mixed-use development
A significant number of condo hotels came on line as the credit crisis was brewing and now, many of them are facing problems. In many instances, the “hotel” part of the condo hotel is performing reasonably well, but the underlying condo ownership structure is dragging it down.
In the context of the current credit crisis, many believe the “new” condo hotel structure is a failed concept. However, much of what is written about condo hotel workouts fails to distinguish between a) condo hotels that are failing as a result of hotel performance issues and b) condo hotel failures that are directly attributable to the condominium structure rather than to basic hotel economics.
Economic problems due to hotel non-performance
Condo hotels that have economic problems resulting from either expenses that are too high or revenues that are too low are no different than any other hotel when it comes to workouts. But while the same principles apply, the process itself is much more complicated because you are dealing with many individual unit owners — not just one hotel owner — and all those owners will need to be cajoled into accepting restructuring pain. Professionals familiar with the complexities involved in hotel workouts, can competently (and painstakingly) untangle these kinds of failed condo hotels.
Economic problems due to the condo ownership structure
On the other hand, dealing with condo hotels that are struggling financially as a result of the condominium ownership structure — regardless of hotel performance — requires professionals with an entirely new skill set.
There is nothing fundamentally wrong with this type of property . . . but many sound projects are suffering now too.
Important background on condo hotels
The early days. In the early 1970s, a number of condo hotel projects were developed, principally in resort areas. At a time when condominium financing generally was in its infancy, the concept of using hard contract pre-sales for equity “credit” with construction lenders was one happily embraced by the development community. Using the condominium financing structure allowed the developer to take advantage of the condominium pre-sale “credit,” thus reducing the hard equity required for construction and increasing construction loan leverage.
Typically, the developer sold individual room units to consumers. The consumer purchased a unit and when he or she was not using the room, the hotel operator (generally not the developer) would put the room in a rental program to be rented to hotel guests. From this, the room owner would receive either a specific percentage of room revenue or a percentage of the profit generated by the room after the payment of operating expenses.
Why most early condo hotels failed
- Agreements between hotel operations and condo ownership didn’t mesh
. The agreements that attempted to merge hotel operations with condominium ownership simply did not work very well in the early days. Many projects were unable to be maintained appropriately because the agreements did not provide the hotel operation with a source of funding for working capital, capital expenses, etc.
- The SEC determined that condo hotel sales were subject to securities registration
. In 1973 the SEC issued a Release concluding that if a condo hotel unit was sold based upon its income potential, or if the unit owner was required to place the unit in the hotel rental program, or if the income and/or expenses of the hotel operation were being pooled among the unit owners, then the condo hotel offering was an offering of securities requiring registration. Since virtually all hotel condos being developed at the time had those precise requirements, the structure quickly disappeared.
the process itself is much more complicated because you are dealing with many individual unit owners — not just one hotel owner — and all those owners will need to be cajoled into accepting restructuring pain
The second wave of condo hotels
In 2001, having had considerable success with it as a second home investment vehicle in Canada, Intrawest asked the SEC for a “No Action” letter stating that condo hotels could be sold in a way that did not offend the 1973 Release. The SEC agreed in 2002, and by 2004 the condo hotel structure was back in vogue.
To achieve compliance under the “No Action” letter, the new breed of condo hotel offering provided very little information to prospective unit purchasers about the rental arrangement and none about the likely financial results of room ownership. Since nature abhors a vacuum, real estate investors, sensing that the condo hotel was a solid real estate play for income property at a lower price point than buying residential condominiums, and with a rental arrangement (albeit unknown) already in place, made up their own financial results.
They were, of course, wrong.
the landscape is littered with stalled condo hotel sales construction projects frozen in the financial deep freeze
Most unit owners paid too much
By late 2005, it was clear that many unit purchasers were not enjoying the financial success that they anticipated and, as their stories were reported in the marketplace, condo hotels began to lose popularity among consumers. Largely unfamiliar with the economics of an operating hotel, unit owners were unhappy with the disparity between what they paid to the developer and the market value of their unit.
Financing for unit purchasers is no longer available
By late 2006, at the same time that the consumer purchasing market was becoming smarter, the emerging credit crunch essentially eliminated the availability of end user financing for condo hotel units. The condo hotel as an asset had always been characterized as a riskier loan than a second home financing, often carrying a 100 to 150 basis point premium to vacation home and timeshare mortgages. This rating had very little to do with the underlying credit of the borrowers, but was more a function of the unknown resale market for condo hotel units, coupled with the FDIC’s unfortunate experiences with the first round of hotel condos back in the 1970s. In any case, these loans were subprime by definition and are now not available at any price.
200 projects stuck in the pipeline
While there are no official statistics, in early 2007, Smith Travel Research estimated that there were slightly over 200 condo hotel projects in the U.S. which were either in late pre-development stages or under construction. There were also many existing hotels which were in various stages of conversion to condo hotels at the same time, the owners of those hotels electing to use the condo hotel structure as an exit strategy.
This is the structure that must be “unwound” and re-structured so that a workout can be accomplished
Setting the stage: how typical condo hotels are structured
In the new, typical condo hotel structure, the condominium common property consists of the room floor corridors. The unit owners own the guest rooms. The developer or its successors own the public spaces (restaurants, spas, meeting spaces, etc.) and the back of the house areas. The condominium documents generally require the unit owners to fund their own debt service, taxes and FF&E, as well as a portion of the undistributed operating expenses, public space FF&E and common area expenses of the hotel. The unit rental agreements, which are generally additional agreements with requirements beyond those in the condominium documents, invariably have provisions restricting unit owner usage and requiring unit owners to provide working capital and make capital expenditures needed to meet specific hotel or, if applicable, brand operating standards. Most unit rental agreements are for terms of one to three years (securities concerns and the lack of meaningful alternative rental opportunities for the unit owners led to the short terms).
This is the structure that must be “unwound” and re-structured so that a workout can be accomplished. Sound complicated? It is.
In part 2 of Restructuring distressed condo hotels we will look at how condo hotels workouts are different than hotel workouts. And for your convenience, here are links to all 3 parts of this article.
the background and structure of the typical condo hotel
critical differences between restructuring condo hotels and traditional hotels
a unique approach to working out some troubled condo hotel projects
Here are a few of the recent articles on troubled hotel loans and assets for your convenience:
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?
Peter Connolly. Formerly of counsel to Jeffer, Mangels, Butler & Marmaro and general counsel of Hyatt Hotels, Peter Connolly is President – Hotels of Palladian Development, and a principal of Parthian Partners, a new Chicago based workout and restructuring firm providing operational, financial and bankruptcy advice to troubled hospitality projects. He can be reached at firstname.lastname@example.org or at 312.297.0038.
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.