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.
Part 2
21 December 2008
Everyone needs to “share in the pain” required to effect a solution.
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.
In the current market, there are a number of solid assets which were structured as condo hotels during their pre-development phases, and generated enough unit pre-sales activity to get built. These hotels are now open or opening, and the developers are closing the sales of their pre-sold units to pay down their construction debt. However, because both the market for unit sales has dissipated and end user financing has disappeared, these projects now cannot sell out to new purchasers.
Foundational principle = 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.
The developers of these projects are left in “take-out limbo.”
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. This is part 2.
Restructuring distressed condo hotels – Part 2
What to do when the hotel is performing
but the condo structure is dragging it down
by
Jim Butler and Peter Connolly
How Condo Hotel Workouts Differ From Hotel Workouts
Part 1 of this series concluded with an important explanation of how a typical condo hotel is structured. If you have not read Part 1:, you will want to review it before you read the background and structure of the typical condo hotel, Part 2:, below, dealing with critical differences between condo hotel restructurings and those with traditional hotels, or Part 3: giving our unique approach to working out some troubled condo hotel projects.
It is important to note that there is nothing systemically wrong with the condominium hotel financing structure. It has its place in the permanent “tool box” used by developers and their advisors to structure hotel projects. However, in the current credit crisis, the structure provides impediments to permanent financing or exit that need remediation.
The basic strategy for working out condo hotels must be to “uncondo” them.
Why even good condo hotel projects are failing
In the current market, there are a number of solid assets which were structured as condo hotels during their pre-development phases, and generated enough unit pre-sales activity to get built. These hotels are now open or opening, and the developers are closing the sales of their pre-sold units to pay down their construction debt. However, because both the market for unit sales has dissipated and end user financing has disappeared, these projects now cannot sell out to new purchasers. And many of the existing pre-sold contracts are not closing, as the purchasers either cannot find financing or are electing to lose their deposit rather than close on assets of questionable value.
Developers in “take-out limbo” and unit owners in shock
The developers of these projects are left in “take-out limbo.” No conventional financing lender will place a mortgage on the residual hotel (the unsold units and public spaces) because no one knows what it means to foreclose on part of a hotel, and no financial buyer will acquire the leftover parts in order to own pieces of a condo hotel from which there is no easily identifiable future exit. A developer that cannot sell out its units will not be able to pay off the construction loan. At the same time, unit owners that do close on their units are beginning to learn, in many cases, that the economics of the hotel business are different than the economics they expected when they purchased their unit.
The basic strategy for working out condo hotels must be to “uncondo” them.
Not your traditional hotel workout – the developer cannot be the workout entity
The basic strategy for working out condo hotels must be to “uncondo” them. Again, it is important to note that these hotels may be performing as well as originally projected by their developers. The problem they now face is that the existing condominium structure is preventing either a sell-out or a take-out. Absent some way to infuse new capital into these projects they will ultimately become economically untenable.
As with all workouts, there will be some marking of equity to market in the rationalization of the ownership structure, and the recognition that the original unit prices were not market value. The original developer risks securities class action litigation if it attempts to buy back the units it sold from the same buyers at a discount to the price it sold them for. So, in most cases, the workout entity for this type of workout cannot be the original developer.
A third party purchaser is required: risk and opportunity
A third party purchaser will be required to drive the workout plan. Because there are no financing and sales exits available for the third party if it fails to “uncondo” the property, the value of the remaining units must be adjusted by what appraisers would call a “marketability discount,” and reduced to justify the risks taken by the purchaser. In order for the third party to make a risk justified return, the discount to fair market value (not the unit purchase prices) will need to be very substantial.
The fundamental principles of hotel workouts must be observed, but with special consideration to the condo hotel structure.
5 Rules for getting all stakeholders aligned in the workout
The fundamental principles of hotel workouts must be observed, but with special consideration to the condo hotel structure. The workout plan must offer some hope to all stakeholders.
- The stakeholders need to be identified and each needs to accept the economic dilemma as its own
. In this case, the stakeholders are the developer, lender and the unit owners. The developer, for reasons noted above, needs to be taken out of the equation, leaving the lender and the unit owners;
- Everyone needs to “share in the pain” required to effect a solution
. In the hotel condo situation, the developer gives up its position on the way out, the lender may need to write down the balance due on the loan to reflect what the purchaser is able to pay for the remaining units, and the unit owners will need to come to grips with the disparity between purchase price and fair market value;
- The stakeholders need to understand and accept that the workout is the only way out
. In the hotel condo circumstances, neither the lender nor the unit owners have any other exit possibilities;
- The party with the workout plan drives the bus
. In the hotel condo situation, the third party purchaser is the entity bringing value and hope to the lender and the unit owners, and cannot allow itself to be placed in a position in which it is negotiating a series of separate deals with a multitude of condo owners. The purchaser makes a deal with the lender and then makes a “take it or leave it” offer to the unit owners;
- The plan needs to offer hope to the stakeholders
. In this instance, that hope may be literally a “hope certificate” in the form of a pay or waive portion of the loan or a subordinated equity interest reflecting the market write-down.
In Part 3 of Restructuring distressed condo hotels we will look at what it takes to “uncondo” a condo hotel. 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:
Do you know the 8 Dos and Don’ts of handling troubled hotel mortgage loans?
The “Comprehensive Situation Analysis” for troubled hotel mortgage loans and workouts
Lender and borrower alternatives for troubled hotel mortgage loans
Butler’s Matrix: Key to hotel mortgage loan defaults, workouts, bankruptcies and receiverships.
Special Servicers and Special Asset teams confer in Dallas for top special servicing conference
“Speed bumps” in the road to bankruptcy for hotels and resorts.
JMBM’s SAVE® Program for Troubled Hotel Loans
Restructuring distressed condo hotels
Terminating hotel management agreements when things don’t work? Not easy, but not impossible either.
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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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 pconnolly@palladiandevelopment.com or at 312.297.0038.
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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.