Troubled Condo Hotel Workouts - The Time Has Arrived.
By Irvin W. Sandman and Russell C. Savrann
Thursday, 31st July 2008 The recent collapse of the residential real estate boom has put significant stress on the hotel industry’s fledgling condo hotel segment.
Despite earlier warnings, some condo hotel developers pursued and completed borderline projects that lacked sufficient prospects for meeting the reasonable expectations of all stakeholders. These projects now face serious claims and potential litigation.
This article notes how we arrived at this time of difficulty, outlines the issues, and provides guidance on how the best results can be achieved for all stakeholders.
How We Got Here
From 2004 to 2007, the hotel industry reinvented and vigorously pursued a new segment—the “condo hotel.” At a time when the hotel industry was seeing slow but steady recovery, the condo hotel concept took advantage of the booming residential real estate market.
Unlike a traditional hotel development, the condo hotel developer sold the hotel rooms as individual condominium units, with the expectation that the unit owners would then place the rooms back into the hotel’s rooms inventory through a rental program.
By accessing the market for residential condominiums, the developer sought and often achieved earlier and higher returns than was possible through traditional hotel development structures. And in well-conceived projects, the buyers of the units enjoyed benefits that compared favorably to traditional vacation or second-home condominium units.
By February 2006, warning flags were raised. We and others in the industry noted the hazards of condo hotel development and cautioned that borderline and even ill-advised condo hotel projects were being pursued. Developers were advised to recognize that, if a development is inevitably going to produce angry unit owners, then the short-term profit might be eaten up quickly by later litigation. We suggested that the best way to avoid a condo hotel litigation “implosion” was to pursue well-conceived projects that have strong prospects of meeting the reasonable expectations of all stakeholders, including unit owners.
By May 2007, “condo mania” had clearly subsided. In the declining residential real estate market, it was essential for the developer to make sure to begin development of a condo hotel project only if it worked both as a hotel (i.e., it created enough operating profit to satisfy a traditional hotel developer’s expectations) and as a condo hotel (i.e., it met the potentially lower profit expectations of a typical unit owner).
The residential real estate bubble has now burst. The condo hotel segment’s promise of high, early returns fueled by the real estate bubble proved too attractive—many condo hotels that lacked sufficient prospects for meeting the reasonable expectations of all stakeholders did get built. Now, the unit owners, who expected positive or at least neutral cash flows, are seeing significant, negative cash flows and declining room values. And developers, who often remain on the premises as the hotel manager and the owner of the “hotel unit,” are faced daily with unhappy owners, increasing expenditures in time and money to deal with the owners, and even lawsuits.
But these troubled condo hotels can be reworked to achieve better stability and balance for all stakeholders if reasonable steps are taken. The stakeholders and their perspectives need to be understood. Experienced advisors must be selected. Proactive, early settlements can be achieved. The lack of organization of the unit owners often needs to be addressed. The hotel business must be evaluated to identify problems and opportunities. Claims and defenses must be objectively evaluated. The reasonable objectives for the workout can then be established and pursued to a good result.
