Condo Hotels - The Most Economical Choice in Secondary Vacation Homes


In a condo hotel, a buyer makes a fee simple purchase of a deeded condominium unit/guestroom. When not occupying the room, the owner may make the unit available to guests at the hotel through a rental management or leaseback program. Any room revenue generated through the program is shared between the unit owner and the developer/managing partner. This scenario provides a host of tangible benefits for the condominium owner, including a deed to a physical room, access to all hotel amenities and the ability to take advantage of a 1031 tax-deferred exchange. Condo hotels differ from other vacation home models in a variety of ways.

The condo hotel concept has numerous advantages over other vacation models, including greater product consistency, fewer ownership conflicts and hassle-free rental opportunities.

Seldom-used vacation homes take time and money to oversee and maintain. With a condo hotel, you get the services and flexibility without the time commitment. The on-site management company takes care of all maintenance, finds renters and takes care of renters' needs on-site.

You have full ownership of your condo hotel unit and may sell it at any time.

When you're not using your unit, you may place it in the hotel's rental management program and share the revenue it generates.

A condo hotel unit is an asset that you may sell at any time, and, you keep 100% of the profits.

Standardized furniture packages are often incorporated into the price, or at minimum, your turnkey unit should look like all the other units in the hotel

Units rented to hotel guests suffer wear and tear. Expect special Furniture, Fixture, and Equipment (FF&E) assessments to replace worn carpet, drapes, furniture, etc.

The rental program allows condo hotel owners to earn rental income and provides access to hotel services and amenities

Potential for tax breaks associated with mortgages and depreciation.

Maintenance free ownership because property managers handle all maintenance.

Ability to take advantage of a 1031 tax-deferred exchange.

To assure room availability for visitors and tourism, local governments may limit the amount of time owners may use their unit.

Financing can be more costly than for a primary residence - usually +1%.

If the owner wants to use the unit, they should notify the hotel in advance.

Owner should pay additional fees if they want to utilize housekeeping and other services.

Income from rental may fluctuate if there is a decline in travel, desirability of the unit, or based on hotel rental rates.

Condo Hotel Owners may need to purchase additional insurance riders to protect against liability claims and damage or loss.

Condo Hotel Owners will pay monthly Condominium Association Fee's

Should a condo hotel owner decide to participate in a rental agreement, they should determine if the property has a static "hotel room" inventory. Commercial unit "rental preferences" over privately owned units could affect rental opportunities, check rental agreement language to insure fair and equitable distribution of rooms among both commercial hotel rooms and participating privately owned condo hotel units.

Additional particulars pertaining to the successful operation of condo-hotels are highlighted as follows:

- Rental contract term is typically 6 months to one year.

- Check owner's intent to occupy notification requirements, necessary to guarantee availability for

individual owners.

- Unit owners should receive quarterly statements showing a detailed breakdown of all unit and account

activity.

- A rotational booking program should be used to ensure that units in the rental program enjoy a fair and

equitable distribution of rooms sold.

- If there is an unusual or extraordinary event, the hotel guest may be charged for damage to the owner's

unit. Normal wear and tear is anticipated and is the responsibility of the unit's FF&E reserve account.

In order to place a unit in a rental program, a management and rental agreement is first signed between the unit owner and the hotel management company. This agreement provides for a number of variables, primarily:

- A portion of the revenues received from the nightly sales of rental program units flows through to the condo hotel owner. This is typically a 50-50 split after a 7-11% Marketing Fee and a 7-10% FF&E Capital Reserve are deducted. The hotel management company/operator retains the remaining portion of the rental revenue stream.

- A Usage Agreement is implemented between the condo hotel owner and the management

company/operator, providing for the implementation of an FF&E reserve.

- The FF&E furnishing packages should meet certain standards. Failure to comply with such standards may either require immediate refurbishment at the unit owners' expense, or the expulsion of non-conforming condos from the rental program.

- Responsibility for the maintenance and repairs of common space is allocated among condominium hotel unit owners, based on their pro-rata shares. A Homeowners' Association (HOA) is usually set up to retain ownership of such areas and oversee the collection of dues from condo hotel unit owners. These dues typically cover reserves, common area maintenance, property insurance and utilities expenses. Property taxes are usually paid for directly by each condo hotel owner, and the hotel manager pays for any operations costs including salaries and other direct hotel expenses.

Developers create projects by building or converting resorts and sell units through sales and marketing programs. Marketing costs can run as much as 11% - 15% of the unit selling price, and are rolled into the price of the unit.

Much of the actual law governing the sale of condo hotels is established by the property's municipality and state. State laws cover most aspects of condo hotel documentation, but there are important federal laws that should be considered. The sale of a condo hotel unit, coupled with certain other elements, classifies the offering as a security.

In 1973, the Securities and Exchange Commission (SEC) determined that selling resort condominiums through a sales effort that emphasized economic benefits (such as rent-programming, mandatory rental program participation and use restriction) made the sale an investment contract and not a real estate contract. This section outlines the key differences between these two transactions.

Security offerings should be registered with the United States Federal Security and Exchange Commission (SEC) and should also meet state level securities registration requirements.

The SEC states that:

- The sale can be marketed as an investment as long as it includes information about anticipated rates of

return.

- A seller can represent a condominium hotel unit as an investment (including mandatory participation in

the rental program and potential appreciation in the value of the unit) and can program rents and

expenses among unit owners.

- All sales materials should have the necessary warnings and disclaimers typical of a prospectus.

- Large projects should file periodic disclosure reports with the SEC, similar to publicly traded companies.

If the securities are not registered and not publicly traded, then there are the following limits on resale:

- Sale is limited to accredited investors (who should have certain income/asset levels)

- General advertisement is prohibited

- Sale or resale requires the use of registered securities broker dealers

This first model is the most prevalent type of fee simple real estate transaction. It separately deeds the commercial area of the operating hotel from the guest room areas. It then turns the guest rooms into condominium units which are sold. The hotel's remaining commercial units are retained and operated separately from the Condominium Association. The hotel offers rental agreements to individual condo unit owners; enabling them to take advantage of rental income while at the same time supporting ongoing hotel operations.

In order to place a unit in a rental program, a management and rental agreement is first signed between the unit owner and the hotel management company. This agreement provides for a number of variables, primarily:

A portion of the revenues received from the nightly sales of rental program units flows through to the condo owner. This is typically a 50-50 split after a 7-11% Management Fee and a 5-10% FF&E Capital Reserve are deducted. The hotel management company/operator retains the remaining portion of the rental revenue stream.

A Usage Agreement is implemented between the condo owner and the management company/operator, providing for the implementation of an FF&E reserve.

The FF&E furnishing packages should meet certain standards. Failure to comply with such standards may either require immediate refurbishment at the unit owners' expense, or the suspension or expulsion of non-conforming condos from the rental program.

Responsibility for the maintenance and repairs of common space is allocated among condominium unit owners, based on their pro-rata shares. A Homeowners' Association (HOA) is usually set up to retain ownership of such areas and oversee the collection of dues from unit owners.

This second model deeds the guest rooms into individual condominium units including ownership of the hotel's operating components such as public areas, meeting facilities, and services.

The unit buyers are automatically part of a Condominium Association and hire a third-party to manage operations and assets. The condominium association shares 100% of the economics of the operating hotel.

This second model is less prevalent because Home Owner and Condominium Associations are typically not allowed to execute contracts for periods in excess of a year. While some credible hotel management companies are willing to operate property's on a year to year basis, it is more difficult to negotiate these terms with hotel brand companies.

A fee simple real estate transaction is not considered a security offering (investment) and does not require SEC registration. In order for a property/development to be considered a fee simple real estate transaction, and therefore exempt from SEC registration, it should meet the following criteria as described in the SEC's series of "no-action" letters: