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Hotels Are Making Room for Condominiums

The hybrid concept of luxury chains selling some of their units is gaining in popularity. There are risks for the developer and the buyer.

June 08, 2005|Mike Schneider | Associated Press

ORLANDO, Fla. — Denver attorney Jacques Machol loves the hotel amenities he gets when he stays at the Fontainebleau in Miami Beach: room service, housekeeping, linen service and a complimentary breakfast.

But Machol isn't a hotel guest. He recently paid $735,000 for his 1,100-square-foot suite.

The hybrid concept of a luxury hotel that sells some of it units as condominiums has become one of the most popular trends in the industry in recent years. Condo-hotels in the last two or three years have expanded beyond traditional markets in ski resorts or Hawaii and into other tourist destinations such as Orlando and Las Vegas. Projects also are under construction in urban centers like Atlanta, Chicago and New York, where the Plaza Hotel is being converted.

Hotel developers like the concept because they spread their financial risk among the future condo unit owners. Condo owners like it because they enjoy the resort-style luxuries, and in many cases the hotel rents out their units when they're away.

The condo-hotel units that are rented are not the same as traditional timeshares. Someone who invests in a timeshare is entitled to only the time that he or she occupies a unit, while someone who invests in a condo-hotel unit buys it outright.

Smith Travel Research, the lodging industry's leading research firm, doesn't keep figures on the number of condo-hotels in the U.S. because the units' popularity is so recent. But the hybrid concept definitely is a hot topic, said Jan Freitag, director of client services for the Tennessee-based firm.

"Every major player, the major hotel owners in the country, are looking at hotel condos, hotel condo conversions, hotel condo construction to see if it fits their portfolios," he said.

The luxury hotel chains -- including Hilton Hotels Corp., Four Seasons Hotels Inc. and Ritz-Carlton Hotel Co. -- have brought new credibility to a concept that was used as a tax shelter until the 1986 Tax Reform Act eliminated the benefits.

"People have a lot more confidence buying into a Hilton or a Four Seasons because they know the name. They know the quality. They know it must be reputable," said Joel Greene, president of the Condo Hotel Center in Miami, a brokerage that sells such units.

Several factors have led to the nationwide boom in hotel-condo units -- the improving performance of hotel companies, the recent investment appeal of real estate over the stock market, low interest rates and baby boomers approaching retirement who want to invest in a second home, said Mark Lunt, a hospitality expert at Ernst & Young in Miami.

Hotel occupancy rates dropped after the 2001 terrorist attacks, limiting the amount of Wall Street money available for building hotels, so developers went looking for another way to finance their projects. A developer typically has to come up with about 40% of the equity for a traditional hotel; a condo-hotel development requires much less investment.

But the concept has risks for the developer and the buyer.

The Securities and Exchange Commission considers the condo offering a security if income and expenses from the rental units are pooled and if a condo unit is sold with the explicit expectation that the buyer will earn money or derive tax benefits from it. If the development is structured as a security, then only a securities broker can sell it, and it is easier for an investor to sue the developer under the SEC's anti-fraud rules, Los Angeles attorney Jim Butler said.

Most developers choose not to sell their projects as securities to avoid the SEC complications, so they are prohibited from discussing the economic or tax benefits from a rental arrangement or project or how much a condo unit can earn in rental income. Many buyers make decisions without all the facts.

"If you're not allowed to communicate revenue expectation, oftentimes buyers are making a decision based on incorrect information or overly optimistic information," Lunt said.

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