So You Think You've Got It Tough

It's a daunting task to operate a condo hotel. Unlike a traditional lodging property that typically has one individual or institutional owner, a condo hotel has scores or hundreds or even thousands of separate owners, each with his or her own agenda of financial, service, design and operational expectations. Two of the biggest challenges condo hotel operators face are managing their room inventories and the expectations of owners.

“The number-one challenge is managing the expectations of condo unit owners,” believes Paul Courtnell, director of the leisure and resorts group of Gunster, Yoakley & Stewart, a Florida law firm that advises clients who own and operate condo hotels. “You have to make sure they're realistic with respect to anticipated revenues and, more importantly, expenses.”

One key to these expectations is the rental management agreement, the basic contract between the condo operator and condo unit owners.

“It's optional for condo owners to enter an RMA, but the vast majority do,” says Courtnell. “They know what they're buying and are predisposed to go into the RMA to earn rental fees from their unit.”

Jerry Cataldo, executive vice president of development for Hostmark Hospitality Group, says another problem is that most unit owners are not hotel-savvy.

“Relations with owners are more challenging than a typical hotel structure because of multiple owners or the existence of a condo board that may not have practical experience in the hospitality industry,” Cataldo says. “It's a very time-intensive challenge.”

Managing owners' expectations and communicating to multiple owners so they understand how their unit will be rented is another major challenge, he adds.

“If this isn't done well and communicated well, you're going to have lots of unhappy people,” says Cataldo, whose company manages 27 hotels, including one condo hotel, the Bella Vista Suites in Lake Geneva, WI.

Simple revenue management and forecasting light versus heavy occupancy is problematic until operators know exactly how much room inventory they have to sell, according to Rick Swig, president of RSBA & Associates, a hotel consultancy that also owns and asset manages hotels.

“There are no best practices yet for operating condo hotels,” says Swig. “House rules that govern when owners get the units, how long they get them for, blackout dates and lead times all shape available inventory and can vary widely from one condo hotel to another.”

Add to that mix the booking of space for groups and other interested parties and the equation becomes even more difficult.

“Marketing to and booking groups and users of meeting space is a significant challenge in a larger condo hotel property,” says Grant Sabroff, senior vice president of business development for Boykin Management, which manages 13 properties, including two condo hotels in Florida, the Pink Shell resort on Estero Island and the Ocean Point Resort & Spa in Miami Beach. “You also may have to manage the owner of the commercial lot, as well as restaurants, spas and other amenities not dedicated to the condo property. If the condo hotel is branded, there's a brand to manage. Plus, you may have to manage and report to a lender.”

Dealing effectively with condo hotel owners requires a dedicated owner services liaison or department, says Scott Steilen, principal of Warnick & Co., a lodging advisory firm working for several condo hotels in the upper upscale and luxury segments.

“Many operators tend to underestimate the level of effort it takes to effectively handle the day-to-day tactical challenge of dealing with dozens to hundreds of owners,” says Steilen. “These owners have made an investment with the developer and believe in the project. An effective line of communications and open exchange between owners and the operator can eliminate a huge portion of issues that elevate into problems. A solid liaison can convert issues to solutions without becoming problems.”

It's smart for condo hotel operators to have somebody on staff whose primary job is owner relations, believes Courtnell.

“Many operators are accustomed to dealing with asset managers, who are sophisticated about the hotel industry and are professionals,” Courtnell said. “Condo unit owners are not professional owners and typically aren't sophisticated in issues of hotel operations.”

Most condo hotels require a 21- to 31-day notification from owners when they want to stay at the property, according to Steilen.

“Whether that just guarantees a unit or their own unit depends on how the rental program is structured,” he says. And the mixing issue in condo hotels further complicates booking and inventory.

“You often have two- and one-bedroom units, as well as units with and without ocean views,” Steilen says. “People who book group business like as much room uniformity as possible because they don't want to have to decide who gets what unit. The operator has to manage all these levels of inventory to fill as many rooms as possible.”

TURN TO TECHNOLOGY

If booking hotel rooms is hospitality 101, an entry-level course, booking condo hotels is hospitality 401, for upperclassmen only. In addition to the other issues, the moving target of how much inventory the condo hotel operator has to sell during a given week creates special booking challenges.

“Condo unit owners are taking a more active role because they're losing money and want to know what the managers are doing to address the situation,” says David Perkins, chief executive officer and president of IQWare, a provider of condo hotel software. “Management companies need to make sure their condo system is robust enough to provide very detailed online owner statements that can handle all the owners' questions.”

Some software programs, for example, will hold back two percent of gross revenues for maintenance, because most owners would rather pay a little over time than a lot at once to maintain the condo hotel, he says.

Condo hotel software also allows operators to rent rooms by a rotation or in a pool formula.

The rotation formula rents a room and then puts it at the bottom of the list and repeats the process, Perkins says.

“A pool formula takes the square footage of the entire hotel, subtracts the common areas, takes the total revenue achieved by the hotel, and owners get a percentage of revenue based on the square footage they own,” he says. “Condo hotel management companies must do proper due diligence before selecting a PMS because they are going to get a lot of questions. They need to be well-equipped to handle all the tasks and owners' inquiries.”

CAPITAL IMPROVEMENTS

How is a condo hotel operator expected to get 200 owners to agree to fund capital improvements if they're happy with their units and properties the way they are? The answer is found in the structure of the deal, say the experts.

“Making capital improvements in a condo hotel is very challenging if the deal was not structured properly, because owners will have a variety of expectations,” says Cataldo. “Yet, it's easier to deal with a condo board than all the individual owners.”

Like many traditional hotels, some condo projects rely on building reserves for improvements.

“Oftentimes, an ff&e reserve is established to let the rental manager hold back funds for ff&e replacement to the units to maintain standards,” Sabroff says. “Or the manager can use a rating system to grade each unit by condition. If a unit is inspected and falls below a certain grade level, the manager can force the unit owner to upgrade by refusing to allow it in the rental pool until the improvements are made.”

Most successful condo hotel projects have reserve funds, adds Courtnell.

“With respect to the condo unit interiors, the unit must meet brand standards if the owner wants it in the rental program,” he said. “The operator can take an ff&e reserve in the range of five percent of room revenue to deal with updating those issues. They should have a capital expense reserve line item in the budget. The level of money has to be there when they need it. Otherwise, they must specially assess the owners and they don't like that. Owners would rather be hit with a velvet hammer and have it taken out over time as the unit is rented rather than all at once.”

A separate reserve has to be collected to address upgrades in public spaces, because all condo owners — whether they participate in the rental management agreement or not — enjoy the benefits of and must pay to maintain public spaces.

It could be that the recent wave of condo hotel development is too recent to know if this process works.

“A typical cycle for heavy CapEx expenditures is seven years,” Courtnell said. “Only a handful of condo hotels have been in operation that long. Whether these rules of thumb work and generate enough money, we don't know yet. If it's not enough, legal documents allow special assessments. Condo owners will have to pay the assessments, and they won't like it.”

ABOUT THAT INVESTMENT

Many individual condo owners buy their unit as an investment, yet condo developers and marketers are not generally permitted to sell them as investments, according to Cataldo.

“People looking to buy a condo hotel unit are often looking for an investment, but you can't sell it as an investment due to Security and Exchange Commission regulations,” he says. “Developers and managers must have thoroughly trained salespeople who can also follow SEC regulations.”

While developers can't provide forward projections of revenue for condo hotel units, they can give historical revenue information, according to Courtnell.

“Condo hotels shouldn't be sold as investments, yet that happens with a nod and a wink from salespeople representing some developers,” Swig says. “Developers have their own sales spins to get the project sold. They are building condo hotels and taking deposits like crazy, but the big question is how deep is this market? How many rooms will be built and not sold and controlled by the developer?”


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THE BIG IDEAS

It's All About Development

One of the reasons condo hotels have gained so much popularity during the last few years is that they allow developers an alternative way to build hotels without having to go through standard financing, according to Rick Swig, president of RSBA & Associates.

Individuals buying condo hotel units can finance 80 percent of the purchase price, similar to financing a primary residence. That's different from traditional hotel financing.

“A traditional hotel gets financed at 55 percent to 60 percent loan to value, plus a mezzanine loan,” Swig says. “First and foremost, condo hotels are financing vehicles.

“But the spin of owning your own piece of a fine hotel gets a little soft in the real world, because they need to function as hotels, which means they are all about location. To be successful, a condo hotel needs to be a well-built product in a great location that is attractive to the general hotel-consumer populace. A condo hotel is a great concept, but the reality is it needs to be a successful hotel operation based on fundamental hotel rules.”

To be successful, however, developers need to understand the market they're developing and have experience with the operating nuances of a condo hotel, he says.

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