Keeping the Inn-Mates from Running the Hotel – Short and Long Term Concerns in Mixed-Use Developments Containing a Hotel March
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Keeping the Inn-Mates from Running the Hotel – Short and Long Term Concerns in Mixed-Use Developments Containing a Hotel March, 2012 I. Introduction The 1990s and early 2000s were a boom time for real estate and hotel condominiums in mixed-use projects were no exception. During those boom times, the development of mixed, multi-use projects which included hotel or residential condominium components and regular hotel components took off. Developers realized that by selling off the hotel and/or residential units, they could “have their cake and eat it too”. Although hotel or residential condominium units were sold without the requirement that the purchasers of the units put the units back into a rental program, in fact, the vast majority of buyers did exactly that. Accordingly, developers of hotels which were in a combined development containing condominiums were able to recoup a large portion of the cost of the project while still maintaining the ability to manage the hotel and derive the income from the hotel operations. Similarly, by including a residential condominium component in a hotel building, the developer could lower its per-room cost of the hotel component which it continued to own and operate. And indeed, without adding the residential component to the deal, including a hotel in a mixed use development could not be economically justified, as the cost of the required elements (separate elevators, lobby and back of house) added expense without offsetting revenue. This was especially true because the sales prices of the residential units in a “high-end” brand hotel building were much higher than in a “traditional” residential condominium. A “Condo Hotel” is where the actual rooms of the hotel are sold to individual unit owners and are operated as part of the hotel on a regular basis. To be clear, we are not really discussing the problems with the “Condo Hotel” structure. While many of the issues discussed may apply if the Condo Hotel is part of a mixed use project, we are discussing what operational issues arise when a hotel is part of a larger mixed use project. This article will discuss the operational issues we feel might not get the fullest attention when the lawyers are creating the structures employed. To aid in the discussion, we have attached a couple of examples from the public record of declarations which address these issues. Neither of these declarations were drafted by the authors, but are attached for reference to aid the discussion. We have collected additional examples from the public record and can make them available electronically for those interested. We also attach a form of management agreement for a hotel operator acting as the manager of the residential component of the mixed use development. This is an example of an agreement that was developed by referring to the agreements used by several major brand operators. II. Structure of Condominiums which include a Hotel Component The legal structure of mixed-use buildings containing a hotel is either (1) a vertical subdivision or (2) a condominium regime. Both structures may be used when the project contains various components in addition to the hotel, such as a residential component, retail, spa, restaurants, etc. A vertical subdivision is not a condominium structure but rather is created by a declaration similar to a horizontal declaration in a homeowner association community, but in this case the “land division” is done vertically, dividing the property into its various components using three dimensional legal descriptions of air apace. There are some states (and in some cases, municipalities), that do not readily accept vertical subdivisions, in which case this slicing and dicing of real property as a practical matter won’t be used, and in those cases, the condominium solution will be employed. A hotel within a mixed use project can also be structured using a single condominium with the residences being individual units and the hotel component being either a single unit in the condominium if the rooms are not being sold separately, or a condominium within a condominium with a master declaration for the entire project with each “use” (residential, hotel, garage etc.) being a unit and the hotel/condo or residential units being established as another condominium if the rooms are to be sold separately as condominium units. Whether done as a vertical subdivision or as a single condominium, the key to properly structuring these projects is to provide a method pursuant to which the developer retains control of all of the common area components of the building. In a vertical subdivision these areas are typically referred to as the “hotel lot.” In the condominium structure these areas are typically referred to as the “hotel unit.” The hotel lot or hotel unit is typically comprised of the exterior of the building, the roof, all the electrical and other utility components, the HVAC system, the elevators, the hallways, the lobbies, etc.; in other words, all of the areas which traditionally are common elements of the condominium. The only common element in the condominium is the ground below the building. As the developer continues to own the hotel lot or the hotel unit it needs the unit owners in the building to contribute to the maintenance of these areas. The developer grants an easement to the unit owners to use these facilities in return for which the unit owners agree to pay the cost of maintaining these areas. The developer retains the right to determine what maintenance is required and therefore sets the annual budget for the maintenance of these areas. Although there is a condominium association, the structure is designed to assure the condominium association has no say on how these areas are maintained, as these areas are not common elements of the condominium. In fact, most of these projects are structured so that even the balconies which are adjacent to the units are also part of the hotel lot or hotel unit with easement rights given to the adjacent unit owners to use the balconies. This way the 8211457.3 2 developer/hotel operator can control what is placed on the balconies in order to control the exterior appearance of the building. Some of the mixed-use communities are done in separate buildings. When a building contains residential units only, it may make sense for that building to be structured as a more traditional condominium so that the unit owners can maintain the common areas of the building, but with the developer retaining an architectural approval right over the exterior of the building. The way in which the project is structured could result in landscaped areas being common elements of the condominium. This can also create an operational problem if the same contractor is not used on a project wide basis. There are additional reasons to maintain “control”. • So that hotel owner maintains voting control throughout development and after sale of all other components • So that hotel owner can effectively delegate to a brand operator and provide a mechanism to assure the quality of service and physical plant • If something goes “awry,” hotel owner is in control of the process to resolve all issues. • To provide flexibility in the sale or financing of the separate components • The hotel owner can effectuate an exit strategy – e.g. remove the project from the condominium regime. As we will discuss later this control of maintenance of the hotel and the overall project is vital to the hotel owner’s ability to employ a major brand to operate the hotel – as without this control the operator’s brand standards cannot be maintained. III. Operational Problems The documents prepared by the developers’ lawyers for these mixed-use projects are complex and voluminous. Although such documents carefully set forth how these projects will operate and spell out the legal significance of the structure, many of the problems being raised by the residential and hotel unit owners occur because they never read and/or understood the documents. Many of the owners are shocked to find out that the building doesn’t operate as a “traditional” condominium and thus they have no voice in the budgeting process or in operations and management. The main operational problem confronted by all of these projects is the way in which expenses are allocated among the various components of the building. The most prevalent complaint that the hotel operators hear about is that some of the expenses should be hotel 8211457.3 3 operation expenses and should not be charged as a shared expense to the hotel room unit owners or to the residential unit owners. A couple of examples of these types of expenses would be the expense of a concierge and the expense of having towels around the pool. Owners claim that the cost of these items should not be borne by them as they are strictly hotel operation items. In structuring these projects, it may be important to exclude from the hotel lot or hotel unit which is owned by the developer, those areas of the building which are designed to generate a profit. For example, restaurants in the building should be created as separated condominium units and not as common areas (that is, not part of the hotel unit or hotel lot). Those restaurant units should contribute to the shared expenses of the building in the same manner as any other unit. This structure may not work if a lender or a brand require the restaurant to be part of the hotel even if it is ultimately operated by a third party. The lenders and the brand want to make sure that the entire hotel, including food and beverage, are profitable.