GT Alert

Condo Hotels: What We Should Learn About Sales

November 2005

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There appear to be many reasons to be concerned about how the thousands of condominium units within condo hotel projects are being sold to the end buyers of those units. There are numerous reports of activities that raise buyer expectations of appreciation in value and return on investment. Perhaps the developer’s sales force or the third-party sales force is simply not adequately trained for the task. Perhaps basing compensation on sales commissions is not the wisest way to sell in the condo hotel context. Perhaps there is a lack of understanding “at the top” about the difference between the sale of real estate and the sale of securities as the SEC currently sees it. But it does appear, without looking too hard or too deep into the matter, that not everyone playing in the condo hotel arena has learned how tricky the sales program can be.

The outright sale of the unit is not all that hard if the buyer is truly interested in the deal as the purchase of real estate, often as a second or vacation home. The buyer may enjoy the appeal of owning something with high-end amenities where he or she can vacation during the year and a manager or operator will have responsibility for renting the unit at all other times. The potential income from the rental of the unit and the potential appreciation in value is beneficial but not the primary motivation for the purchase. The complexity builds when the buyer is interested in the deal because of its investment nature, the potential annual returns from the rental of the unit and the long term appreciation in value to be realized upon a future sale. That starts to look like a “security,” which would be fine if the project was registered as a security, which most domestic condominium projects are not, and, therefore, are required to be sold as real estate.

So, how does our current understanding of the law impact the issue of condo sales in condo hotels. The SEC has said that it will take “no action,” which is as close as you can get to the idea that what is being sold is not a security, in the following instances:

• there is no emphasis on economic benefits the purchaser might receive from the rental of the purchased condo-hotel unit or from the managerial efforts of a third party manager/operator of the project

• there are no representations regarding economic or tax benefits of ownership

• there is no advertising of the rental services in the materials offering the unit for sale

• written material containing publicly available information regarding comparable develop-ments (and not including rental projections, estimates, or speculative information) is provided to prospective purchasers

• no contract for rental or management of the purchased unit is entered into before the unit is purchased (but it now seems that it can be at the same time or at least when the deposit is non-refundable and the contract has no unsatisfied contingencies)

• there is no rental pooling arrangement (rather than a rental program agreement)

• there are no limits on occupancy by the owner in the sale documents other than those established by generally applicable zoning laws (but there can be limitations later under the rental program agreement)

These are relatively clear guidelines. Particularly the first concept, that there is no emphasis on the economic benefits to be gained by the owner of the condominium unit from the efforts of a third party, such as the operator or manager of the condominium project. Remember that in the condo hotel context, the condominium project will be within a hotel or resort. This means that care and caution are called for in each condo hotel transaction to construct a sales program that is presented to the public as the chance to buy real estate.

Many sales presentations and programs seem to engage in precisely the conduct that is to be avoided. Perhaps this is because many, if not most, potential buyers of condo hotels (but certainly not all) are buying for all of the wrong reasons (in terms of SEC concepts). Buyers are lured to one project over another because of the name recognition and strength of the manager, since it is the manager and its reservation system that will yield room nights and income for the buyer. Buyers are looking for a place to “invest” their capital, and real estate, in the form of a condo hotel, is available and accessible. Buyers do believe that they will have a positive net cash flow from the ownership of the unit, further augmented by appreciation in the value of the unit looking forward to the ultimate sale of the unit. In very simple terms, the real world is upside down from what is intended to occur under the SEC rules and the no action letters.

What to do? What to do?

Good question. Since this business model has not progressed through a complete cycle and we have very few “booms” and “busts” to look at, we are left with trying to develop some practices to follow. The general sense seems to be that condominium developers and managers, particularly the national brands or “flags,” need to develop a record of the sales process and the subsequent sale of the rental program. Buyer disclosures, acknowledgements and releases may or may not be a “safe harbor” when things get interesting, but it is certainly a wise idea to have as much information as possible, including statements from the buyer, indicating that the buyer bought the property as real estate, without emphasis on the economic benefits that might arise, and without reliance upon third-party management. We are all watching and waiting, but we should be actively waiting and looking for ways to protect ourselves and our clients for that day when, disappointed by the net rental income from the unit and the lack of resale opportunities, condo hotel buyers raise the issue of the underlying transaction as the sale of an unregistered security rather than the sale of real estate.

This Alert was written by Nelson F. Migdal in the Washington, DC office. Please contact Mr. Migdal at 202.331.3300 or any member of the GT Real Estate group if you would like to discuss any issues raised by this Alert.

© 2005 Greenberg Traurig

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