Condo Hotels: What We Should Learn About Sales
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of this Alert.
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.
|“…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
- 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
- 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.
“…the real world is upside down from what is intended
to occur under the SEC rules and the no action letters.”
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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This GT ALERT is issued for informational purposes only and is not intended
to be construed or used as general legal advice. Greenberg Traurig attorneys provide
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