Condo Hotels: The Latest Twist In Buying a Vacation Residence

Hoping to cash in on Americans' appetite for second homes, developers are increasingly selling something new: a piece of the resort. Condo hotels are the latest attempt by companies to slice and dice the housing market.
By: Michael Corkery: The Wall Street Journal Online
Hoping to cash in on Americans' appetite for vacation properties, hotels are increasingly selling something new: a piece of the hotel.

In the past few years, developers have started aggressively marketing "condo hotels," which look and feel like regular hotels with one difference - you can buy an individual room. Owners can use that room whenever they want, and they also share in any income when the hotel rents it out to other guests.

Properties like these aren't entirely a new concept: Real-estate mogul Donald Trump developed an early one 14 years ago. However, today the number is rising. As of December, condo-hotel rooms made up 11% of the roughly 113,170 new hotel rooms under construction in the U.S., according to Smith Travel Research, based in Hendersonville, Tenn.

At one San Diego property, the Hard Rock Hotel, scheduled to open next year, all 420 units will be condo-hotel rooms. Last summer, developers Mr. Trump, Bayrock Group and New York developer Roy Stillman announced they are building a 298-unit condo hotel in Fort Lauderdale, Fla. Actor George Clooney is a co-developer with Related Las Vegas in a project to build a casino and 926 condo-hotel units.

Projects like these are different from timeshares, which typically don't generate income, and limit owners to only a few weeks' use a year.

Condo-hotels are popular among developers because selling units to individual buyers lets them cut the cost of maintenance and utilities. Prices of units at the San Diego property range from a $400,000 "studio suite," with a kitchen area and one bathroom, to a $2.3 million two-bedroom property that's more akin to an actual condo than a hotel room.

For investors, the advantages aren't as clear-cut. The owner gets income only if their room is rented: If bookings at the hotel drop, so does the room owner's income. Meantime, the owner still has to cover real estate taxes and often a mortgage, as well as monthly maintenance fees. Those fees -- much like regular condo-association assessments - cover things like maintenance and general repairs to the building.

Resale values are also uncertain. "We have no data on whether you can sell it for more in five to ten years" says John Vogel Jr., a permanent adjunct professor at the Tuck School of Business at Dartmouth College. It's a particular concern amid signs that the overall real-estate market may be cooling. Condo-hotels are "a complicated and risk-filled asset class" that lack a long-term track record, says Mark Lunt, a lodging analyst at Ernst & Young in Miami.

On top of everything, for a room owner, it can be tricky to decide when to rent it out and when to use it yourself. After all, if you use your room during peak vacation season - the time you'd most likely want to - you can miss out on earning the highest seasonal room rates.

Proponents of condo hotels say one advantage is that the owner can use the property more often than a typical timeshare or fractional-share property. Since condo-hotels also have prospects for generating rental income, some are also purchased as investments.

"We thought of it as the best of both worlds - having other people's money buy our second home," says Kimberly Hartke, who three years ago bought a $700,000 unit with one bedroom and a living area at the Fontainebleau resort on the oceanfront in Miami Beach. Ms. Hartke, who lives in Reston, Va., says her family used it about 30 days last year. She and her husband paid for most of the unit up front and took out a relatively small mortgage. She says on average the rental income has covered about 35% of their expenses, but she expects the income will increase as the hotel gets more popular.

Some experts warn that condo hotels shouldn't be viewed as simply an investment. "I would be very cautious about buying," says Ken Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley. "It is certainly not the best way to invest in real estate. You should buy it to use it; if the investment works out, even better."

Condo hotels are the latest attempt by developers to slice and dice the second-home market.

Second homes can be a good investment if they are in an area where residential real estate is appreciating quickly and there's a strong rental market. The downside is that the owner is responsible for all the upkeep, from cutting the grass to finding a plumber.

That's helped drive the market for a wide array of "fractional ownership" programs. Typically in those arrangements, buyers pay for the right to use a condo or villa. That cuts their ownership costs, but they're also typically limited to using the unit just a few weeks a year.

Timeshares often let users have access to numerous properties nationwide and overseas. But they have a mixed history when it comes to resale values. Fractional ownership is a variation on timeshares in which a buyer often gets use of a property for a longer period of time. In addition, they've tended to show stronger resale values partly because they are often located in more upscale communities where it's tougher to buy in general.

Timeshares can be tough to resell because they tend to lose value over time, it costs money to market them and it can be hard for a prospective buyer to get financing for an older timeshare. Overall, "No piece of a unit is going to resell as much as a whole unit," says Robert J. Webb, a senior partner in the hospitality practice in the Orlando office of the law firm Baker & Hostetler.

When shopping for a condo-hotel property, the first thing to realize is that you're actually shopping for a hotel: A condo-hotel room has the best shot at being a successful investment if it's a prime property located somewhere with heavy demand for hotel rooms. "If it doesn't work as a hotel, it won't work as a condo hotel," says Mr. Webb.

However, hotels can be a fickle form of real estate, since they can they be sensitive to even slight shifts in the economy and even the weather. And projecting rental income can be surprisingly difficult. Many developers say buyers shouldn't expect to make a profit from renting their room -- but they avoid giving specifics.

One reason: They say they are afraid of triggering the Securities and Exchange Commission to regulate sales of the units as if they are a security. Mr. Webb says many developers are taking their cue from a November 2002 letter that the SEC sent to Vancouver-based Intrawest Corp., a developer of condo hotels. In the letter, the SEC suggested it wouldn't take enforcement action if the company sold the condo hotels under certain conditions. One condition was not to provide prospective buyers with projections of income or expected occupancy.

There are ways around it. Some developers set up a "rental office," separate from the "sales" office, to provide information about the broader rental and hotel market in the area. For instance, when deciding whether to buy their Fontainebleau unit, Ms. Hartke and her husband, Keith, studied rates and occupancy at an existing hotel nearby.

Without information like this, says Mr. Lunt of Ernst & Young, "It's kind of like buying a stock without checking the prospectus."

A newly formed group, the National Association of Condo Hotel Owners, is in the process of creating a service to assess different projects for potential buyers, by studying such things as the cost of operations, rental programs and potential competitors.

One important test of a project is whether an experienced hotel company is operating the building, since that could give the building an edge in attracting nightly guests. A number of brand-name hotels, such as Starwood Hotels & Resorts Worldwide Inc. and Marriott International Inc., are managing condo-hotel projects across the U.S.

Currently, the vast majority of condo hotels - 212 projects - according to Smith Travel Research, are being developed by independent developers (though that doesn't mean they won't affiliate with hotel brands in the future). There are only a couple dozen or so projects now affiliated with a major hotel company, according to Smith Travel Research, although of course a brand name alone isn't a guarantee of success.

Location is also key. Experts say it helps if the condo-hotel is in a year-round resort or a popular city where demand for hotel rooms is strong. Properties in second-tier markets that aren't heavily traveled spots might be risky.

The tax issues surrounding condo hotels can be complex. Tax laws vary depending on how many vacation properties someone owns, how often they use the units and the legal structure of the ownership. Mr. Webb says a condo hotel cannot be used as a tax shelter - meaning buyers can't use losses from a failing hotel development to reduce their income taxes.