Should the Condominium buy its own Hotel Program?
As a hotelier of 25+ years the easy answer is YES. In a one-dimensional, simple world where profitability is the only consideration, you are simply transferring profitability from one entity (the hotel program owner/operator) to another (the unit/apartment owners).
That said, most of us who have owned units in a condominium have come to realize that nothing in this setting is quite as simple as it sounds because of other dynamics at play.
My goal in this discussion will be to walk you through the metrics and then the dynamics of the decision so that the Condominium Board of Directors can have meaningful discussions on whether to proceed.
The first question, of course is why buy?! I have observed answers that range from mistrust, anger and frustration to others who do a thorough analysis showing that well run hotel properties can yield higher returns to owners. That said, one element seems to always prevail in all discussions and that is the feeling that the building can “control its own destiny.”
So a first next step in this consideration would be to conduct an initial “SNIFF TEST” to determine whether the metrics of the deal make sense (see Metrics Statement below) and at the same time, understand the metric differences between a “traditional hotel” and a “condo-hotel”.
There are six (6) expense categories that differentiate “traditional hotels” and “condo-hotels”. They are (1) Utility Cost, (2) Property Operations & Maintenance, (3) Property Taxes, (4) Insurance expense, (5) Interest expense on mortgage and, (6) monthly Maintenance costs paid on commercial units owned by the hotel program. All other revenues and costs should always be the same as in a traditional hotel.
Before I go further, please let me comment on the hotel industry as a whole; until September 11, 2011 the industry had always confidently relied on historic data to determine future financial projections. Combining the events of 9/11 and the financial crisis that followed years later, our dependence on those historical metrics were temporarily altered. That said, since 2011 we have been again tracking and able to determine future data through historic analysis with considerable accuracy and confidence.
The hotel industry being as large as it is provides hoteliers with reliable sources of information and data culled from thousands of hotels annually. One such source is a report that is favored in the industry call the HOST Report (published by Smith Travel – STR). I have used this report for over a decade to compare the results of hotels overseen to others that are in the same region, price category, of similar size and in similar location. It is worthy to note that the HOST Report provides conservative (average) results and these are best for projecting condo-hotel profitability. Knowing that a good operator is capable of outperforming average results is something that can be considered at a later time in this study.
2011 results shown in the Metric Statement below combine HOST reported data representing “FULL SERVICE” “LUXURY” “RESORTS” in the ‘SOUTH ATLANTIC” region that encompasses “150 to 300 ROOMS.” I have placed additional weight on “LUXURY” “RESORT” data in this example as it tends to better depict oceanfront properties in south Florida and that is where my operations have been based. I have also made adjustments to reflect typical results of a condo-hotel as opposed to traditional hotel results in that region. That said, we can create data for any hotel in any area of the country.
Many of the line items on the Metrics Statement below are worthy of discussion and will be addressed in future BLOGS but for now I’d like to focus on the specific area labeled “Condo Hotel Adjusted Expenses“.
Property taxes are low because they are mostly absorbed by individual unit owners in the building. The hotel program pays their share of property taxes on the specific commercial units they own (usually front desk, executive office, employee cafeteria, closet spaces, housekeeping and maintenance departments, etc.).
Insurance expense is another comparatively low-cost line item compared to the traditional hotel as liability issues that occur inside units in the hotel program are normally covered by individual unit owner policies. (I will share a horror story about a unit owner who did not have her renters insurance properly in place upon turning her unit over to the hotel program and the resulting consequences in a future BLOG entitled horror stories ~ see BLOG HORROR STORIES ahead). The aggregate hotel program “Insurance expense” line item that you see on the Metric Statement below covers liability due to staff negligence, employee protection, executive protection, theft protection and the like and I will address “INSURANCE” in a future blog.
Distributions paid to owners are amounts determined by the hotel owner/operator after it is decided how much TOTAL PROFIT they wish to make. (It is interesting to note here that a Hotel Operator can be hired to manage the hotel for 3 to 5% of gross revenues plus an incentive bonus on profits in contrast to having the owner Operator also earn profits). In the case study below I show what would have happened if the condo owned the hotel program and I use 42% of Gross Room Revenue as a monthly distribution amount. Please note that this percentage was not an arbitrarily picked amount taken out of thin air, but rather was determined after taking operating costs, variable costs and bonuses into consideration. In this case, (again assuming the hotel program is owned by the Condo) the hotel program was able to pay unit owners 42% during the course of the year and an additional $850,000 at year-end as a bonus (13th payment) at which time they also paid the Operator a $150,000 performance bonus, simultaneously.
Before I leave this brief explanation of DISTRIBUTIONS (another area that will be explored fully in a later BLOG) it is important that unit owners DO NOT GET STUCK ON THE PERCENTAGE AMOUNT DISCUSSED (in this case 42%) because, if you ask 10 unit owners in condo-hotels what percentage of revenues they are earning you will often get 10 different answers! I will provide you (under separate cover) an “Apples to Apples” conversion comparison calculation (CCC) so that this number makes sense and can be compared to other programs after DEDUCTIONS that are sometimes taken by hotel programs before distribution.
A 13th Dynamic Payment at year-end would only be calculated when the Condominium has purchased the hotel program and would be considered a year-end bonus to unit owners in the program for profitable operations. I like Rental Management Agreements (RMA’s) that tie Operator Performance Bonuses and 13th Dynamic Payments together so that profit rewards both the unit owners and Operator simultaneously. In this example I used an 85%/15% split of profit, Unit Owner to Operator respectively and as you can see left $88,819 as profit to be used to decrease monthly maintenance payments in the condominium budget next year.
Hotel Program Condo Maintenance are the monthly fees paid by the hotel program to the condominium on the commercial units they own. Needless to say, the traditional hotel does not incur this expense.
I have seen Utility Expenses on hotel program Profit & Loss Statements that come from (1) utilities billed directly by the utility companies to the hotel on their commercial units via sub meters, (2) an allocation percentage billed to the hotel program by the condominium – in this case 15% was used or (3) no Utility Expense shown as a separate line item at all – utilities where there is no sub-metering are paid for by unit owners through monthly condo maintenance fees collected by the condominium.
Property Operations & maintenance (POM) expenses are low by comparison to what the traditional hotel expense is because unit owners in the condo-hotel pay for maintenance required inside their own units. The owner coordinator will generally contact the owner requesting permission to make repairs that are necessary at discounted prices.
Finally, debt on a condo hotel program is normally very low by comparison to a traditional hotel (but because of limited access to funding of the condo hotel vehicle, at substantially higher interest rates). The purchase of a hotel program (some call a virtual hotel) is normally ”inexpensive” and the debt assumed often, (1) is paid over time to the developer, (2) a bank or (3) does not exist at all. Of course, the purchase of the hotel program by the Association could require the condo to have to borrow funds needed to close, a special assessment to raise funds to close or the acknowledgement of the assumption of existing debt to by the Association in exchange for the hotel program. Once again, the point I am making is that debt in a condo hotel is normally not substantial.
All of these savings seen above and in aggregate should allow hotel programs to payout distributions that replace these costs plus profit. The only variable that is not taken into consideration is what each unit owner paid for his or her unit and, in turn, what the cost of debt service on said apartment. The “buy price” is the determining factor of whether the condo will have positive or negative cash flow each year to the unit owner.
See Screen Cast on….
Other matters affecting the purchase decision of a hotel program include….
Does the Board of Directors have the desire and capacity to take on an additional business burden? As a volunteer group the Board is already sharing a large burden in overseeing the operation of the condominium; can they take on more? A good CAM provides adequate information to keep the building running and the Board well-informed and able to make critical decisions. A similar relationship would need to be established if the condominium were to acquire the hotel program with an independent owners representative / hotel expert that would serve the Board in a similar capacity. That said; please understand that a different sophistication is necessary in overseeing the performance of a hotel operation than that of a condominium. To succeed, a Board of Directors must be able to listen to and rely on their professionals. If that is not possible, the cumulative effect of taking on this new business can be failure.
The hotel is a complex multimillion dollar operation capable of generating sizable income but requires attention. A qualified hotel operator can provide the expertise necessary in operating the property to an acceptable standard and an independent owners representative/hotel expert can provide monthly status reports insuring that any conflicts of interest** in reporting results are eliminated. My company performs these duties.
Is the Board of Directors, a member of the Board of Directors or a Task Force created at the behest of the Board of Directors willing to make the commitment necessary to review findings of the Asset Advisor and make recommendations which ensure that industry standards and benchmarks are maintained and met consistently? The Asset Advisor must have the full power and support of the Board of Directors behind him or her in order to efficiently and effectively report findings and seek corrective action. Without it, the hotel can never operate with true integrity and at full performance strength.
Condominiums unfortunately can be breeding grounds for petty argument, contempt and power grabs which are not conducive to running a multi-million dollar business. Consistency in leadership, integrity and transparency have to be the cornerstones by which your new business is built and the appropriate vetting of professional assistance must take place so that reliable professionals and appropriate “checks and balance systems” can be put into place. I cannot stress enough about how important it is that the Board of Directors stay as far away from day-to-day operations as is possible and allow the hotel professionals to operate the business. The Asset Advisor (or a designated member of the Board) is the appropriate executive contact person to seek or demand change of a hotel executive and timely meetings scheduled in order to accomplish goals and requests should be kept on a bi-weekly basis. It is my opinion that the commitment to this “military style” system of respect and communication should be observed and is essential to the ultimate success of the hotel program.
Finally, if the Board of Directors wishes to pursue the due diligence toward the acquisition of the hotel program, the next step would be to approach the hotel owner and to determine a fair sales price in purchasing the same. This is usually a factor/multiplier applied to net profit which is produced after taking owner distributions over the past 3 years into consideration. We and a well-respected national law firm and certified public accounting firm have created the structure, documents and contracts necessary to achieve this transaction and would be pleased to discuss the same with you if you are so inclined.
Many more factors of the Condo-Hotel business surround this intricate business and we as experts will provide you with an all-encompassing narrative through our BLOGs on the ways to achieve success with your condo-hotel for everyone. The key, as in most businesses is paying close attention to well established METRICS of the hotel industry and the quality control and training techniques provided by well established operating companies. We can insure that you are provided with a list of such operating companies that will adhere to FAIR management fees, FAIR performance bonuses and FAIR management practices.
If this or any of our BLOG’s are of particular interest please feel free to drop me a line at CondoHotelAnswers@gmail.com or post right on the BLOG for discussion.
**since performance, incentives and bonus fees are all predicated on results it is wise to have a second set of eyes of an expert reporting to the Board independently. If the Operator prepares Budgets and reports to the Board on performance it could be argued that this information could be tainted to favor the Operator. What’s more the Budget prepared by the Operator should be independently verified by an independent expert with knowledge of the industry.