Failed Condo Hotel Turnarounds, Workouts, Bankruptcies and Opportunistic Investment
By Jim Butler and Peter Connolly.
Tuesday, 23rd December 2008
Hotel Lawyer on restructuring distressed condo hotels: Restructuring distressed condo hotel projects and loans secured by them is moving to the top of the list for many lenders, owners and investors. Condo hotel deals are so complex and varied that there is no single "silver bullet" to take care of all problems.

Combining JMBM's legal and business experience in advising on more than 100 condo hotel and hotel condo deals with a veteran condo hotel expert, here is a 3-part article to explain: Part 1: the background and structure of the typical condo hotel, Part 2: critical differences between condo hotel restructurings and those with traditional hotels, and Part 3: a unique approach to working out some troubled condo hotel projects.

Long-term we are very bullish on well-conceived and executed condo hotels. The problem is that stakeholders have to survive through the short-term, and except in exceptional situations where there is unusual sponsorship, unique windows of financing, and special demand factors, the next few years will be very tough sledding. Properly structured condo hotels that have gotten financing for construction and end user sales, and completed their sales efforts prior to the housing bubble's bursting are fine. There is nothing inherently bad about condo hotels

JMBM's hospitality lawyers believe that condo hotels have earned an enduring place in hotel mixed-use development. They are viable. They make sense. They will continue to be very useful. Damning failed condo hotels in the current downturn is like bashing single family residences in the housing bust.

There is nothing fundamentally wrong with this type of property -- when it is structured properly and built in accordance with sound economics of supply and demand. Yes, there are a lot of poorly conceived and executed condo hotels that deserve their fate, but many sound projects are suffering now too.

A landscape littered with distressed condo hotel opportunity (and danger)

Although there is nothing wrong with the condo hotel concept, the landscape is littered with stalled condo hotel sales construction projects frozen in the financial deep freeze. Construction lenders, like Lehman, have reneged on binding loan commitments, and end-user financing has virtually disappeared. Many great projects are now in deep distress. Most condominium buyers are hiding under the bed at home, saving their money and hoping they don't lose their jobs. Most lenders are ignoring even great projects because they are hoarding capital to cover their capital depletion from derivative losses, no documentation home loans and investments with the likes of Bernie Madoff.

As the optimist said, "Somewhere in here there has to be a pony!" The question is: Can you find it?

What to do when the hotel is performing but the condo structure is dragging it down
How to "Uncondo" a Condo Hotel

Part 1 of this series concluded with an important explanation of how a typical condo hotel is structured (Part 1). And Part 2 covered some critical differences between condo hotel restructurings and those with traditional hotels (Part 2). You will want to read these before Part 3 giving our unique approach to working out some troubled condo hotel projects (Part 3).

It is important to note that there is nothing systemically wrong with the condominium hotel financing structure. It has its place in the permanent "tool box" used by developers and their advisors to structure hotel projects. However, in the current credit crisis, the structure provides impediments to permanent financing or exit that need remediation.

Converting to a traditional ownership structure the property can be financed

The basics of the workout plan revolve around terminating the condominium. All condominiums are essentially corporations and can be terminated based on a) state and local laws on termination and b) the termination provisions of the condominium documents. In most cases a supermajority of the units must vote in favor of terminating the condominium corporation. The condo hotel workout plan is centered on convincing a sufficient number of unit owners that terminating the condominium is the only hope they have to preserve any asset value in their units, so that when combined with the units purchased by the workout purchaser, the supermajority number of units will vote for termination. Once the hotel has been converted to a unified and more traditional ownership structure, it can be financed or brought to market on a conventional basis.

Stop selling and closing on units: convincing the lender this is best

The first step in this process is to stop selling units. If there are units under contract that have not closed, the lender and the developer need to agree not to close those contracts. While there are virtually no sales being made in the current market, whatever sales activity is occurring should cease immediately. It may seem intuitive that the sales process needs to end, but it should be recognized that the construction lender's first instincts will be to insist on closing existing contracts as a way of getting paid down and will push to sell more. That lender will have to be convinced that it will be more likely to receive full payment on the loan by permitting the termination of the condominium and the conversion to a traditional ownership structure. Again, as is the case with the unit owners, it will be difficult if not impossible for the developer who was the borrower to effectively manage that process with the lender.

Equity write downs: convincing unit owners this is best

The heavy lifting in this workout process clearly will be dealing with the unit owners. A group of frustrated people need to be told that they made substantial errors in their hotel investment analyses, and that the only chance they have for an exit is an equity write-down now in exchange for hope of a recovery later. This process will be difficult, time-consuming and frankly, painful, as the unit owners will have to work their way through the stages of denial and anger on the way to acceptance.

In all cases, the workout plan should include some of the amenities that presumably caused these individuals to buy units in the first place. For example, extending the same owner use price that was available under the unit rental agreements for a few extra years, or providing ownership recognition to these people are not overly expensive gestures that may make the bitter pill of financial disappointment a bit easier to swallow.

What should the new structure look like? It depends on units sold.

There are several options for the replacement structure that should be considered for the condo hotel workout, largely dependent upon the number of units which have been sold as a percentage of the total units in the hotel. If only a small number of units have actually been sold and the transactions closed, it may be advisable, depending upon the mood of the unit owners, simply to buy them back.

If the majority of the units have been sold, then it may be preferable to restructure the entity as a partnership with the unit owners becoming limited partners. There are certainly a variety of structures in between those extremes that may be deployed, depending upon the individual project circumstances. At this point in the process, the tools used in traditional workouts, such as carried interests, preferred returns on new money, and the like, can be used to minimize the de facto write-downs to make the offering one that will get the unit owners over the goal line. A lender or potential purchaser embarking upon this type of workout should consult their hotel lawyers and advisors about both local legal requirements and the correct approach for their particular situation.

"Key" money -- bringing in a brand

Since new money will be needed to accomplish these workouts, sources of funds need to be identified. In addition to the normal equity sources, consideration should be given to bringing a brand into the workout mix, and requiring either "key" money or equity as the price of brand expansion. One of the better attributes, at least for workout purposes, of the most recent condo hotel development boom is the fact that most of these projects are not branded, as the major lodging companies avoided them. In the current economic climate, the brands recognize that the easiest path to increased distribution is rebranding rather than new construction, so key money should be available . The timing of the introduction of a brand into the workout process will need to be carefully evaluated, however, as most of the major brands will not want to be associated with the "uncondo-ing" activities.

Does a condo hotel workout sound complicated? It is, or anyone would be able to do this work and we wouldn't call them "workouts!"

But consider that a carefully crafted plan to fix a broken condo hotel can unlock considerable value in the kind of hotel asset that you would like to include in your portfolio. The work is time consuming and complicated, but the opportunity is unprecedented.

The hospitality lawyers at JMBM's Global Hospitality Group® have a great library of free resources on dealing with troubled hotel loans. Go to top of the home page at www.HotelLawBlog.com, click on the "HOTEL LAW TOPICS" tab, and then select "Workouts, Bankruptcies & Receiverships."

This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We've done more than $50 billion of hotel transactions and more than 100 hotel mixed-used deals in the last 5 years alone. Who's your hotel lawyer?

Peter Connolly. Formerly of counsel to Jeffer, Mangels, Butler & Marmaro and general counsel of Hyatt Hotels, Peter Connolly is President - Hotels of Palladian Development, and a principal of Parthian Partners, a new Chicago based workout and restructuring firm providing operational, financial and bankruptcy advice to troubled hospitality projects. He can be reached at pconnolly@palladiandevelopment.com or at 312.297.0038.

Our Perspective. We represent developers, owners and lenders. We have helped our clients as business and legal advisors on more than $50 billion of hotel transactions, involving more than 1,000 properties all over the world. For more information, please contact Jim Butler at jbutler@jmbm.com or 310.201.3526.
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