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Condos Help Seal Hotel Financing Deals

With lenders today having virtually no appetite for large-scale resorts or convention hotels, developers in search of financing for high-end product are faced with two alternatives trim the size of their projects significantly, or add condominiums to their plans.

Why are condos so attractive to hotel lenders? For starters, proceeds from the sale of the units can be used to pay off part of the construction loan. And because condo units supply a revenue stream before the property even opens, lenders are willing to provide a 75% loan-to-value for condo-hotels compared with a 60% loan-to-value for a traditional hotel project, explains Frank Nardozza, chairman of REH Capital Partners, a Fort Lauderdale, Fla.-based hotel investment company.

There's hardly any other way to get a major new-build project financed today, Nardozza emphasizes.

Condo-hotels also produce higher returns for investors. Leveraged returns for a condo-hotel can exceed 30%, says Nardozza, while leveraged returns for a standard hotel range between 15% and 25%. Still, the complications involved in developing condos including the need to set up pre-sale offices and form neighborhood associations to represent the individual owners discourage some companies from going that route.

Top 5 Hotel Markets Number of Rooms* Existing Supply Recently Opened** Under Construction
1. Orlando 115,075 2,209 5,009
2. Chicago 99,553 1,699 2,14
3. Los Angeles 97,293 706 749
4. Atlanta 90,312 792 2,475
5. Washington, D.C. 87,685 1,172 3,175
*As of July 2003
**Recently opened: Hotels that opened in past 12 months.
Source: Smith Travel Research/PPR/FW Dodge

Revenue from condo sales is used to finance the property, so condos become part of the project's equity, explains Ted Darnall, president of the real estate group at White Plains, N.Y.-based Starwood Hotels and Resorts Worldwide Inc. (NYSE: HOT). Even though the pure, traditional hotel economics aren't necessarily supporting the level of growth that we've seen in the past in our industry, there are new economics created by these [condominium] projects, emphasizes Darnall. It's a means of finding equity that you couldn't find in other environments. It's a very good, successful model.

As a result, Starwood has revamped its growth strategy by including condos in the mix. The company, an owner and franchiser of luxury hotels, previously specialized in destination resorts such as the $180 million, 735-room Westin Kierland Resort & Spa in Phoenix, which opened in November 2002. However, in late July Starwood unveiled plans for two W hotels the company's trendy, boutique-style brand that were designed to appeal to today's skeptical lenders.

Although the W Dallas Victory Hotel and Residences and the W Fort Lauderdale Hotel and Residences will feature less than half of the hotel rooms of the Kierland resort, they will be the first W properties to offer condo units. The hotels are scheduled to open in late 2005 and December 2006 respectively. The Fort Lauderdale property, which will be owned by Capris Resorts LLC, will contain 346 hotel rooms and 171 condo units, while the Dallas property, featuring 251 hotel rooms and 94 condos, will be owned by Gatehouse Capital Corp., Hillwood Development Co. and Southwest Sports Realty. Starwood will manage the properties.

The Economy's Influence

The condo-hotel trend picked up steam about three years ago when New York-based Millennium Partners developed several Ritz-Carlton and Four Seasons projects in markets such as Boston, San Francisco and New York.

Starwood's new strategy of including an ownership-unit ingredient in its projects is part of the plan for the Aladdin Resort in Las Vegas. In August, Starwood partnered with investors from Orlando-based Planet Hollywood and offered $635 million for the casino, which went bankrupt in September 2001. The team plans to convert 600 units into timeshares. In early September, the offer was under review in U.S. Bankruptcy Court.

There's good reason for hotel lenders to be skittish. The industry has yet to post consistent revenue gains since the Sept. 11, 2001, terrorist attacks. The total revenue per available room (RevPAR) nationwide dropped from $41,335 in 2000 to $35,753 in 2002, a 13% decline, according to the Hotel Research Group, a division of San Francisco-based PKF Consulting.

The three-year slump in hotel revenues also has taken its toll on overall development activity. As of July, the total number of hotels in the construction pipeline dropped 27.4% compared with July 2002, according to Henderson, Tenn.-based Smith Travel Research.

The number of upper upscale hotels under construction fell to 44 in July of this year compared with 70 in July 2002, according to Smith Travel Research. The Smith Travel upper upscale category is a wide grouping of chains ranging from Sheraton to Four Seasons, which the hotel companies themselves more commonly label as upscale and luxury hotels, respectively.

Although construction is on the wane in most markets, the exception to the rule is Orlando. As of July, there were 5,009 hotel rooms under construction in metropolitan Orlando, up from 2,838 rooms in July 2002, according to Smith Travel Research (See sidebar on page 42).

Financing has been very hard to come by over the last couple years for most companies, says Scott Johnson, vice president of development at Omni Hotels, which holds an ownership interest in most of its hotels. The Irving, Texas-based company has three projects under construction, including the 511-room, $124 million Omni San Diego scheduled to open in spring 2004.

But Omni Hotels has yet to announce a new project this year. The company, which also purchases properties for conversion to the Omni brand, has not been able to find a property to buy this year because sellers are expecting higher prices than their properties are worth in the current operating environment, says Johnson.

In another signal that these aren't the best times for developing large-scale luxury hotels, Ritz-Carlton has cut back its development plans in the U.S. after opening properties at a torrid pace in the past few years. The luxury hotel company, a division of Bethesda, Md.-based Marriott International Inc., has opened five hotels in the U.S. in the past 12 months, but now only has one project under construction and one other project in the pre-planning stages.

Although there are several U.S. markets the company considers candidates for Ritz-Carlton properties, including San Diego, Seattle, Dallas and Beverly Hills, Calif., the company wants to focus on managing the properties it has recently opened before embarking on more U.S. projects.

We have defined our goals for the next five years, and most of those plans involve new hotels in Europe, the Middle East and Asia, rather than North America, says Simon Cooper, president of Ritz-Carlton.

Thinking Small

With lenders wary of committing to large-scale resorts, some hotel companies are concentrating on expanding their portfolios by developing smaller hotels. They're also venturing into unglamorous secondary markets where there is more room for new supply. Starwood is developing a 150-room to 250-room prototype for its Westin and Sheraton brands geared toward secondary and tertiary markets. Hilton, meanwhile, is gearing up for an expansion of its Conrad brand, which is a boutique-style luxury hotel.

Starwood estimates that there are 20 Sheraton hotels and 15 Westin hotels in various stages of development modeled after the company's new prototype. The scaled-back hotels, which offer many of the same amenities as the larger Sheraton and Westin properties, are part of a strategy to grow market share against its two main rivals, Marriott and Hilton.

We think there's a solid opportunity for growth there, says Darnall. We're happy with the construction pipeline for the Sheraton and Westin prototypes. The company plans to own about 10% of the prototype properties and franchise the rest.

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