Condotels

Condo hotels (“condotels”) are the next step in the evolution of hotel properties. Developers build a luxury resort and help finance it with pre-sales of the individual units that make up the resort. A management firm takes care of the HOA and maintenance of both the property and the units, while taking a roughly 50% cut of the revenue from any rentals. How do you evaluate these units from the point of view of a property investor?

Background

I just recently started diving into the world of real estate investing, reading books and listening to every podcast I could find on the topic. At a recent real estate investing seminar that I attended, the opportunity to buy brand new units at a resort in Orlando “minutes from Disney World” was presented and I thought “oh, this is so turnkey that it sounds perfect for me, plus I can visit sometimes!” I got all the glossy promotional materials, and all the rules around the HOA and payments and personal use of a unit. And … realized that I didn’t know the first thing about this kind of property.

Concerns and Research

The obvious concern is “when can I use my unit”. Some condotels have blackout dates. The property I was considering did not have blackout dates, but after a visit the unit would be put at the end of the rental rotation queue. And my guests and I could use the resort facilities up to 30 days in a year. I would not likely use it for 30 days in a year, but I could imagine hitting that limit if I let my extended family make use of the unit.

I was also initially surprised by an HOA fee. Do guests get charged a resort fee? What does the HOA fee actually cover? There was a separate cleaning fee charged for the daily maid service, but this made me wonder how many other fees there would be. And the real shocker for me was seeing that the property management firm would split the room income with me 50/50… but was this split on the gross or net income?

I tried to get more information from both a sales person and a mortgage broker that worked with the condotel, but neither could really give me pointers besides what was in the materials provided by the company. My initial searches on the company did not turn up anything useful, so I was stymied until a friend suggested to me that the concept was similar to how timeshares are run. That eventually led me to some articles about “condo hotels”, also called “condotels”.

Once I found the right search term, it was much easier to find articles discussing the pros and cons of this form of investing. And the results were skewed heavily against buying a condotel unit unless you view it as a vacation home rather than an investment. I picked out some key quotes from the many articles I read an have roughly organized them into three categories: investing, rates, and profitability.

Investing

Are condotels a good investment vehicle? It seems that multiple entities are preferring to cast them as “vacation homes” to avoid any culpability about the marketing or profitability. It’s also important to consider what is the exit strategy, which is a major failing of timeshares

• “And real estate agents and developers are barred by securities regulations from divulging room rates or expected occupancy level, which would make the condos into investments rather than real estate.” [1]
• “MGM says owners shouldn’t look at rooms as investments but as second homes, thus financial expectations like Ader’s are unjustified.” [1]
• “To sell it, you have to consider that Condotels appeal to a very niche market, other investors or possibly vacation home buyers. Then they would have to be all cash or part of the small percentage the [sic] can obtain financing.” [8]

Occupancy Rates and Room Rates

Having occupancy and room rates to plug into your spreadsheet is mandatory. The opportunity I was considering listed a room rate of about $250/night, but when I did a search online I found one third-party discount booking site listing rooms for roughly $100 less. If your room is used for a promotional offer, you still split the income with the management firm. It’s also important to find “comparable” properties nearby and understand how promotions and discounts at other properties can affect your property. For example, a resort near Disney World probably has a room rate that is effectively capped by the pricing that Disney World offers; has Disney World ever offered deep discounts during economic downturns? At one time, the National Association of Condo Hotel Owners (NACHO) would do market research and provide guidance on these kinds of questions, but it appears that NACHO is now defunct.

• About the MGM Mirage Signature: “Owners expected their rooms to be rented out at Las Vegas’ typical 85% occupancy rate for $200 and up per night.” [1]
• “These places generally do not have 100% occupancy. I would think they are closer to 62% occupancy on a monthly basis and subject to seasonal use, depending on the hotel flag.” [1]
• “Some of the private flags have lousy central reservation systems further reducing occupancy percents.” [7]

Profitability

Although there were a couple of mentions of people who were able to make money with condotels, the consensus is that they are not likely to be profitable because of low occupancy rates and high maintenance/upgrade costs.

• “If the operators were confident about high rental income, they wouldn’t be cutting you in; they’d just borrow from a bank.” [1]
• “I happen to know someone who has several million invested in condotels and that’s all he invests in and makes a killing.” [9]
• “We own a unit associated with a major resort. [Not a “condotel”.] In my experience, rental income does NOT cover costs.” [10]
• “Even if you do not have significant damage from a particular rental guests, the “wear and tear” from normal vacation life in a heavily rented unit is significant.” [10]
• “In addition to losing 50% of the income to the management company in my case they could also insist that you upgrade your unit to their specifications, at their schedule, their price and their contractors.” [10]

Conclusion

The US is such a broad market that it shouldn’t be thought of as a single market; there are always some areas on the upswing and others on the downswing. As a less popular vehicle, condotels have less competition among investors (useful for getting in, challenging for getting out). My general feeling after reading all the articles was that I didn’t understand enough of the underlying market forces that could help me understand how to evaluate opportunities, and the lack of control over marketing and pricing is not something I am ready for just yet. Thinking over it more, I distilled the main points along a single dimension of good/bad.

Cons:

• needs a commercial lender, and a higher downpayment [1]
• occupancy rates might not meet expectations [1,3]
  • dependent on marketing by management [1, 2]
• maintenance fees come out of owner’s share of income [1,2, 3]
  • maintenance fees can be high [1, 3]
• taxed at commercial rates [3]
• may need to reserve your own unit weeks in advance [5]
• considered more of a second or third home than an investment [1, 3, 5, 7]
• overbuilding [6]

Pros:

• turnkey properties with little owner involvement [3]
• vacation home when visiting [1, 8]

Summary of Questions

The different articles brought up some variations that you’ll see from one opportunity to the next. I compiled a list of questions for myself to consider the next time I’m considering one of these opportunities.

1. Using my unit:
   1. blackout dates?
   2. shifting existing reservations that overlap?
   3. where does my unit go back into the rental pool?
   4. can I and my guests use the resort facilities?
      1. does this change if you use a separate management company?
2. Money:
   1. cleaning fees
   2. HOA dues? What does it cover, versus any resort fee that guests are charged?
   3. How is income divided? (~50/50 with the management firm is typical.) Is this on the gross or net income?
   4. Occupancy rates
      1. does the reservation system discourage visitors?
      2. does the hotel flag attract visitors?
      3. is there strong competition nearby?
         1. Disney World probably creates a ceiling on the nightly rate of nearby units.
   5. Daily/Nightly rate
      1. is the property offering deep discounts on third-party sites?
3. Exit plans
   1. how does the value of comparable units at other hotels appreciate?
   2. Is there much of a market for selling units? Is there a glut of units for sale?
   3. Will purchasers be able to easily find financing?
      1. Are you willing to finance the purchaser?

References

1. A Room of Your Own
2. Mr. Cheap - Condotels
3. Condotels - Good or Bad Investment?
4. Tips on Buying a Condotel as a Rental Residence and Investment
5. Investopedia - Condotel
6. Condotels Don’t Pencil Out
7. BiggerPockets - Buy & Hold Condotel units
8. BiggerPockets - Condos in Vegas-MGM or Palms Place?
9. BiggerPockets - Are Condotels a good investment?
10. TripAdvisor - Owning a condotel unit