Trends Driving the Growth of Condominium Hotels

After more than two decades of sustained success in the US, the condominium hotel is finally coming to Europe. This is where the future of condo hotels lies, says Ian Chappell, senior vice president of investment sales at Jones Lang LaSalle Hotels, the world’s leading hotel investment services firm. Chappell, who has worked for LaSalle for 12 years, has published his research after focusing on the sector for two years.

Condominium Hotels – Europe’s Latest Hotel Phenomenon outlines how the concept operates and its rise in popularity. To the public, condos look like regular hotels. However, they are actually multiple ownerships behind a brand cover.

They have been popular for more than 20 years in the US, where the hospitality sector is better established with a wider range of vacation and leisure products, Chappell explains. Now, he says, conditions are ripe for the condo market to flourish in Europe.

BREAKING INTO EUROPE

According to Chappell, Europe is ready for condos thanks to high pricing levels in the commercial real estate market and compressed yields in the hotel investment sector: “With fewer opportunities to acquire commercial real estate investments at prices that reflect attractive income yields, investors are prepared to shift further along the risk-reward spectrum.”

“With London hotels experiencing a rise across revenue, room costs and occupancy rates, it is set to be an exciting period.”

While initial costs may vary from a €100,000 room in a Mediterranean resort to £250,000 (€370,000) for a London room, the average returns expected are between 6% and 7%.

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In a typical condo arrangement, the revenue from the room would be split, with 50% going to the investor and 50% to the operator. The hotel would typically keep the profits from other areas of the hotel, such as restaurants, bars, spa and additional amenities. The investor would probably have to pay business rates and a service charge out of their share of the income.

“It’s still in its early stages in Europe,” says Chappell. “In the US, the organisation has diversified into many different types.”

US BRANDS LEAD INVASION

The leading US condo operators are now eyeing up Europe and preparing to test the water. Starwood is exploring the idea in its Spanish hotels, which will have villas and apartments in a rental pool, says Chappell.

Hilton and Marriott, which are already well established in the timeshare market, are also expressing interest. And Donald Trump, who has extended his condo hotel projects out of the US and into Dubai, may now have Europe in his sights.

According to Chappell, new players are already entering the market, such as GuestInvest and Galliard Homes, alongside the established European models, such as Pierre et Vacances. GuestInvest’s first 20-room investment hotel, Guesthouse West in Notting Hill, London, sold out within weeks and owners are seeing returns of more than 6.8%.

The group, founded by Johnny Sandelson in 2004, allows investors to stay up to 52 nights annually free of charge and receive rental income from the room’s use during the rest of the time. Its next hotel, the Nest in Bayswater, is scheduled to open in 2007 and 50% of the 160 rooms have already sold.

In October, the group announced a £55m initiative to launch its third hotel on one of London’s oldest City Grade II listed sites, the former Whitbread Brewery. The Chiswell Street Hotel, due to open in 2008, will add a further 200 rooms to the group’s portfolio, bringing its total to 400 across the capital.

Rooms are going on sale from £240,000 with investors guaranteed a 6% return for the first year of operations. The group plans to expand into at least ten gateway cities worldwide, capitalising on a £140m equity/debt injection from Bank of Scotland.

Johnny Sandelson, CEO of GuestInvest, shares Chappell’s optimism: “With London hotels experiencing a rise across revenue, room costs and occupancy rates, it is set to be an exciting period for GuestInvest and our investors as we continue to grow.”

Meanwhile, Pierre & Vacances, a market leader in Europe’s hospitality market, is developing its sale and leaseback scheme whereby individual units are sold to investors for a minimum nine-year lease with prices starting from €100,000 and guaranteed returns.

Another company highlighted by Chappell is Galliard, which plans to develop an aparthotel opposite the Houses of Parliament, to be managed by the Park Plaza Europe as an upscale hotel. With 14 floors and more than 900 letting units, it will be largest project of its kind in the UK. Prices start from £175,000, offering a guaranteed 6% return until 2015.

WIN-WIN SITUATION

The driving force though, according to Chappell, is the would-be investors. “I think a lot of this is driven by buyers. We have seen a high increase in demand in the hotel sector from people who want to buy a hotel. But hotels are expensive to buy and this is an alternative way to get a foot in the market.

“The man in the street has more disposable income nowadays and buying a hotel room for €100,000 is within reach. Then, if they get a good income return, it’s a good investment.”

He says condominium investment is preferable to buy-to-let because it is managed by an established brand and repairs, decoration, marketing and occupancy are taken care of. It also makes business sense for developers and operators.

Developers can recoup much of their construction costs up front while retaining ownership of the shared facilities. Chappell explains: “It gives groups more capital to buy their products, and hotels are always looking towards the next product line; it’s also a good way to extend a brand.

“Hotels don’t like owning, they don’t like leases, they like to operate and this works well as a franchise or managed brand.

“It’s also a low capital-intensive way to expand a network of hotels into city centres where it’s difficult to compete. And it’s all about brand loyalty and marketing. If you have 300 condo rooms, that’s 300 visitors to add to your marketing list.”

CHOOSING A ROOM

A key factor to the success of any real estate or hospitality investment is location. Favourite places for condo development are resorts and city centres such as Paris or Madrid, where overseas and business visitors can be relied upon.

It is the international brands that are more likely to develop condominiums along the Mediterranean coast, according to Chappell, where the climate supports a longer trading season. His advice is to work with a recognised brand and operator, whatever the location.

“A five-star independent operator is more restrictive than a recognised three-star – the more established the brand, the better the chance of success. Five-stars can also be expensive because you need to generate a higher revenue to cover refurbishment and redecoration costs.”

“I can see an investor with a mini-portfolio of bedrooms, with a room in each capital.”

But when buyers purchase a condo room are they making an investment or a vacation choice? “It’s a bit of both,” says Chappell. “The bit that says you can use it for two to six weeks of the year is the ‘carrot’ of a second home with all the advantages of timeshare and none of the disadvantages. But the amount of use you get from it has an impact on the revenue generated, so keener investors purely see it as an investment to create revenue.”

In the UK, the investment also has appeal as a tax-efficient saving, as it can be included in SIPPs. However, to do this, investors must forego their usage of the room, otherwise it would constitute a ‘benefit’.

FUTURE EXPECTATIONS

Chappell believes condo hotels are an attractive investment. But, he warns, it is important to be aware that the market is changeable and returns cannot be guaranteed. “These things have to be taken in line with hotel performance, which in the current climate is good.”

However, a question mark still remains over the resale market. Chappell says: “There isn’t an established secondary market because a lot of the schemes are still very new. But there are no restrictions on how you sell and it works as any real estate sale in that you would pay stamp duty and capital gains. I think the market is not there yet because of the room availability.”

As with any investment, there are risks to take into account. “There is an income risk – unless the operator is paying a fixed rent then the rental performance is going to go up and down,” warns Chappell. “Owners of the rooms also have obligations to meet future capital expenditure and if you have a good brand with high standards then these will be significant for regular repairs, renovation and service charges.”

On the whole, however, he considers condos to be a superior investment to timeshare, which can suffer from higher depreciation in resale.

Chappell sees European investors really warming to condos in the next decade. “I can see an investor with a mini-portfolio of bedrooms, with a room in each capital and collecting a healthy income from those rooms. Other investors may prefer to purchase blocks of rooms in different locations with interests in four or five hotels and directly buy into the hotel sector. At the moment investors are still getting to grips with the product.

“For condos to really take off, investors who would traditionally buy-to-let residential schemes or conventional investments will have to be persuaded to take a closer look. But it’s gathering pace and it is at a very exciting stage.”