Published by the CIPS Network of the National Association of REALTORS®
Fourth Quarter 2006
Foreign Investment in U.S. Condo Hotels
By John M. Vernon, Esq.
The condo hotel boom may have spread worldwide, but the U.S. is still the top market for investors from any nation. Recent worldwide polls have shown fairly conclusively that the U.S. is considered the most stable market with a good risk/return tradeoff. Why are foreign investors attracted to the U.S.? There are many, many answers to this question. The U.S. provides diverse climates and markets, readily available travel options, stable governance, and open access to markets. And investment in the U.S. comes from sources worldwide. For example, an Australian group recently announced plans for a new condo hotel development in downtown Austin,Texas. At the same time, German investment in Florida has been on the rise. These are just two examples of the trend. However, even in a market as open as the U.S., foreign investors still need to be aware of potential regulatory pitfalls. These pitfalls can come for either the developer or the condo hotel unit purchaser.
The developer’s perspective
One of the biggest concerns for a developer is to avoid problems with the Securities and Exchange Commission, more commonly known as the SEC. Given the amount of control over the units desired by some luxury brands, this task may prove difficult at best. There are essentially three instances where the securities laws will be triggered:
- The condominium unit is offered in conjunction with any rental arrangement or similar service that emphasizes the economic benefits provided to the unit purchaser by the managerial efforts of the project owner/developer, or any third party designated by the owner/developer, with respect to rental of the condominium units;
- The condominium unit is offered in conjunction with a right to participate in a rental pooling arrangement; or
- The condominium unit is offered in conjunction with a rental or similar arrangement pursuant to which the unit purchaser is required to hold the unit available for rental for some part of the year, must use an exclusive rental agent, or is otherwise materially restricted with respect to occupancy of the unit.
This poses some complexity, if not impossibility, for the luxury brand that wishes to have absolute control over all the units in the building. The simple answer, of course, is to just comply with federal Securities Laws. The alternative is to take the creative way around the SEC rules, perhaps by putting requirements in the condo association agreement rather than in the offering. However, this is treading a fine line. Guidelines have been noted in other articles about condo hotels and securities issues in the U.S. Here is a summary of a few guidelines.
First, the sales group and the hotel management group must be kept entirely separate from one another. This means no common employees, common filing cabinets, or common anything.
Second, the management program offered by the hotel must be entirely voluntary. This lack of control may not be acceptable to some of the luxury hotel chains worldwide, and may be the sole factor for acquiescing to SEC guidelines.
As a third and final example, the real estate personnel may not make any mention about the money to be made from renting the unit. Rather this has to be positioned as a vacation home, not an investment with an annual return.
There are other specific points, like rents must not be pooled, but overall, there are many, many guidelines to be aware of and be wary of in structuring condo hotel offerings in regard to SEC rules and securities laws. Of course, more issues beyond simple rent need to be analyzed as well, such as any revenue from shared areas, if distributed, and how that may impact securities laws, domestically or abroad. The condo hotel can be run in so many different ways that the case by case element of the analysis cannot be emphasized enough, and so expert counsel is generally the cornerstone to a successful venture. Sites like www.hotel-online.com also give a good overview of what to expect, and important background information so that you are prepared to meet with counsel.
The unit owner’s perspective
The unit owner’s concerns are essentially the developer’s concerns. Unit owners want a nice location, a well-kept building, and a high quality of service, but they will also be concerned with upkeep of common areas and how profits from common facilities, like restaurants and gift shops, might help them save on their condo fees. These concerns need to be completely addressed in the contracts that accompany the sale of the unit.
Foreign unit owners will also be concerned about taxes in the U.S., which include federal, state, and local. Depending on the specific arrangement for the condo unit, the owner may be responsible for property taxes and income taxes, among others. There are also issues related to double taxation in their home country which must be closely examined, as well as estate tax implications should the property owner pass away. It would generally be in the best interest of these owners to seek advice of an expert in international taxation, especially since accurate online resources are scarce. Information on federal taxes can be found on the IRS's web site, www.IRS.gov.
Foreign investment in U.S. property, while generally among the least restrictive worldwide, still poses complexities and risks. It is important that any potential investor understand those risks, especially as they apply to their role in the transaction. As the condo hotel continues to develop, these rules are like to evolve further. This potential for change only reinforces the need for thorough research at the time of the transaction, which can generally be accomplished through an expert in the field. Once these complexities are dealt with, developers and unit owners will be able to breath easier and enjoy the property.
Copyright© by John M. Vernon 2006
John M. Vernon is a partner in the law office of Vernon Goodrich, LLP. Mr.Vernon advises hospitality companies with regard to international acquisitions, financing, managing and franchising properties; licensing technology, brands, web and internet services, intellectual property protection, and real estate associated with hotels, resorts and restaurants; litigating, arbitrating and mediating disputes. He also serves as an adjunct professor at the SMU School of Law in international franchising. Reach him at jvernon@vernongoodrich.com.
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