Primer on mixed-use project characteristics, brand approval requirements

NATIONAL REPORT from ISHC – The development of a branded mixed-use project in either an urban or resort environment is complex, challenging, enervating and, typically, exciting. It requires flexibility, discipline and expert involvement.

This article presents an overview of the branded mixed-use hotel with a branded residential component.

The branded mixed-use project under a hotel management agreement, like most HMAs, display the following characteristics:

• All capital obligations and risk of economic loss in the operations remain with the owner; unless negotiated in an arduous negotiating environment, there are no guaranties

• The development and operating standards are established by the manager

• The manager will have broad discretion over operations, marketing and repair and maintenance, significant input into capital programs and all employees, including hiring, firing and compensation and benefits matters

• The Owner’s ability in each of the following circumstances is limited  to contest certain elements of the annual budget that are characterized as “brand standards;” to involve itself in operations; and to  
• terminate the manager

• The manager might dictate the involvement of one or more preferred designers

• There will be restrictions on the sale of the project

• Operations are mostly controlled by the manager and are dependent on market conditions, performance issues, continuing capital calls for upkeep and refurbishment, and appeal of the project

• Financial terms for compensation of the manager will fall within market-driven norms

• The manager’s liability is likely limited to gross negligence, willful misconduct or fraud

• The term is long, potentially approaching 60 to 75 years

A luxury hotel’s operations are complicated but likely enhanced by the presence of residences developed and sold by the owner under the brand’s name (for which a license fee is charged; custom and practice suggest a fee between 2% and 5% of gross residential sales, with a percentage paid upfront), and residential operations (maintenance, homeowner association governance and day-to-day operations) would fall under the manager’s dominion.

Any plan for including the rental and operation of the residences within the hotel inventory will be reviewed, vetted and approved – if not mandated – by the brand. Indeed, the design of the residential units themselves, the marketing plan and use of the brand’s name, logo and images, and, in some cases, the identification of the developer’s sales force and the sales methods, will require the brand’s approval.

Included in the requirements for brand approval are, typically, most or all the following:

• Name and use of the brand

• Sales website contents (must include certain brand-mandated disclaimers)

• Sales team (or sales agency) makeup and sales team “pitch”

• Homeowner/Condominium Governance Documents (which must vest control over the association in the owner, and enable the brand to act as owner’s delegee)

• Management terms (including compensation to the brand) for association management

• Design, including all public and back-of-house areas

• Benefits for buyers, particularly if affecting the hotel or the brand’s system of residential offers

• Services and costs to be charged to residents

• Amenity and resident use packages

• Substantive aspects of the rental program, including sharing arrangements between owner and the residential owner (the brand is compensated via the HMA due to flow-through in the hotel income statement)

• Manner by which the owner presents the rental program to potential buyers during or related to the sale process
  
  

As U.S. law has jurisdiction over sales of securities to Americans wherever located, and websites and collateral materials promoting sales are accessible or received by Americans in the U.S., the U.S. government asserts jurisdiction.

No brand wants to face the U.S. Attorney in New York City, Washington, D.C. or Miami for a Securities Law violation.

U.S.-based brands, especially, but even the non-U.S. domiciled brands, rely heavily on U.S. Securities Laws to avoid “rental pools” and obtain indemnifications – if not require guaranties – against Securities Laws and Consumer Protection Laws violations in the sale process. Fortunately, procedures that have been approved in individual instances have arisen and inform the process of sales and the manner of marketing buyers’ participation in the rental program.

A ‘rental pool’ connotes a sharing (pooling) of revenues and distributions net of shared (pooled) expenses; a ‘rental program’ is simply a means of renting out the residences according to a sharing of revenue formula to be determined between the unit owner and the owner. One unit’s rental has no effect on another’s rental. Brands abide the restrictions that U.S. Securities Law might place upon control of rentals, while benefitting from the imposition of the restrictions that enables them to demand appropriate and complete indemnification from owners/developers. The owner must also conform to the association governing documents and marketing and sales materials under the laws of the jurisdiction (whether in the U.S. or elsewhere) where the project is located (and, if in the U.S., those states where the project will be directly marketed).

Many states have filing requirements, including approval by the Office of the Attorney General of the state.  Compliance here adds a layer of complexity, time and cost to the entire process.

It would be unusual for all aspects of the residential transaction to be completed concurrently with the negotiations, execution and delivery of the HMA document set; however, the owner/developer must understand the issues that will arise when the HMA document negotiations are completed.

At a minimum, all parties should pursue completion of detailed outlines addressing the rental program terms (including sharing of revenues and payment of expenses), the homeowner/condo association management terms, unit owner use and access to common areas and amenities, rules and regulations on third-party rental capabilities and more. The branded residences program takes on its own life.

Michael Shindler, ISHC, president, Four Corners Advisors, Chicago

The views and opinions expressed in this column do not necessarily reflect the opinions of Hotel Investment Today or Northstar Travel Group and its affiliated companies.