The Condo Hotel Rental Program Agreement
The Condo Hotel Rental Program Agreement
Fourth Annual Hospitality Law Conference
Houston, Texas
February 2 – 3, 2006
© 2006 Russell Savrann
As Bart Bartholdt concluded his article “The Condo Hotel: When Might the Security Laws Apply” (© 2005 Graham & Dunn PC), “[s]tructuring a rental program to be offered in connection with Units in a condo hotel, in such a way as to avoid the securities laws, requires careful attention.” In the spirit of “careful attention” this article looks at elements of a rental program agreement (“Agreement”), offering comments and discussion illustrating the unique operational issues it presents. Each project and hotel owner is unique, therefore the guidance and language provided is intended as a starting point for the drafter.
These comments focus on the requirements of the hotel owner. Developers and their counsel should carefully review the need to balance standards and rights of hotel guests with the property rights of the unit owner and the Home Owners Association. As this is an evolving practice area without a long track record with regard to branded Condo Hotels, it is important to keep abreast of local and state requirements. These guidelines are derived from sources in use within the State of Florida which has the most mature condo hotel market. As each project is unique not all of the guidelines and suggestions I have included in this article may apply.
I. Key Elements of a Condo Hotel Rental Agreement.
1. Unit Owner Acknowledgement of Securities and Exchange Compliance.
A primary concern of the hotel owner (“Hotel Owner”) is to ensure that the sales and marketing team selling the condominium unit (“Unit”) have not made any representations to the unit owner (“Unit Owner”) that would be outside of the SEC no action guidelines. An acknowledgement by the Unit Owner that the sales process was clear of any such representations is advised. The above cited article provides a clear review of the SEC issues.
2. Exclusive Authority to Rent.
The Hotel Owner needs to receive from the Unit Owner authority to rent and manage the Unit Owner’s Unit. The Hotel Owner may subsequently assign the rights to rent the Unit to a third party hotel manager (“Operator”) that may be, but does not have to be, a brand. The Hotel Owner needs to have an exclusive right to rent the Unit. When a Unit Owner also accepts consideration for sub-renting the Unit, in addition to the redirection of revenue from the hotel, there is a reasonable likelihood the state and local hotel taxes are not being collected. It is suggested that the Unit Owner refer all rental opportunities to the Hotel and that the Unit Owner reimburse the Hotel for the rental value of the Unit over those dates with or without a penalty. As the integrity of the rental program is at stake, bypassing the hotel rental program should be a material default.
3. Term.
The initial length of term is a business decision to be determined with the Hotel Owner and the Operator. Most agreements automatically renew for the full initial multi-year term. In the interest of fairness the Hotel Owner should be given a full six months prior to the term date to receive written notice on non-renewal. Be careful with commencement dates. A project under development should have the rental program term commence when the hotel is open as determined by the Hotel Owner, not on the signature date or when title transfers to the Unit Owner.
Special termination rights may be offered where the Hotel Owner and/or the Operator desire to make material changes to the Rental Program. The Unit Owner may be granted a short period to give notice with the termination effective at a later date.
The Unit Owner should acknowledge that conflicts might arise between the Unit Owner’s right to use of the Unit and the hotel’s need to rent the Unit. Most agreements give priority to the hotel’s needs. These conflicts arise over guest reservations that (i) interfere with Unit Owner’s allocated use time due to occupancy demands and/or (ii) when there is a guest reservation or occupant for the Unit beyond the termination date of the Agreement. In some condo hotels the Unit Owner may keep personal property on premises for when they are in house. In these circumstances, the Agreement needs to require the removal of the personal items and/or grant permission for the hotel to remove and store the items.
4. Rental Procedures.
The rental procedure and rates section should be broadly drafted to protect the Hotel Owner and the Operator from the repercussions of a Unit Owner’s unrealized expectations of income and revenue. For example, the Unit Owner’s expectation is that the Unit will be included in a reservation system, that his or her Unit will be rented in a fair and equitable allocation, and that the Unit will have the same return or revenue as like Units in the property.
In order to avoid the claim that the Unit was not rented fairly, the Hotel Owner should represent that the Unit will be rented subject to (i) available inventory, (ii) normal industry practice and (iii) subject to the policies and procedures of the Operator. This section should clearly provide that pursuant to industry practice the Hotel Owner may give priority rental to those Units that command the highest rental rates and that any system of rotation is subject to among other things (a) guest requests and preferences, (b) factors of differentiation such as Unit size, location, view, type of Unit, and other relevant issues, (c) usage of the Unit by the Unit Owner or its guests and (d) the remaining length of term.[1]
Disclaimers of performance should be provided. The Unit Owner should acknowledge that despite the efforts of the Hotel Owner the Unit may not be rented for the same or substantially the same number of nights, and may not receive the same or substantially the same net rental income, as other condominium Units participating in the rental program within the same room class for any time period. It should further be provided that the rental income may not exceed assessments and other costs associated with the Unit.
The Hotel Owner should reserve the right to cancel a reservation for the Unit if for any reason, in the opinion of the Hotel Owner, the Unit no longer meets the standards of the hotel or is otherwise unfit for rental to guests.
It is advisable to determine in the Agreement whether the Unit will be a nonsmoking or pet friendly Unit. This election will apply to the Unit when occupied by the guest or by the Unit Owner.
5. Rates and Collection.
Room rental rates are set by the Hotel Owner. The Hotel Owner should reserve the right to change the rates in its sole discretion. The following are conditions for which a Hotel Owner may adjust the rates without notice to the Unit Owner: (i) changes in operating costs, (ii) rates of comparable properties, (iii) special discounts, (iv) extended length of stay, (v) group discounts, (vi) Hotel Owner or Operator employee discounts programs, (vii) corporate discounts, (viii) package plan discounts (ix) customer loyalty programs and (x) matters deemed relevant by Hotel Owner such as consideration of customer base, market segments and seasonal variations. The Hotel Owner should reserve the right to use the Unit for promotional and other complimentary purposes in the Hotel Owner’s discretion.
All remunerations from the rental of the Unit should be collected by and through the Hotel Owner. For control the Hotel Owner is responsible for all sales, use, occupancy, bed, resort, tourism and or other taxes assessed in conjunction with the Unit rental.
The Hotel Owner should be given the discretion to handle all guest complaints with authority to discount room rental rates, move guests to alternative Units, provide credits, reimbursements and refunds as required. In the event a guest is moved to another room, the rental should be allocated proportionately between the Units on the night of the transfer.
6. Adjusted Unit Revenues.
In general, the Unit Owner receives a percentage of the “Adjusted Net Revenue” from the rental of the Unit. The following is a representative list of costs and expenses that might apply to the calculation of the Net Adjusted Revenue.[2]
Adjusted Net Revenue is derived following the deduction of costs and expenses from gross rental revenues net of discounts rebates or credits collected from the rental of the Unit.
Cost and expenses customarily include: (i) administrative charges, (ii) management fee, (iii) rental program expenses (which may include housekeeping, consumable guest supplies and other standard hotel services to hotel guests), (iv) operating, administrative, accounting/bookkeeping, collection and reporting expenses, that include employee costs and expenses, (v) charges and fees for reservations, (vi) sales and marketing services, (vii) other centralized services, (viii) credit card, (ix) travel agents and other rental related commissions, and (x) operating licenses and permits (“Gross Rental Program Expenses”).
The Hotel Owner may also allocate a portion of the Gross Rental Program Expenses to the Unit based on the approximate Hotel Guest usage of the Unit as compared to all other Units in the rental program (“Expense Deduction”). To the extent the actual costs and expenses are less or greater than the Expense Deduction, any overpayment shall be returned to the Unit Owner and any underpayment shall be charged to the Unit Owner.
7. Unit Owner’s Expenses and Charges.
A Unit Owner can expect to have to pay certain expenses directly to the payee. Examples of expenses typically attributable to a Unit are assessments and other amounts due to the condominium association, reserves, fees and charges due to the Hotel Owner; utilities not covered by condo assessment, real estate and personal property taxes, debt service attributable to any debt service on the Unit and its contents and all insurance costs.
The Unit Owner will also be responsible for all amounts due to the Hotel Owner under the Agreement, all fees and charges for hotel services used during the owner occupancy not otherwise collected at check out.
8. Insurance.
The Hotel Owner should establish the minimum insurance requirements to be carried by the Unit Owner. The Unit Owner should be expected to carry at minimum a HO-6 Condominium Policy or its equivalent or such other insurance as the Hotel Owner shall specify from time to time. The policy should include liability insurance of at minimum $1,000,000 per occurrence and property insurance covering personal contents and fixtures within the Unit. The property policy shall be “all risk” or “special risk” form on a 100% replacement cost basis. The personal contents policy is important where the furnishings are provided to maintain a standard.
The Unit Owner should be required to name the Hotel Owner and other Hotel Parties as additional insured and include a waiver of any rights of subrogation against Hotel Owner. (Define as Operator, manager, licensor, franchisor, contract vendee or service provider to Hotel Owner.) It is a good practice to require the Unit Owner to provide a Certificate of Insurance evidencing the required coverage at the commencement of the Term and at any renewal period and include a requirement that the Additional Insured will be given notice of cancellation or material change in coverage. In some circumstances the Hotel Owner may provide insurance at market or at below market rates. In this circumstance the Hotel Owner can require the Unit Owner to purchase insurance from the Hotel Owner. [3]
9. Maintenance of Standards.
In the interest of providing a quality and consistent product for the hotel guest the Operator will maintain that standards are the most important section of the Agreement. As the branded condo hotel is a relatively new product, the typical luxury condo hotel is new or newly renovated and has not suffered the inevitable wear and tear of the aging property. Most branded hotels will require the purchase of a standard FF&E package and standard operating supplies package upon entering the Rental Program with a prohibition on substitution. Sufficient reserves should be assessed for a renovation and replacement of FF&E every five years. Any FF&E purchased for the Unit through the reserve shall remain the property of the Unit Owner and any proceeds from the sale of used furnishings shall be deposited in the reserve. Any reserve balance needs to be paid to the Unit Owner upon termination of participation in the Rental Program unless the Hotel Owner approves the assignment of the Agreement whereupon the Reserve Account is retained for the benefit of the subsequent owner.
All actions necessary to maintain the hotel standards as determined by the Hotel Owner in its sole discretion are at the Unit Owner’s sole cost and expense. In order to ensure sufficient funds are available for replacement, repairs and renovations, the Hotel Owner will capture from gross rental revenue a reserve that is typically 5% (“Reserve Account”). The Hotel Owner needs to maintain the right to adjust the reserve percentage from time to time.
In the interest of meeting immediate needs and having a Reserve Account with sufficient funds, some Rental Programs require the Unit Owner to deposit funds into the Reserve Account upon signing the Agreement and permits the Hotel Owner to make purchases from the Reserve Account below a certain monetary amount on an emergency basis without giving notice to the Unit Owner.
In order to assure the maintenance of standards, give the Hotel Owner the right to enter the Unit for the purpose of conducting an annual inventory all standard FF&E and standard operating supplies such as linens, small wares appliances etc. As it may be impractical and too costly for the Hotel Owner to track or keep certain common operating supplies from being commingled between the Units and hotel rooms such as bed sheets and towels, allow the Hotel Owner to assess all of the Unit Owners and applicable hotel rooms for replenishment and/or replacement of the inventory.
The Hotel Owner should have full discretion in applying the Reserve Account funds to the cost of maintenance, supply, repair, replacement, and refurbishing of the Unit and all furnishing and supplies therein as necessary to maintain the standards, including periodic deep cleanings excluding payment of maintenance, supply, repair, replacement, and refurbishing of the Unit following any Unit Owner occupancy period so long as a departure fee is collected and is adequate to cover the expenses.
The Hotel Owner should be responsible for collections from hotel guests. In rare circumstances a guest can cause significant damage to a Unit and its contents. The Hotel Owner should be responsible for collection, and if necessary, costs of litigation to collect damages from the guest. If amounts are owed to both the Hotel Owner and the Unit Owner, then the amount collected should be allocated between the parties in proportion to the amounts owed to each. The Unit Owner is responsible for, and should expect, normal wear and tear to the Unit.
If at any time the Hotel Owner in its opinion believes the reserve fund insufficient to maintain the Unit in conformity with the standards, the Hotel Owner may require the Unit Owner to cover the deficiency. It is important to reserve a right of self help for the Hotel Owner whereby the Hotel Owner can cover the costs and expenses and set off from current and future revenue.
Failure to comply with the standards should be a default with Hotel Owner having the right to suspend the rental of the Unit and the provision of other services such as telephone, internet, business center, spa, etc.
10. Owner Occupancy.
Key issues with Unit Owner occupancy are, as discussed earlier, conflicts with guest reservations, sub-rental, dates of use, and payment for hotel services including housekeeping and other services.
A recommended practice is to give priority to hotel guest reservations over Unit Owner requests, unless the Unit Owner reservation is made within the established notice period. As each project is unique, the Hotel Owner should establish the amount of advance notice to be required for Unit Owner reservation, based on non peak and peak seasonal considerations. In peak season a six month to one year advance notice period for Unit Owner use is not unreasonable. Notwithstanding a Unit Owner’s advance reservation, the Unit Owner should not be guaranteed occupancy rights as hotel inventory may not be sufficient to meet guest needs.
The Hotel Owner should not be liable for damages in the event of a conflict with a guest reservation, even if the conflict is due to the negligence of the Hotel Owner. At no time should the Unit Owner have the right to require the Hotel Owner to relocate or evict a guest.
The Hotel Owner may also set blackout periods which should be provided to Unit Owners on an annual basis and/or assess an additional daily charge for Unit Owner occupancy over certain peak dates or seasons.
In designing a Rental Program the Hotel Owner will establish the number of days the Unit Owner is entitled to occupy the Unit. These days can be further restricted by season. Occupancy of less than a set number of days can be deemed to be the set number (i.e., any occupancy of less than 7 days shall be counted as 7 days for purposes of calculating the number of days used by Unit Owner).
A mechanism to ensure the Unit is fit for guest rental and complies with standards is for the Hotel Owner to assess a “Departure Fee” on the Unit Owner to cover cost to the Hotel Owner to clean, supply and prepare the Unit for guest rental. These charges are deemed necessary as the Unit Owner generally occupies its Unit for a longer period of time than a hotel guest and the Unit Owner may not avail itself of daily housekeeping services.
In order to ensure the prompt payment of charges and the smooth operations of the hotel, the Hotel Owner should require the Unit Owner and its guests, to abide by hotel rules including check in and check out times and require a credit card be provided on check in for incidental hotel charges, daily housekeeping (if requested) and the departure fee. The determination whether to charge the Unit Owner’s or Unit Owner’s guest credit card or apply the charges to the Unit Owner’s account should be at the discretion of the Hotel Owner.
Although the Unit Owner controls its unit, for Hotel Owner access and general security purposes, the Hotel Owner may at Unit Owner’s expense make any necessary modifications to the locking and or security system for the Unit to comply with the locking and security system of the hotel.
11. Termination and Default.
Grounds for termination should include (i) the failure to pay any amounts due to the other party following notice and opportunity to cure; (ii) the failure to perform a material covenant, obligation or condition after notice and opportunity to cure; (iii) upon the expiration or earlier termination of any Operator management agreement for management of the hotel; and (iv) automatically upon the sale or other conveyance of title to the Unit from Unit Owner.
If the Hotel Owner waives the termination upon sale, and approves an assignment of the Agreement to the subsequent Owner, then the Unit Owner’s reserve should be retained by the Hotel Owner for the benefit of the subsequent Unit Owner.
If a Unit Owner is in default, then the Hotel Owner may, in addition to all other remedies available to it, suspend the rental of the Unit and the provision of other services.
A final accounting should occur not later than 30 days following termination. To the extent the Unit Owner owes Hotel Owner any amounts the Hotel Owner should be given the right to set off the receivable from any revenue owed to the Unit Owner including balances in the Reserve Account.
Due to the difficulty of determining post termination damages, the Hotel Owner can consider including a liquidated damage provision for the value of the lost rental income for the remaining term. The calculation can be based on a percentage of the average daily room rate for comparable Units over the prior twelve months multiplied by the remaining days from the termination to the expiration date. Any liquidated damages would be in addition to amounts due prior to termination. If the liquidated damages provision is found to be unenforceable, then be sure that such an event does not void any additional rights of the Hotel Owner to collect post termination damages.
12. Indemnity Risk of Loss.
As the Hotel Owner manages the Rental Program for the benefit of the Unit Owner, the Unit Owner should indemnify, defend and hold the Hotel Owner harmless, for any and all liabilities arising in whole or part arising out of any maintenance, renovation, replacement, repair, condition, rental, management, or operation of the hotel, the Unit or the rental program, or the performance of the Agreement except to the extent such liabilities are caused by the gross negligence, willful misconduct or illegal acts of Hotel Owner during the term.
The Unit Owner assumes all risk of loss to the Unit and its contents that are not covered by the required insurance policies. The Unit Owner needs to release the Hotel Owner and Hotel Parties from any claim to recover any loss or damage to the Unit and its contents including any liability arising out of the health, safety or welfare of the Unit Owner and/or any occupant or user of the Unit.
13. Reports.
In addition to monthly statements of account provided by the Hotel Owner, the Unit Owner may request, or be provided with reports, relating to the performance of the Unit and the hotel. The Agreement should address what data the Unit Owner is entitled to and when the reports will be provided. Otherwise, the Unit Owner’s requests can be an unanticipated financial and administrative cost.
II. Conclusion.
The condo hotel, being a hybrid of real estate and hotel products, presents novel issues for the hotel developer, operator, purchaser and counsel. Each Agreement will have common elements, however as each project is unique and there is no set format, the rental program agreement may be detailed or general and in all cases needs to reflect the underlying business structure of the condo hotel.
If you have additional questions regarding this area of law, please contact Russ Savrann at (203) 653-2820 or rsavrann@sandsav.com or Irv Sandman at (206) 368-0802 or isandman@sandsav.com.
[1] An aggressive Hotel Owner can further provide that the Condo Hotel rooms owned by the Hotel Owner will have rental priority over all condominium Units participating in the Rental Program.
[2] The allocation of expenses by and between the Hotel Owner and the Condo Association can come into play. In some circumstances the Hotel Owner will allocate non revenue elements of the property such as the hotel kitchen as a condo association expense even when restaurant is retained by the Hotel Owner in the commercial or front desk Unit. Ultimately these abuses which increase the Unit Owner’s cost may lead to Unit Owner litigation.
[3] Purchasing insurance from the Hotel Owner may be the only option available in some markets due to changes in underwriting following the 2005 hurricane season. Hotel Owners, HOAs and Unit Owners may be subject to dramatic increases in insurance costs and may have to consider self insurance or participating with captive insurance products.