CONDOMINIUM HOTELS
LEGAL STRUCTURE
AND
ALLOCATION OF OPERATING EXPENSES
BY
Theodore J. Novak
Jeffrey N. Owen
DLA Piper Rudnick Gray Cary US LLP
203 N. LaSalle Street
Chicago, Illinois 60601
(312) 368-4000
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INTRODUCTION
The legal structure used to create a Condominium Hotel will vary from jurisdiction to
jurisdiction but tends toward three fundamental structures. They are: (i) a traditional
condominium, with Unit Owners owning and controlling the entire project, including the
facilities necessary to operate the hotel; (ii) a condominium in which the facilities that are
necessary to operate the hotel are placed in a separate Shared Facilities Unit, which is owned by
the developer and managed by a hotel operator; and (iii) a building which is subdivided into
separate components, with one component comprising the condominium, consisting primarily of
hotel rooms owned by individual Unit Owners, and the rest of the building owned by the
developer as a separate parcel of real estate, in which most of the improvements and facilities
necessary to operate the Hotel are located.
A Condominium Hotel is first and foremost a hotel, and to succeed, the project must
achieve occupancy levels and room rates that are competitive with the local market. A hotel has
many different and unique elements required for successful operation, and carries with it
categories of cost that differ from traditional residential condominium projects. To the extent
that the hotel is not successful, the individual Unit Owners typically bear the cost of any
operating expense deficiency.
In this paper, we intend to describe the three fundamental legal structures tending to
dominate the legal landscape. In addition, we will discuss the expenses that are usual and
customary in hotel operations and how these expenses are allocated and charged to
Condominium Hotel unit owners in each of these different structures.
Please note that this paper assumes a project containing a hotel condominium with
limited amenities, as opposed to a more complex project containing a separate dedicated hotel
tower, residential tower and retail complex.
DIFFERENT LEGAL STRUCTURES
Traditional Condominium
In a Condominium Hotel created as a traditional condominium, the project consists of
individual condominium units set up as hotel rooms for use by transient hotel guests, with the
rest of the building characterized as common elements and owned by the Unit Owners as tenants
in common equal to their percentage interest in the condominium. In this structure, all of the
traditional elements of a hotel, such as the hotel lobby, registration desk, meeting rooms (if any),
corridors, elevators, housekeeping and service closets, health club and fitness area, meeting
rooms and any related amenities are located in the common elements and as such are owned by
the Unit Owners. A homeowners association (“HOA”) will be responsible for maintaining and
operating the entire project and will usually delegate that obligation by management agreement
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to a hotel management company. All costs and expenses incurred by the HOA (and the hotel
management company) will be passed through to each unit owner, usually by monthly
assessment pursuant to a budget adopted by the HOA, and allocated to each unit by percentage
interest or some other equitable basis. Typical Hotel Service Expenses (as described in greater
detail later in this paper) incurred or allocated to each unit will be charged to each Unit Owner by
the hotel management company.
The management agreement entered into between the HOA and the hotel management
company tends to be short term, and is subject to statutory rights of termination in favor of Unit
Owners on turnover of control of the condominium from the developer to the Unit Owners and at
other defined points in time. In addition, budgets for repair, renovation and capital
improvements are also subject to more persistent Unit Owner oversight, making it more difficult
for the hotel management company to control operations and to make capital expenditures when
needed to renovate hotel facilities.
Condominium with Hotel Unit or Shared Facilities Unit
In this type of legal structure, the entire building is created as a condominium, but there
are several types of units. There are individual units which are owned by the Unit Owners, set
up as hotel rooms for use by transient hotel guests, but the rest of the building that is typically
part of a hotel (lobby, front desk, elevators, corridors, housekeeping and service closets on each
floor, laundry facilities, other facilities customarily associated with hotel operations such as the
health club and meeting rooms) are located in a “Hotel Unit” or “Shared Facilities Unit”
(hereinafter referred to in this paper as a “Shared Facilities Unit”). The Shared Facilities Unit is
owned by the developer, and management is usually delegated to an experienced hotel operator
by long-term management contract. One of the benefits of this structure is that the developer and
hotel operator retain complete control of hotel operations, and the management agreement is not
generally subject to statutory rights of termination possessed by the Unit Owners.
The Unit Owners and hotel guests are granted various access, use and other easement
rights by the Condominium Declaration over the Shared Facilities Unit, and the owner of the
Shared Facilities Unit is obligated to provide certain services to the Unit Owners and hotel
guests, such as maintenance, cleaning, housekeeping, linen service, security, accounting and
financial administration, and operation of the rental program. In exchange for the grant of
easements and the obligation to provide services, all of the costs and expenses of owning and
operating the Shared Facilities Unit are passed through to the Unit Owners, based on the
percentage interest of the Unit Owners in the Condominium, excluding from such computation
the percentage interest of the owner of the Shared Facilities Unit.
The owner of the Shared Facilities Unit will promulgate an annual budget and is granted
the right by the Condominium Declaration to assess and collect these expenses from the Unit
Owners. The Shared Facilities Unit owner is also granted lien rights and other remedies if a Unit
Owner fails to pay such assessment. In addition, the budget also includes a line item for reserves
to repair, replace and even upgrade the Hotel as and when needed, in the discretion of the owner
of the Shared Facilities Unit, in keeping with the standards of operation dictated by the
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Condominium Declaration and other project documents. The rights given the Shared Facilities
Unit owner are usually exercised by the hotel management company.
Condominium with Separate Hotel Component
This type of legal structure is similar to the Condominium Hotel with a Shared Facilities
Unit, except all of the improvements and facilities that are placed in a Shared Facilities Unit are
instead located in a separate subdivided parcel or parcels of improved real estate, are separately
owned by the developer, and are not part of the Condominium (such separate parcel is
hereinafter referred to as a “Hotel Owned Component”). The other characteristics inherent in a
Shared Facilities Unit are present in a Hotel Owned Component: grants of rights of access and
use to Unit Owners, obligations to provide essential hotel services imposed on the owner of the
Hotel Owned Component, the right to charge back to the Unit Owners the cost and expense of
operating the Hotel Owned Component. The Hotel Owned Component is owned by the
developer, and management obligations are delegated by long term management agreement to a
hotel operator.
The interrelationship between the Condominium and Hotel Owned Component is usually
governed by a Declaration of Covenants, Conditions, Restrictions and Easements (“Declaration”)
which is recorded against the entire project and which provides, among other matters, for
structural support, enclosure, ingress and egress, utility services and the maintenance, repair and
replacement of facilities and components necessary for the efficient operation of the Hotel. The
same budget and assessment rights and regime granted to the owner of a Shared Facilities Unit
are also incorporated into the Declaration for the benefit of the owner of the Hotel Owned
Component.
CONDOMINIUM HOTEL EXPENSES
Generally
The Owner of a Condominium Hotel unit generally must pay the following categories of
expenses: (i) principal and interest incurred by the Unit Owner in financing the acquisition of the
unit; (ii) real estate taxes (sometimes charged on the individual unit owner’s unit together with a
percentage share of real estate taxes charged to the HOA Common Elements or to the Shared
Facilities Unit or Hotel Owned Component); (iii) assessments for HOA managed common
elements, based on those portions of the project that are made part of the common elements of
the Condominium, which the HOA is obligated to maintain under the project documents; (iv)
expenses of owning, operating, insuring, maintaining, repairing and replacing the improvements
and facilities located in the Shared Facilities Unit or the Hotel Owned Component; and (v)
services required to be provided to the Unit Owners (and hotel guests) as part of Hotel
operations, which are either fixed or derived from the use of the hotel unit, operating expenses
arising from the ownership, maintenance and operation of the Hotel. Many are familiar with
expenses charged under (i), (ii) and (iii), which are traditional costs incurred in owning and
operating any Condominium; the expenses incurred under (iv) and (v) are more unique to hotel
operations and bear further scrutiny. These expenses generally break down into two categories:
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expenses incurred in operating, maintaining, repairing and replacing the physical building
improvements and facilities comprising the Hotel, and expenses incurred in providing services to
the Units and the individual Unit Owners and hotel guests.
Shared Facilities Unit/Hotel Owned Component Expenses.
Depending on the legal structure, a Unit Owner will be obligated to pay the cost and
expense of owning, using, operating, maintaining, repairing, replacing and renovating
improvements and facilities located in the Shared Facilities Unit or the Hotel Owned
Component. This obligation includes real estate taxes assessed against the Shared Facilities Unit
or Hotel Owned Component, and utilities consumed in operation. The obligation to pay these
costs is usually imposed in consideration of the various easement and other rights being granted
to the Unit Owners by the owner of the Shared Facilities Unit or Hotel Owned Component over
such properties.
Each year, the hotel operator, on behalf of the owner of the Shared Facilities Unit or
Hotel Owned Component, will prepare a detailed proposed budget for these costs (the “Shared
Facilities Budget”). The Shared Facilities Budget will usually include (i) the estimated annual
expenses for the ownership, operation, use, maintenance, repair, replacement and refurbishment
of the Shared Facilities Unit or Hotel Owned Component, (ii) cash requirements for the year,
including wages, materials, insurance, services, supplies and all other expenses related to the
Shared Facilities Unit or Hotel Owned Components, (iii) all costs needed to reimburse the
developer for all general and special condominium assessments and use charges incurred by the
Shared Facilities Unit or Hotel Owned Component, (iv) utility costs for the Shared Facilities
Unit, real estate taxes for the Shared Facilities Unit or Hotel Owned Component and other fees,
costs, charges or expenses incurred by Developer in connection with the ownership, use,
maintenance, operation, repair and replacement of the Shared Facilities Unit and all
improvements located within or upon the Shared Facilities Unit, and (iv) a reasonable amount
considered by the developer to be necessary for adequate reserves. Once adopted, each Unit
Owner is obligated to pay such Unit Owner’s share of the Shared Facilities Budget, based on the
Unit Owner’s allocated share, usually monthly.
The amount reserved by the developer (the “Hotel Reserve”) is maintained in a
segregated special reserve account to be used solely for making capital expenditures and paying
for the costs of deferred maintenance in connection with the Shared Facilities Unit or Hotel
Owned Component. One of the primary purposes of the Hotel Reserve is to reserve funds for the
periodic repair, replacement, refurbishment, enhancement and update of the Shared Facilities
Unit or Hotel Owned Component, as may be performed or required from time to time in the sole
and absolute discretion of the developer and hotel operator. The benefits of a Hotel Reserve are
obvious and avoid the need of having to impose a special assessment on the Unit Owners or
finance the cost of such improvements. The hotel operator, on behalf of developer, will
determine from time to time the appropriate level of the Hotel Reserve based on a periodic
review of the useful life of improvements to the Shared Facilities Unit or Hotel Owned
Component together with periodic projections of the cost of anticipated major repairs,
replacements or improvements to the Shared Facilities Unit or Hotel Owned Component, or the
purchase of equipment to be used by the Developer in connection with the Shared Facilities Unit
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or Hotel Owned Component. The Hotel Reserve also may be used to defray the cost and
replacement of FF&E in the Unit.
Hotel Service Expenses
Service expenses charged to Unit Owners in a Hotel consist generally of two types: (1)
fixed costs (which are charged to each Unit based on certain Unit characteristics [number of
rooms, suite, size, etc.]); and (2) costs for Per-Use Services (which fluctuate based on the period
of time a Unit is occupied and the use of services by the hotel guest for such Unit). Accordingly,
each Unit Owner’s monthly Hotel Service Expenses will equal the sum of (a) the total monthly
fixed costs for such Unit; plus (b) the product of (i) the number of nights during such month that
such Unit is occupied, multiplied by (ii) the Per-Use occupancy charge for each night of
occupancy in such type of Unit. The following is a summary of typical Standard Fixed Services
and Per-Use Services:
Standard Hotel Fixed Cost Services:
The following “Standard Hotel Services” are provided to all Unit Owners,
whether a Unit is occupied or unoccupied, which are charged on a daily or monthly basis
and which will be included as part of the fees and charges paid for by each Unit Owner:
(i)
Reception Desk. The management company engaged by the HOA to
operate the Condominium Hotel generally provide staff who will be on duty at the
reception desk in the hotel lobby 24 hours a day, 7 days per week to handle registration,
issue room keys and to orchestrate services to hotel guests. For security purposes and to
monitor occupancy, anyone seeking to occupy a room usually must register with the front
desk and will be issued a room key (or, to the extent that a Unit Owner or employee or
relative of such Unit Owner has its own room key, such room key will be activated or
reactivated, as the case may be, at such time).
(ii)
Lobby/Bellman Staff. Lobby/bellman attendants will be available 24
hours a day, 7 days per week, to transport baggage and packages to and from the Units
and to store baggage as needed.
(iii) Security. Hotels usually have at least one security guard who will be on
duty at all times either in the hotel lobby or at another security center.
(iv)
Telephone and Telecommunications Service. Telephone operator
service is provided 24 hours a day, 7 days per week, for assistance with incoming call
routing, message service, wake-up call service and outside operator connections. High
speed internet connections are usually provided.
(v)
Cable Television Service. Each Unit is usually connected to cable
television service which will offer a variety of stations. Premium movie channels and a
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pay-per-view service offering movies, specials and sporting events are available to hotel
guests as a per use charge.
(vi)
Licensing and Permits. The hotel operator will procure and maintain in
effect all licenses and permits required for the operation of the hotel in the jurisdiction in
which the hotel is located, including any liquor licensing requirements for in-room bar
service.
(vii) Marketing. The hotel operator will provide marketing and promotional
services (including staff, brochures and advertising and production costs) for the rental of
units.
(viii) Tax Filings. All hotel accommodation, occupancy, sales or other taxes
applicable to hotel operations will be collected and remitted by the hotel management
company to the appropriate taxing authority, on behalf of all Unit Owners (except for
income taxes assessed against a Unit Owner), and the hotel management company will
file with the appropriate taxing authorities all necessary tax returns related to such taxes
and applications for refunds, if any.
(ix)
Financial Administration and Accounting. The hotel management
company will provide staff, 24 hours a day, 7 days a week, to collect room rental
payments, monitor and collect miscellaneous charges such as telephone, pay-per-view
and room service charges from hotel guests, and keep the financial records for each Unit.
The hotel operator management company also will maintain detailed records of all such
charges and revenue and will issue a statement to each Unit Owner detailing such
charges, on a quarterly or monthly basis.
(x)
Concierge Services. Staffing of a concierge desk is usually a fixed cost,
to provide a variety of other services (limousine and transportation services, valet parking
services, tickets to sporting and theatrical events, restaurant reservations and similar
services).
(xi)
Intensive cleaning. Certain intensive housekeeping services will be
performed periodically, as necessary, such as heavy vacuuming; steam-cleaning
draperies; scrubbing bathroom walls, floors and fixtures; interior window washing; rug
steam cleaning; wall and ceiling cleaning; and window shade cleaning.
(xii) Inspection, Repair and Maintenance Services. Electricians, carpenters,
plumbers and maintenance workers will be available upon request from Unit Owners and
hotel guests to provide ordinary repair and maintenance services, including minor repairs
to furniture, plumbing and appliances, paint touch-ups, replacement of cracked tiles, etc.
In order to maintain the standards of the hotel, the quality of the decor, furniture,
furnishings and maintenance of every Unit is subject to ongoing review by the hotel
management company. If a Unit or the FF&E does not comply with the hotel
management company standards, and the Unit Owner does not perform the work or
purchase the items recommended by the hotel management company with reasonable
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promptness, the hotel management company may perform such work or purchase such
items at the expense of the Unit Owner.
Per-Use Services:
The following “Per-Use Services” are typically made available to all Unit Owners
and hotel guests, the cost for which will be charged as part of the bill upon check-out
from the Unit:
(a)
Linen Service and Housekeeping. Cleaning and linen service will be
provided to each Unit following each night of occupancy of a Unit, including cleaning
bathrooms, removing trash, dusting furniture, vacuuming and changing sheets, pillow
cases, towels, washcloths and bathmats. The charge for such cleaning and linen service
will depend upon the room type. The cleaning services described in this subparagraph (a)
are usually mandatory for each night of occupancy of a Unit and are usually part of the
daily rental rate charged for the occupancy of such Hotel Unit.
(b)
Provision of Supplies. Customary hotel supplies will be provided to
guests as needed, usually including the following: guest stationery, pens and note paper;
laundry bags; facial and bathroom tissue; soap, shampoo and conditioner; shower caps;
sewing kits; telephone directories; hangers; and ice buckets and trays.
(c)
Telephone and Telecommunications Services. Telephone company
charges for local and long-distance calls from each Unit, and any internet service or other
telecommunications service charges, if any, will be charged to and payable by each guest
on a per-use basis in addition to the daily rental rate charged for the occupancy of such
Unit. In addition, high-speed internet service may also be charged on a per-use basis.
(d)
Pay-Per-View and Premium Channel Charges. Premium movie
channels and use of pay-per-view services will be charged to and payable by each Hotel
Guest on a per-use basis.
(e)
Valet Service. Valet, laundry and dry cleaning service are usually made
available from an independent valet operator. This service can be arranged directly or
through the concierge.
(f)
Business Center. The cost of services provided to guests in a business
center (faxing, copying, email, transcription, etc.) will be charged on a per-use basis.
(g)
Room Service. Food and beverage service delivered to the hotel room.
The level of Hotel Service Expenses will vary, depending on the quality of the Hotel.
The difference in quality is a function of staffing: a five-star hotel will usually have many more
employees providing services per guest, than a more limited service hotel. If a Unit is placed in
a rental management program, the expenses described above are typically offset by room
revenue, and any excess revenue will be shared between the Unit Owner, the developer and the
hotel management company, after a management fee is taken first. If not placed in a rental
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program, the Unit Owner bears all responsibility for expenses and does not benefit from any
rental activities undertaken by the hotel management company.
SUMMARY
The key factor in determining which structure to use is how the shared hotel facilities are
to be owned and operated. A traditional condominium provides the simplest structure and allows
the developer to sell all of its interest in the project but sacrifices control and the ability to
allocate expenses to the Unit Owners and increase expenditures after control of the condominium
is turned over to the Unit Owners. A structure which has a Shared Facilities Unit or a Hotel
Owned Component allows the developer and the hotel management company much greater
control over future hotel operations. In addition, when there is a Shared Facilities Unit or a
Hotel Owned Component, if the Condominium Hotel is not succeeding as a hotel, the right to
manage the project by the developer and the hotel management company is protected and the
developer and hotel management company may, without undue interference from Unit Owners,
spend funds to renovate and upgrade the hotel to improve financial performance. The ability to
use a legal structure which has a Shared Facilities Unit or Hotel Owned Component will vary by
jurisdiction, depending on local condominium ordinances, subdivision control ordinances as well
as the terms and conditions of state acts and the customs and practices of the regulatory agencies
entrusted with the administration of these laws. Consultation with experienced local counsel is
important.
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