Condominium Hotels: How Developers and Hotel Operators Can Control the Shared Facilities Without Overcontrolling Shared Facilities Expenses
Condominium hotel projects are typically structured in a manner intended to create maximum management and operational control in favor of the hotel owner/hotel operator over those areas of the project that are necessary for optimally and effectively operating the project as a hotel. There are two ways to achieve this objective. In the first scenario, the areas and facilities that would otherwise be “common elements” or “common areas” in a typical non-condominium hotel regime are taken out entirely and are included in that portion of the project comprising the hotel. This area is referred to as the “Hotel Lot.” The second scenario is where the areas and facilities that would have traditionally been labeled as “common elements” or “common areas” are instead designated as a commercial unit within the overall condominium regime, and is referred to as the “Hotel Unit.” In each scenario, those portions of the Hotel Lot or Hotel Unit which are necessary or beneficial to the unit owners of the condominium hotel units are designated as “Shared Facilities.”
Under the Hotel Lot scenario, the units that are available for purchase by consumers constitute the condominium hotel regime, and all remaining portions of the building outside of the units, including the stairwells, hallways, elevators, lobbies, fitness area, restaurant, etc., (collectively, the “Shared Facilities”), are included within the Hotel Lot, which is not part of the condominium hotel regime. The Hotel Lot may also include areas outside of the condominium building structure, such as recreational amenities, marina areas, docks, pools and open space. Under the Hotel Unit scenario, the Shared Facilities are located within the Hotel Unit, and the remaining units that are available for purchase by consumers together with the Hotel Unit constitute the condominium regime.
Benefits of Shared Facilities Ownership
Regardless of which structure is chosen, the Shared Facilities are owned and controlled by the developer/hotel owner. The benefits to owning and controlling the Shared Facilities are enormous. Ownership allows the Hotel Lot or the Hotel Unit owner to mandate the standard by which the Shared Facilities will be operated and maintained. The Hotel Lot or the Hotel Unit owner then grants an ingress, egress, use and enjoyment easement in favor of the condominium hotel unit owners making the Shared Facilities available for use by the condominium hotel unit owners and their guests and invitees, the Hotel Lot or Hotel Unit owner and its guests and invitees, and owners and operators of any commercial units within the overall condominium regime. This easement is coupled with a payment obligation, in which the unit owners are obligated to pay their pro-rata share of the expenses relating to the maintenance, upkeep, operation, repair, replacement, etc. of the Shared Facilities. These rights and obligations are documented in an agreement that is referred to as a “Shared Facilities Covenant” or in the Declaration of Condominium or other agreement, depending on the specific legal structure of the condominium hotel project.
When it comes time to define the payment obligations with respect to the Shared Facilities, it is critically important that the Shared Facilities budget presents an accurate reflection of reasonably anticipated expenses. In addition, the contribution to the Shared Facilities expenses by the condominium hotel unit owners should be fair and proportionate to the amount of anticipated use of the Shared Facilities by the unit owners. There are several methods that can be utilized to allocate Shared Facilities expenses to the condominium hotel unit owners and they include the following:
• Square Footage Allocation Method
The Square Footage Allocation Method calculates the total square footage of the Hotel Lot or the Hotel Unit and the total combined square footage of the remaining condominium units and allocates expenses based on hotel square footage of the units. For example, if the square footage of the Hotel Lot or the Hotel Unit is 500,000 square feet and the total combined square footage of the remaining condominium units is 500,000 square feet, then the Hotel Lot or the Hotel Unit would pay one-half of the Shared Facilities expenses, and the remaining condominium units would pay one-half of the Shared Facilities expenses. This extreme example is not utilized in practice because it largely defeats the purpose of passing a significant portion of the Shared Facilities expenses on to the condominium hotel unit owners. Instead, developers typically select a percentage of the Shared Facilities budget, which may bear some relation to the square footage of the Hotel Lot or the Hotel Unit, and obligate the Hotel Lot or the Hotel Unit to pay such amount. For example, using the 500,000/500,000 square foot hypothetical, it may be that the Hotel Unit or Hotel Lot is obligated to pay 10 percent of the Shared Facilities expenses because it is determined by the developer that approximately 10 percent of the Hotel Lot or Hotel Unit will be dedicated to the core operations of the hotel business.
• Revenue Generating Allocation Method
If a portion of the Hotel Lot or the Hotel Unit is a revenue generating area, such as a restaurant, spa, poolside bar or other amenity, the condominium hotel unit owners should not be obligated to pay for the operation, maintenance and repairs relating to that portion of the Hotel Lot or the Hotel Unit. The reason, of course, is that since the Hotel Lot or the Hotel Unit is receiving the benefit (i.e., gross revenues) of such revenue generating areas, it should also bear the expenses associated with operating such areas. This does not, however, mean that the Hotel Lot or the Hotel Unit cannot also charge the condominium hotel unit owners a fee for the use of such amenities. For example, if the total Shared Facilities budget is $1 million and $200,000 of those expenses relate to the revenue generating portion of the Hotel Lot or the Hotel Unit, then the Hotel Lot or the Hotel Unit should pay for at least $200,000 of the Shared Facilities expenses. In the event the amenities are being provided to the condominium hotel unit owners at a discounted or subsidized rate (for example to encourage participation in a rental program), it would not be uncommon to pass along a portion of the expenses to them.
• Purchase Price/Value Method
Another method that can be used to allocate the Shared Facilities expenses include value or purchase price of the condominium hotel units relative to the value of the Hotel Unit or the Hotel Lot. For example, if the appraised value of the Hotel Lot or the Hotel Unit is $10 million and the total combined value of the remaining condominium units is $90 million, then the Hotel Lot or the Hotel Unit would pay 10 percent of the Shared Facilities expenses.
There is no single method that is perfect or risk free, but any selected allocation method must be comprehensive, fair and reasonable in order to withstand scrutiny when evaluated. If a developer has no reasonable basis for the expense allocation, the developer is likely to face challenges from condominium hotel unit owners and associations. Currently, there is little judicial guidance on this topic, so it is critically important to develop a fair allocation which is well documented and supported by sound business judgment.
• Associations Will Fight Back
In a lawsuit filed by the Grand Bay Residences Condominium Association, Inc. and Grand Bay Tower Condominium Association, Inc. in Miami-Dade County, Florida, (Case No. 05 00642 CA 09, Circuit Court of Miami-Dade County, Florida, filed January 11, 2005), the plaintiffs challenged, among other things, the method of allocation of shared facilities expenses. Specifically, the plaintiffs alleged that certain of the expenses payable under the covenants were unconscionable and challenged the developer’s ability to assess the plaintiffs with respect to the common areas without identifying what was to be considered a common area. The plaintiffs also alleged that the share of assessments allocated to each tract pursuant to the covenants did not bear a relation to the number of units within a particular tract, the acreage of the tracts, or the ownership interest in the common area. The plaintiffs’ reasoning that the allocation was “unfair, unreasonable, and unconscionable” rested on the notion that the majority of the units within the community (approximately 57 percent) were located within the hotel and condominium and that the preponderance of the common areas were located within the hotel and condominium hotel area. The percentage of common area fees paid by the hotel and condominium hotel constituted approximately 30 percent of the overall common area expenses. The plaintiffs argued that the allocation of assessments should coincide with the number of units in each of the tracts. The plaintiffs further argued that because the hotel has a high occupancy rate and its use of the common areas is intense, it should therefore be allocated a higher percentage of the common area budget. In this case, the hotel operator was not sued and the complaint does not suggest that the hotel operator was culpable of any alleged wrongdoing. The developer could have potentially avoided litigation on these issues if the Shared Facilities budget had been structured so as to balance more evenly the costs paid by the Hotel Lot or the Hotel Unit and the remaining unit owners.
• A Fair and Reasonable Formula Is Best
The risk to the developer and the owner of the Hotel Lot or the Hotel Unit of passing on an arguably disproportionate amount of the Shared Facilities expenses to the condominium unit owners is twofold. First, the developer may face a deterrent effect from a sales and marketing standpoint if condominium unit owners bear too large of an economic burden. Secondly, in a potentially tighter condominium hotel market, where condominium unit owners have become more familiar with Shared Facilities budget structures, we are seeing more resistance and push back against Shared Facilities budgets from purchasers, unit owners and associations. As a rule, it is advisable to be fair and reasonable in setting the Shared Facilities allocation formula in order to avoid potential long term, costly disputes over matters that are largely subjective and over which the judiciary may be sympathetic to associations and homeowners.
We would like to acknowledge the assistance of Robert Riva, a law clerk in the Jacksonville office of Holland & Knight, for his contributions to this article.