23 Oct

Are You Lending Money to Condotel Project? This is What You Should be Aware of

Every condotel project is able to generate certain revenues and profit through the operation and so the guaranteed return is supposed to be covered by the operation. However, in case of high guaranteed return and weak market conditions.

Is the developer offering guaranteed returns?

Guaranteed returns are a method of increasing attractiveness of the potential investment in the product. They help buyers to make purchasing decision, limiting their risk of cash flow. It is often used for products less familiar to buyers such has condotel or second home residences. From Developer view point, every condotel project is able to generate certain revenues and profit through the operation and so the guaranteed return is supposed to be covered by the operation. However, in case of high guaranteed return and weak market conditions, the developer will need to top up on the guaranteed amount with its own equity (or additional loan). A typical operation should be able to generate 5% – 7% return of the initial cost, for any guaranteed return higher than that, or during start-up period, there is a considerable risk of negative operational net profit, after the guaranteed has been paid.

Lenders of condotel projects should carefully check whether the developer has successfully planned a proper sinking fund to cover the guaranteed returns in their Feasibility Plan.

Does the unit design fit the business model?

For a traditional 4 star resort the room size could vary from 27 sm – 32 sm and for a five star resort the room would be a minimum of 35 sm up to 42 sm or more in case of a luxury positioning. Condotels however, typically have more of a  residential feel, with larger room sizes compared to typical hotels, usually offering units that could start form 55 sm. There are several implications of larger units in the business model. First of all it will be related to operational issues. Large units require more costs without necessarily generating more revenues.  The selling price per unit also increases considerably when the unit size is large, making it harder for developers to achieve the guaranteed returns if the rental price does not increase by the same amount. Facilities offered also play a very important role in the business model, when a lack of facilities lead to weak operations and too many facilities lead to high costs that are difficult to recover from operations.

Has the developer carefully considered future supply?

In developing countries the barrier of entry are relatively low for developers. It is easy for projects to obtain approvals and the development can take place faster compared to more mature markets. That leads to, in several cases, high market volatility due to shorter market cycles, with supply catching up fast to demand imbalances but there also is a greater risk of oversupply.  A proper Market Study should be performed to truly analyse the future supply and plan accordingly.

Has the developer implemented a proper rental pool contract with the unit buyers?

One very common mistake in condotels is the developer’s focus on short term sales, without properly planning for future operations. Developers often are not able to foresee future problems related to operation since they have never been involved with hotel businesses. This can causes issues related to the use of the units after opening and create situations where the unit owners are renting units independently and at different prices compared to the central operation. This will cause severe challenges to the revenue stream and could compromise the whole feasibility of the project. Also the use of facilities by the unit owners should be well planned from the beginning.

Does the investment amount consider pre-opening and operating equipment?

Residential projects and condotels are two very different business models. Developers often wrongly plan condotel projects by considering this product as a second home residential project with some operational features. The construction costs usually focus on building the structure and interior finishing only. The reality is, if a proper condotel is planned, it should be planned like a typical hotel project. That would include a pre-opening budget (which for a normal 200 rooms four star hotel could be as high as US$1.5 million), operating equipment (which could count up to 8% of total costs), proper back of house, proper front of house and related facilities.  That said, not every beach project needs to be a condotel. Developers should consider other second home project types, such as vacation residences as possible alternatives, but, does the developer know the difference between a second home project and a condotel?

Does the developer have an exit plan?

Often, developers do not plan enough for a proper exit plan in addition to the simple sales of the residences. Developers should consider that third party investors may be interested in buying the development a few years after completion. However, since the units have already been sold, what does the investor really buy? The answer is, they buy the operational cash flow, which is very much related to the rental pool contract that was secured with unit buyers. If the rental pool structure is weak and the agreement poorly executed, the value of the development could be seriously compromised. Developers should be very careful in the planning stages to be able to secure future values.