09 Dec

Are You Building a Condotel? Should Guaranteed Returns be Part of the Marketing Strategy?

Condotel and second home products are usually unable to generate particularly lucrative ROI. This is due to the nature of the product which requires full operational support to be able to compete with hotels and resorts once completed. The typical operating costs of a full service condotel or resort range from 33% to 42% but it can be as high as 65% of the gross revenue depending on the positioning, facilities and services.

The expected investment yield highly depends on the price. Smaller and more affordable units are able to generate up to 8% return on the purchase price, while in more expensive and larger units, the return is lower, in the range of 4% to 5%. This is highly subject to the market conditions, the usage by the owner and the ability of the management company to achieve profitability. Luxury properties, such as large villas, are less able to produce significant net rental returns, they typically generate only 2% to 4% on the purchase price.

In order to incentivize sales, a very popular choice of late has been to offer a rental guarantee on the product. This practice is common in countries such as Thailand, Indonesia and Vietnam where the competition is very high and developers need to offer extra incentives to buyers to trust the project. The guaranteed rental return offered can be as high as 12% guaranteed return for a period of 8 years (for instance in Vietnam). This is considerably higher compared to Thailand and Bali, where developers typically offer 7% guaranteed return and only in rare cases is the return higher.

The guaranteed returns are, in certain cases, backed by a bank but the majority of the current products are guaranteed only by an SPV created specifically for the project. These guaranteed products become more risky for buyers when less experienced developers enter into large scale projects with an inadequate amount of equity or not supported by any bank. The risk mainly relates to operation after completion. In case the guaranteed return is higher than the achieved cash flow, developers will be obligated to fund additional capital during the guaranteed period in order to deliver on their promises to purchasers. In several cases, the guaranteed return is incorporated in the planning stages and reflected in the higher selling price, in order to cope with the long term return commitment. This structure needs to be well planned by developers and requires a lot of careful analysis before being implemented.

In recent times, the guaranteed return offered by some of the largest players has put pressure on smaller developers to offer a similar structure, in order to keep pace with the bigger competitions. In our view, guaranteed returns are not always necessary in case the product is well built, of good quality and has long term value appreciation potential. There are a few well planned and executed second home projects in Vietnam that have not offered guaranteed returns but have proven to be a valuable investment product for buyers.