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6 factors that negatively impact investments

by Steve Bergsman

Dollar signDespite the oversized ego, I’ve been a big fan of Donald Trump. After all, how many real estate developers have created a “brand” out of a family name? Once, when I interviewed him, he told me putting “Trump” on a building created a huge premium as compared to, for example, an equivalent apartment unit built by someone else.

So it was with some dismay as I watched him over the past few years try to carve his way through the world of condo hotels, now often advertised as “condotels.” This product has been on my watch list as one of the worst real estate investments ever created for the simple reason that it is really just a financing mechanism for the developer and for all practical purposes, caveat emptor, which in today’s world means let the buyer be damned.

Basically, a condotel works like this: An investor buys a condominium in a hotel building and then allows the hotel to use the unit for guests when the owner is not in residence. The sales pitch suggests the buyer will recoup investment costs and fees through the daily rental of the condo unit by the hotel, which, by the way, rarely ever happens.

During what I refer to as the condominium pandemonium era, which lasted from 2002-06, condotels were a hot product. In that final year of pandemonium, Lodging Econometrics counted the opening of 32 condotel projects with 4,831 units. It was near the height of the market when Trump jacked up the business even further with flamboyant, high-end projects in Honolulu, Chicago and Las Vegas.

With the Trump name on the buildings, presales starting in 2006 and 2007 looked great. But, three years later, the closings on the presales haven’t happened, and Trump has been stalled on the highway to riches — including lawsuits with lenders on the Chicago project and reportedly turning the condotel units into straight apartment rentals in Las Vegas.

According to the local Las Vegas press, the Trump Tower here was 100 percent presold, but opened with less than 30 percent of sales closed. If buyers don’t close their deals, they forfeit deposits. (Think 20 percent on a $1 million unit!)

Don’t cry for “The Donald” since his condotel ventures were a bit of greed play, and although the Trump product was extremely high-end with many luxury amenities, this wasn’t about creating a better product for the customer. Condotels get done because it favors the developer.

Borrowing from an investment book I authored, “Let’s say, for example, a developer builds a hotel at a cost of $100,000 a unit. The developer owns it for seven to 10 years, then sells it at a tidy profit. However, if the same developer decides to build a condo hotel, he presells each unit for $150,000, in effect taking all the profits upfront that would have accumulated across the next 10 years.”

One can’t blame developers for trying to get more profit and cut risk at the same time, but let’s see why condotels really haven’t worked for investors:

1. Take the money and run. Developers made all kinds of promises, but after completion and sale of units, they just handed the building over to a manager, which tried, often without success, to fulfill all the exaggerated promises.

2. No cash flow. Developers of condotels were mostly concerned about getting the capital to build with almost no regard as to how investors might recoup some of their investments.

3. No research. It’s doubtful that an investor in a condotel ever looked around at the local hotel market and said, “Gee, to make any money on my unit, I would have to rent it for $400 a night, but even a luxury room in this market averages only $200 a night.”

4. Big names. A number of major hotel companies moved into this market, but the premiums for their management services has slipped, as had room rates. No one is making any money.

5. Overbuilding. Unlike other real estate sectors, which are suffering from capital and financing problems, the market for condotels was flat-out overbuilt — and that takes years to correct.

6. Financing. Even if you wanted to buy into a condotel today, it’s doubtful you could find a bank that would finance this loan. Lenders have come to view a condotel mortgage as a high-risk investment. Unfortunately, if you actually own a condotel unit, lack of financing is a key factor that drives down pricing.

Despite all the negatives, there are buyers for condotels. I guess one can’t change human nature, but there is a certain personality that wants to be associated with a Trump, Four Seasons or Ritz-Carlton project. In some regards, they get what they paid for: a high-end experience, terrific amenities and cachet.

However, when all is said and done, the condotel is really not much better than a timeshare, which is not an investment at all, but the limited acquisition of real estate “usage.” You may own the condotel, but your actual use of it is limited, which is at least better than the downside of your investment, which is unlimited.

Steve Bergsman is a freelance writer in Arizona and author of several books, including After the Fall: Opportunities and Strategies for Real Estate Investing in the Coming Decade.

Copyright 2009 Inman News

See our feature, Alternatives to “Buying” Real Estate.

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