Room with a View in the Lap of Luxury

By Kathryn Tully

(Reprinted from Financial Times, June 8, 2007)

Dubai’s Palm Jumeirah, billed as “the Middle East’s most desirable address”, is attracting famous buyers. David and Victoria Beckham have bought a place on the man-made island that sticks out in the shape of a palm tree into the Gulf.

The development, while quirky, is luxurious. Palm Jumeirah will have restaurants, hotels, shops and cafés along its two-kilometre “trunk” and deluxe villas along its 17 “fronds”, each with its own beach.

And a new big swinger is coming to town. Donald Trump is building a five-star, high-rise Trump International Hotel and Tower slap bang in the middle of the trunk, with two conjoined towers that will straddle the canal running up the centre of the island.

When the project is completed in 2009, the one-, two- and three-bedroom suites and penthouses will boast sea views from every room as well as access to boutiques, restaurants, bars, pools, a luxury spa and health club. And, as this is going to be a condo-hotel, individuals can buy a suite for themselves.

For a no-maintenance, no-hassle holiday home, condo-hotels can be appealing. Unit buyers get a suite in a luxury hotel and access to all the amenities when they want them. For the rest of the year, the unit can be put into the hotel’s normal reservations system.

Unit owners share the rental income from that specific unit with the operator and pay a maintenance fee. In return the operator runs the hotel, maintains the room and provides all the normal guest services.

It can be a decent investment. Buyers can potentially profit on the rental income after the maintenance fee, contents and liability insurance, property taxes and even mortgage-interest payments are taken out. In addition, investors benefit from any appreciation when they sell their unit.

Joel Greene, president of Condo Hotel Center, a real estate broker that specialises in condo-hotels, says that 90 per cent of his customers are buying condo-hotel units as an investment. Shrewd investors will compare the rates per night and occupancy rates at other hotels in the region and compare the rental programme with other condo-hotels, the rental split, the cost of insurance on the property and the maintenance fee.

The rental income is usually split so that 50 per cent goes to the unit owner and 50 per cent to the hotel operator, after a 10 per cent maintenance fee is taken off the top, although the exact formula varies from property to property.

The main hitch is that while many buyers look at these developments as an investment, unless condo-hotel offerings are filed with the Securities and Exchange Commission, they cannot be marketed as such. Brokers can only talk about the real estate and lifestyle benefits.

“I can talk to buyers about the amenities, the franchise, the customer service, the location; how much beach front there is or how many golf courses, but I cannot talk about anything like occupancy expectations, the expected rate of return or pro forma income,” Greene says. That does not stop would-be investors from working these things out themselves, but it does mean they have to approach with caution.

That said, 2007 and 2008 could present some buying opportunities. Worries about the US economy, higher construction costs and oversupply in some markets have slowed condo-hotel demand in the US in 2007.

According to the commercial real estate brokerage firm Marcus & Millichap, sales of high-end condos and condo-hotel units costing $500,000 to $1m have fallen 24 per cent over the last 12 months, although those costing $1m or more fared better, falling 12 per cent.

Hessam Nadji, managing director of research services at Marcus & Millichap, says developers are likely to discount units by 10-30 per cent over the next 12-18 months. “A lot of people who would like this product are probably sitting on the sidelines at the moment. I don’t think there’s going to be a major price correction, but I don’t think we’ve hit the bottom yet,” he says.

The need to discount varies a lot from location to location. Although the first condo-hotel markets to be developed, such as Miami, Fort Lauderdale and Las Vegas, have slowed dramatically, properties developed by elite brands such as Trump, Fairmont or Ritz-Carlton in the best locations are still selling well.

“Buying a unit in a development with a strong brand is very important,” says Jeffrey Davis, senior vice-president with Jones Lang LaSalle Hotels in New York. Selecting one with facilities such as golf courses and high-end spas is another winner. Then there is location. “Condo-hotels are a proven product in resort locations and seem to garner a lot of interest as second homes, but for me, the jury’s still out as to whether they work in urban areas,” Davis says.

Not everyone agrees with this prognosis. According to Marcus & Millichap, 75 per cent of high-end condo sales costing more than $500,000, including condo-hotel unit sales, are concentrated in just 10 US markets – New York, Los Angeles, Orange County, Fort Lauderdale, Miami, the San Francisco Bay area, San Diego, Boston and Washington DC. Many of these are urban areas.

Nadji says: “If you look at the downtown revitalisation wave going on throughout the US, baby boomers are choosing to live in downtown areas, near their jobs, in 24-hour cities. This bodes well for urban demand. There are also a lot of high net-worth offshore buyers looking at gateway cities in the US.”

Overseas markets are also attracting US buyers. Dubai is the hottest overseas market, in Greene’s opinion, particularly with the building of Dubailand, a $20bn development of six themed worlds with 45 attractions, to be twice the size of all the Disneyworld and Disneyland resorts combined. Dubailand’s goal is to bring 15m tourists to Dubai by 2010.

But Greene says Panama, Costa Rica and Baja California, Mexico, are reasonable and have growth potential. “You can buy something for $200 per square foot in Mexico, Costa Rica or Panama, compared to perhaps $1,000 per square foot in South Florida or even $2,000 in New York.”

The most developed markets such as South Florida and Las Vegas have seen prices level off after a few years of rapid growth. Speculators had driven up prices and, with that, the cost of financing, construction and materials.

In Las Vegas, some condo-hotel developments, including some celebrity-endorsed projects, have been canned. Last year a collaboration between George Clooney, Rande Gerber (Cindy Crawford’s husband) and developer Related Las Vegas to build a $3bn condo-hotel complex just off the strip was cancelled.

The selling of condo-hotel units is unpredictable, as buyers’ resale options have not been properly tested. “There’s no indication if you buy a room and want to sell it five years from now how it’s going to trade then, as there’s no secondary market data to let me know that there’s true residual value there,” Davis says.

Because condo-hotel units are usually sold on the basis of plans, before a shovel is even put in the ground, and many that have been sold are still being built, deciding whether the developer has got its budget right is even more problematic. “Once the hotel starts operating, will the company realise that they haven’t charged enough to the unit owners and need to reassess the future sales contracts?” Davis says. “That would certainly impact the residual value.”

That has not stopped new buyers jostling to grab a piece of certain properties. When marketing began on the new Trump International Hotel and Tower in Waikiki, Hawaii, last year, units for more than $700m were sold in the first eight hours, with buyers spending on average $1.5m.

No one knows how the new Trump development on Palm Jumeirah will fare as marketing is not due to start until later this year. The chances are, though, that it will also be a popular bet for those attracted to a room with a sea view and the whiff of a profit.