Condo Hotels Growing Old Gracefully
There are only two things in life you can be sure of; death and taxes. Despite a recent boom market for real estate on the island, there are many existing projects that are now between 10 and 15 years old.
Although this is a lifetime in dog years, it's just a blip on the property market monitor of long-term stability and value.
There are two distinct groupings within the existing Phuket purchaser's pool. There are those who reside full or part-term in their units and those who bought as an investment – for which they expect a return from capital appreciation and rental yields. However, the picture is blurring with an increase in the number of owners planting their feet firmly in both camps and shifting their investment strategies depending on their situations and financial necessities.
More recently, we've seen hotel-managed products offering short-term rental guarantees, letting returns and usage by owners. As the market softens, more and more pure residential projects have turned to offering this type of scheme. They install hotel management companies or developer management to differentiate their product and spur sales. At the same time, we are starting to see established condo-hotel projects being pushed aside by new hotels. The shrinking demand for condo-hotels that have not continued to modernize or invest back into the property means they are quickly becoming uncompetitive. Hotels are fundamentally capital intensive as an asset class.
While hotel management companies typically reserve 3% of revenue for replacement and capital work, the developer's total expenses typically range from 5-8% of total turnover during a 10-year period. That capital has to be plowed back into the property, not only maintain the asset, but to keep it viable in the market place. Take a typical condo-hotel in which a residential structure has been put together. One of the key points for owners is keeping maintenance and assessments at a reasonable level.
Most projects have used the straight 'resico' (residential) market to compare these fees. In reality, estate management companies are continually under the gun to contain expenditure.
Many hotels put aside funds to cover the replacement of furniture, fixtures and equipment, but condo-hotel projects often put these expenses on the back burner, because most owners do not reside in the properties full time and they want the lowest possible out-of-pocket spend. All in all, it's a recipe for disaster. The impact is now being felt at many condo and apartment projects here. What might have passed as suitable hotel furniture packages in an under-supplied market in the past are not applicable today. Capital infrastructure, which is expensive to upgrade, cannot be covered by maintenance fees or sinking funds. Information technology is another key component in hotels with front- and back-office software being frequently updated.
So where does the money come from? The reality of condo-hotels is that hotel management acts as an agency. They take care of operations and employees on behalf of the owner. In most cases there is limited financial downside. Operators endeavor to perform through fees coming from a combination of revenue and bottom-line gross operating profit. So once a developer has sold off a project and exited, it's up to the unit owners to fund capital infusions and operate cash flow, including losses, and to continually upgrade the property.
We now see residential projects that want to convert to hotel operations but lack the proper infrastructure and equipment to do so. The residential projects often lack the essentials that a hotel would use, such as computers, vehicles and service areas. More importantly, inexperienced project owners often expect guests to simply start showing up when they open up as a hotel, but it takes time to gear sales and marketing. Most new hotels have already invested a lot of time and money on marketing their new venue for about a year before they open the doors to guests.
For conversions, property owners need to dip into their pockets and retro-fit standard furniture packages and operating equipment. They also need to provide working capital along with money for sales and marketing. It's not an investment in their units, it's a yield-based investment made to spur rental returns. More interesting is when you try to marry the two different sets of owners in a project when they each with an entirely different objective from the other.
Those who live or reside there part time want to contain ongoing fees or additional investment, while the second group, who look to returns, need to view rentals with growing significance. We are aware of at least one project on the island that has been paralyzed by ongoing differences of opinion, causing their capital appreciation and resale market potential to decline.
None of these are issues are going to go anywhere soon. They'll continue to provide content for this column, without a doubt. It's important to understand and work with estate management companies and hotel operators in order to ensure long-term capital budgets and forecasts are prepared. Yardsticks of performance continue to be there, but it's impractical to think that if you buy into a lifestyle property, revenue will always cover costs. Upside and downside risks are always present in any investment. Capital appreciation growth is the best objective of any property owner.