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The Risky Downside Of Ownership

Falling tourism numbers affecting Hawaii condotel owners

Andrew Gomes,  Jul 14, 2009

Hawaii's visitor industry downturn hasn't been kind to big hotel companies and their employees. But tourism's economic pain is also being directly felt by people who dabbled in a unique type of real estate that was hot several years ago — the condotel.

Condotel conversions — deals where developers acquired hotels and sold units individually as condominiums — transferred ownership of properties, including the Ala Moana Hotel, Kauai Beach Resort and Luana Waikiki, to working-class people outside the tourism industry.

Several thousand rooms were sold this way in recent years, and were attractive in part because of prices often between US$100,000 and US$200,000. But now owners are realizing some of the downside risk of such deals.

Condotel unit owners are receiving reduced income because of falling occupancy and discounted room rates, and in some cases management companies have added or increased fees for services to owners.

In at least one instance, rental income has been cut under a management contract clause called "force majeure." A force majeure, or superior force, clause excuses parties to a contract from obligations if an uncontrollable force, such as a hurricane or war, strikes. In this case the management company is taking more room revenue under force majeure due to the economic downturn.

"It's kind of bad," said Takashi Wakui, who works for a Japanese travel company in Waikiki and owns a unit in the Palms at Waikiki on Ala Moana across from Hilton Hawaiian Village Resort & Spa.

Typically, condotel owners receive close to 50 percent of revenue from their units under contracts with professional management firms that market and maintain the property. But some owners have seen their take fall to between 25 percent and 40 percent.

"It's certainly a tough time," said Mike Paulin, owner and CEO of Honolulu-based Aqua Hotels and Resorts, which manages four Waikiki condotels.

Of the four condotels managed by Aqua, only the Palms has a force majeure clause, which Paulin said was enacted to protect management company finances and preserve operations.

"The owner really has the upside on the property," Paulin said. "Management companies do not share in the risk of ownership."

Under force majeure terms at the Palms, if average revenue per available room for midpriced hotels on Oahu declines more than 10 percent based on an independent monthly survey, unit owners' take is reduced to rental proceeds minus management expenses instead of 50 percent of room revenue.

Outrigger Hotels & Resorts, which manages several condotel properties, said it has adjusted some fees, but has not enacted any force majeure clauses.

"The question is, when do you pull the trigger," said Steve Winter, vice president of Outrigger's condominium management division. "Hopefully we don't have to."

A major Hawaii condotel management firm, Aston Hotels & Resorts, hasn't enacted force majeure clauses in any of its condotel contracts, according to Kelvin Bloom, company president and CEO.

However, Aston has reduced room rental distributions at the Islander on the Beach Hotel on Kauai because too many units — about 15 percent — aren't in the rental program, in some cases because owners are losing units to foreclosure.

One owner there said she is receiving 30 percent of rent revenue from her unit, down from 50 percent when she bought the property.

"It's tough times for everyone," Bloom said. "The declines that the individual owners are experiencing, we're experiencing right alongside them."

Since 2001 when the local real estate market began heating up, an estimated 3,500 or more Hawaii hotel rooms have been converted to condotel use typically by developers that bought and renovated old hotels then resold them by the room.

Some unit buyers clearly understood the dynamics of ownership that include marketing and maintenance expenses, service fees, renovation reserves, room rates, occupancy, and resort property taxes. But others didn't, including many who bought with the intent to resell units for a profit.

In 2005, when the Palms units were sold, Hawaii's hotel industry brought in a record US$3 billion in revenue, and 81.2 percent of rooms were filled on average, according to a survey by Hospitality Advisors LLC.

This year through May, statewide hotel occupancy averaged 67.8 percent, and revenue per available room averaged US$127, down from US$161 for all of last year and US$136 in 2005.

Jerome Andrade, who works at Borthwick Mortuary and bought a unit at the Palms in 2005, said his annual profit last year was US$3,000 compared with US$5,000 in the first year after his purchase.

This year, the drop in revenue is shaving profit close to break-even, though there's been only one month where revenue didn't cover the mortgage payment.

The force majeure enactment initially surprised Andrade, but he said he understands the economic challenges of running a hotel, and he compliments Aqua for its effort to keep the property competitive.

"It hits you in a certain way, but it's better than me going down and renting (the room) to people," Andrade said. "For me as an owner, I'm happy."

Kelvin Ro, chef and owner of Diamond Head Market and Grill, owns two units at the Palms. He said revenue may be significantly down, but his units still pay for themselves.

Wakui, too, said that despite his monthly revenue falling from about US$1,000 to between US$500 and US$700, the payments still cover his mortgage, and he hopes to ride out the downturn to better times for Hawaii's no. 1 industry.

"I don't have a choice," he said.

Falling tourism numbers affecting Hawaii condotel owners
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