Hotel Condos: A Profitable New Market Opportunity

A few years ago, developer Kathleen Webb wondered about the viability of a mixed-use project that her firm was planning in Arlington, Va.

Webb, a principal at The JBG Companies, Chevy Chase, Md., says the property, located in the Rosslyn business district near the USA Today building, was approved for a 360-room hotel and office tower. The project had a lot going for it: a spectacular location near Key Bridge, with a view of Georgetown across the Potomac River, and a prestigious architecture firm, New York-based Pei Cobb Freed & Partners, as designer.

The cause for Webb's concern was the hotel market's slow recovery from what she calls the moribund '90s and the impact of the 9/11 terrorist attacks. "After 9/11, the hotel market stumbled badly and financing was absolutely nonexistent," says Webb. "I think at that time we would have preferred to delete the hotel altogether."

Arlington County officials would not let the developer delete the hotel, but they did approve a rezoning change that probably saved the deal.

The reconfigured project, called Waterview, now includes two towers: one a 600,000-sf office building, the other a "hotel condo" that combines a 155-room boutique hotel (to be operated as the Hotel Palomar by the Kimpton Hotel & Restaurant Group) and 60 luxury full-time residential condominiums.

"The market for hotels and hotel financing disappeared, so having it rezoned part hotel and part residential was the only way we could have carried the hotel off," says Webb. The project is set to open in late 2007.

Webb is not alone in discovering that it's sometimes a lot easier to secure financing for a hotel project that also includes a full-time residential component—that is, a hotel condo. Other developers are also discovering that this relatively new product is highly desired by an emerging group of potential buyers. Until recently, hotel living was purely the domain of the ultra-wealthy residing in five-star Ritz Carlton, St. Regis, or Four Seasons properties. By adding condominiums to four-star hotel brands such as Hotel Palomar, W Hotels, and Omni Hotels, developers can target an upscale client who is willing to pay a premium for the benefits of hotel living—room service, maid service, and pools and spas—but were previously priced out of the market.

"We think that the opportunity to develop condos and hotels in that category is just wide open," says Troy Furbay, SVP for acquisitions and development at Kimpton, who worked with The JPG Companies on Waterview. "There's not a lot of competition in the environment right now. Nobody has really staked their claim in that category."

"Although you hear great things about hotel recovery, the industry is still not back," says Patrick Ford, president of Lodging Econometrics, a Portsmouth, N.H., firm that serves as an industry authority on hotel real estate. "Lots of inner-city construction is not feasible for a pure and simple hotel. It doesn't work." What does work, he says, is putting full-time condo residences into the mix.

Ford points out that developers are always looking to do the maximum amount of development with a minimum amount of personal investment, so having individual homebuyers put their money into the project lowers the developer's debt obligation and investment risk, which in turn makes the deal more attractive to lenders.

The Metropolitan Condominiums and the Omni San Diego Hotel connect directly to PETCO Park (at right in photo). Condominiums are located in the upper 10 floors of the tower. Photo: Hornberger + Worstell

In order to secure the necessary funding, however, banks first have to understand the financing concept. In markets where hotel buildings with full-time condos are new, that's not always easy.

Just ask Greg Clay. As senior vice president of JMI Realty in San Diego, he introduced the idea of hotel condominiums to this southern California market about five years ago and found it hard to secure financing because lenders simply couldn't get the concept.

"You have lenders that financed hotels or lenders that financed condos, but not many understood both product types," says JMI's Clay. "Because our hotel was the majority of the project, we ended up going with a hotel lender, whom we then had to make understand the condo component."

The project, which was completed in 2004, is a 33-story tower that includes the luxury Metropolitan Condominiums on the top 10 floors and the Omni San Diego Hotel on the lower floors. It was designed by San Francisco-based Hornberger + Worstell and has a glass sky bridge connecting it to neighboring PETCO Park, home of the San Diego Padres, and anchors the city's new Ballpark District.

Clay guesses that his financing structure bucked the industry trend because the Omni Hotel, unlike many new hotel projects, probably could have been built without the condominiums. That's because San Diego needed hotel rooms in the Ballpark District, which is adjacent to the convention center and borders the popular Gaslamp Quarter.

This case illustrates an extremely important point about hotel condo projects: The location must justify the hotel portion of the project or you don't have a viable scheme. "If you're a developer, the first criterion is that a hotel must be justified on that spot," says Ford of Lodging Econometrics. "If a hotel isn't justified, it should not be built." In other words, adding luxury condominiums to a poorly sited hotel will not save a poorly located project.

Ford also cautions that condominiums should not be added to hotels in cities without a strong residential market or those where there isn't a specific interest in inner-city living. He recommends hotel condo projects for cities with major downtown cultural attractions and those showing a high rate of returning residents—primarily baby boomers moving back to the city after selling their single-family homes in the suburbs.

Both baby boomers and empty nesters are attracted to hotel condo projects because of the no-maintenance, high-amenity lifestyle.

"It's service on demand! Living somewhere where everything can be taken care of for you is very attractive for the long term," says Karen Johnson, SVP of advisory services for Jones Lang LaSalle Hotels, Los Angeles. "When you put these hotel services as an overlay onto the condominium product, you can get some fantastic premiums over the traditional condominium product."

Many four-star hotel brands are starting to explore that potential. "We think that there's an unexploited niche in many markets, certainly here in Dallas, and the sales of the residences have pretty much borne that out," says Marty Collins. He's the president of Gatehouse Capital Corp., the local firm co-developing the W Dallas Victory Hotel and Residences, the first hotel condominium property in the W Hotels' portfolio.

"The first tower did very, very well, and as a result, we added a second tower, which is already half sold," says Collins. The project, with 250 hotel rooms and 150 condominiums, will open in May. "The hotel added a significant premium to the residential sales price," he says.

Another four-star brand tapping into the hotel condo market is Kimpton Hotels & Restaurants, which, in addition to its Arlington, Va., property, is also working on a project in Dallas, to be marketed under the Hotel Palomar name.

"I think the residential component fits very well with our brands and the whole underlying concept of wellness and lifestyle," says Afzal Hemani, VP of acquisitions and development for Kimpton, who's overseeing the Dallas facility, which is scheduled to open this summer.

Metropolitan Condominium units sold for an average $1,200 per sf at a time when San Diego’s most expensive units sold for $780 per sf. At that end of the market, units had to have first-rate finishes; the kitchen shown above has European-style cabinetry, stainless steel appliances, and stone countertops.

One note of caution, however: Hotel condo buyers are not willing to pay for just any hotel brand. "Do consumers want to live in a Hilton or a Marriott?" asks Troy Furbay, who's working on the Hotel Palomar job in Arlington, Va. "We're betting they probably don't."

Developers have the advantage in these partnerships, but they need to choose the hotel brands that they associate themselves with wisely, says Lodging Econometrics' Ford. They need the right brand to help them sell a lifestyle that surpasses housekeeping and room service offerings.

Marty Collins is betting that the W Dallas Victory Hotel and Residences will deliver a living experience not available from other brands, namely the W's trendy, edgy, hip reputation. "It took a little courage to set out and do something modern, but we were convinced that modern and high-design is the forward trend," says Collins. "We're very focused on our positioning and our image and the entire basket of goods, rather than simply having a hotel and putting residences on top."

For example, in selecting a restaurateur, Collins's team consulted the Zagat Survey to see which one was consistently listed as number one in New York City. The winner: Tom Colicchio, chef/owner of the Gramercy Tavern. When selecting a club and bar operator, they looked for the bar that sold the most Red Bull, a high-caffeine energy drink and mixer. That distinction went to Las Vegas's Ghost Bar, so they were hired. The spa is being run by Bliss.

Exclusivity is also highly desirable in these types of projects. The W residences, which average 3,000 sf, have only four or five units per floor.

The Residences at Hotel Palomar in Dallas will offer boutique lifestyles. The hotel portion will be set within a former Hilton Hotel that's being extensively renovated, while the condos will be in a newly constructed, 150,000-sf, 10-story tower.

The project will offer loft units—separate from the condo tower, and unique to the hotel condominium market—that average 1,200 sf. Condo owners and hotel guests will have separate entries and valets, but will share access to the swimming pool, fitness center, and the 8,500-sf spa run by New York City-based Exhale.

The 170,000-sf Metropolitan Condominiums in San Diego has only 37 residences, ranging in size from 1,500 sf to 2,500 sf, set approximately four per floor. "We tried to make each unit be a corner unit," says architect Mark Hornberger. "We used wrap-around windows and put balconies in great locations." Located on the upper floors, the units have commanding city and water views. The building has separate entrances for hotel guests and residents, and one of the two swimming pools is for the exclusive use of condo owners.

The four-star market that W, Kimpton, and Omni considered wide open when they first entered it a few years ago will get more crowded in the coming years as developers seek alternative financing methods and hotel brands expand their lifestyle offerings to the residential market.

The first projects have recently opened or are set to open over the next 12 months, and several others have been announced. Based on condominium sales alone, these combination projects have been very successful, but the market still appears to be cautiously optimistic. "Things are getting very complicated and more complex," says Gatehouse Capital's Collins. Future success in this field will depend on pushing the experience beyond the typical or expected. "It will be all about the product offerings," he says.