One “little” legal change has revolutionized and revitalized condo hotels

The condo hotel lawyers at JMBM have helped clients with more than 100 condo hotels and hotel condos. Our experience proves that well-structured condo hotels play a valuable role and have earned an enduring legacy in the hospitality industry. They make new hotel development feasible where limited financing and high construction costs would otherwise be prohibitive. And now one recent legal change sweeps away some of the knotty issues that have hampered condo hotel growth, and reignites the popularity of this approach with a “new breed“ of condo hotels.

We are now at a pivotal point for condo hotels. We are witnessing the complete turnaround in the way developers will structure condo hotel deals — particularly for high-end and luxury properties. This 180 degree turnaround in approach is creating a new and better breed of condo hotels that builds upon past successes and takes a giant step forward.

This was all accomplished with the stroke of a pen late last year when the Securities and Exchange Commission (SEC) adopted Rule 506(c) in response to the express requirements of the JOBS Act. The JOBS Act required the SEC to eliminate the prohibition on using “general solicitation” in private placements under Rule 506 where all the purchasers of the securities are “accredited investors.” Effectively, this single legal change has suddenly made it feasible for most hotel developers to structure and sell their condo hotel projects as “securities.”

This is a big change! Over the past 50 years or more, with only a few isolated exceptions, all condo hotel deals were tortured monstrosities of legal convolution. Because of the prior securities laws, it was not practical for most developers to have their offering be considered a “security” because it was not practical to register the securities with the SEC (as in an IPO), and general public solicitation is essential to the sale of real estate like condo hotel units. However, under the prior law, achieving the critical “non-security” status imposed some nonsensical legal requirements.

Most of these absurdities resulted from the fact that investors typically buy condo hotels as an investment and want the kind of information that would be relevant to making an intelligent investment decision. However the prior SEC rules effectively prevented developers from selling condo hotels as an investment with the relevant information and structure to provide the greatest prospects of success. This created the practical paradox that it was illegal for developers to sell condo hotels as an investment, but it was not illegal for buyers to purchase condo hotels as an investment (and most buyers did so).

Practical implications of the new approach

In other articles, we intend to provide more background and detail for those who are new to the condo hotel scene. But this piece is designed for those who already know the basics, and perhaps even struggled with the limitations of condo hotel structure under the old rules. Thus, we move straight to the key considerations that hampered condo hotels under the old rules, and explore how the “new breed” of condo hotels (structured as securities to take advantage of the latest legal changes) is now positioned to become the dominant approach for this entire niche.

The table below summarizes some of the most significant requirements or features that distinguish the old approach of avoiding security status (and the old SEC rules on private offerings), from the new approach of accepting security status and complying with the new Rule 506(c). The critical requirement for the new approach is that all buyers of condo hotel units must be “accredited investors.” Generally speaking, this means that each purchaser must meet the requirement of either (1) a minimum net worth of $1 million (excluding primary residence), or (2) a minimum income of more than $200,000 per year (or $300,000 for a married couple) for each of the last two years, and reasonably expects the same for the current year.

So here it is in a nutshell, or in this case, a table.

Summary of the big changes wrought by new SEC Rule 506(c) and how it will revolutionize condo hotels

Click here to view table.