A condo hotel is an operating mode of economic activity1. In practice it is a hotel where the property is shared by a condominium of investors that jointly finance the project and are remunerated in proportion to their respective participation by the operating results of the project, which is administered by a hotel operator.
From the perspective of the entrepreneurs, who plan and will manage the hotel, a condo hotel is a mode of financing the project. Those who build and manage the hotel aim to be remunerated for their services, but first someone must finance it. In this sense, the condo hotel appears as an alternative to implement the project.
For those who finance the project, the condo hotel is a form of investment. The ownership of the condo hotel is in general restricted to economic purposes. Therefore, the person that decides to invest funds in this type of real estate project has the main goal to monetize money. This article will examine the investment side of the condo hotel.
II. Market participants
In all its stages, from planning, marketing, fundraising, incorporating and operating the hotel, the market for condo hotels involves different stakeholders, each with their interests, roles and responsibilities. The market participants are the following:
- the Developer (development company): the company responsible for planning, designing and launching the hotel project as well as for the promotion and construction of the hotel, even if it hires a construction company. In this process, the Developer takes care of the documentation, the contracts and the works and also the marketing, although usually it retains third parties, which may be a real estate brokerage house or a group of brokers (Realtors), to intermediate the sales. The Developer has an active role throughout the period of the distribution offer of the project to the investors, until the delivery of the works and the beginning of the management of the hotel. It is liable for complying with the applicable laws such as the Condominium and Units Development Law (Lei de Condomínio e Incorporações), the Brazilian Civil Code (Código Civil) and the Brazilian Consumer Protection Code (Lei de Defesa do Consumidor), and the regulations issued by the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários - CVM) related to the offer of the condo hotel as a financial investment.
- the Realtors: the company and/or the professionals engaged in the intermediation, presentation and sale of condo hotel units to the investors. They receive a percentage of the sales as remuneration and have an important role, because they are the link of contact with the investors.
- the Hotel Operator: the company responsible for managing the hotel after the project is concluded and that will operate the business on a daily basis and be accountable, distributing the economic results to the investors/co-owners. Usually the management agreement has a fixed term, which may be renewed or not, and the remuneration is a percentage on the hotel revenues. The Hotel Operator takes a more active role after the delivery of the works and the beginning of the operations, but it participates and has responsibilities as offeror of the investment.
- the Investor (co-owner): the person or legal entity that adheres to the collective investment contracts (CICs) of a condo hotel2 and provides the funding of the project with his/her/its financial resources, by acquiring a stake in the business and, with it, the right to participate in the results obtained with the commercial operation of the project.
- the Asset Manager: although not mandatory, it is also possible to have the presence of a professional who acts as a sort of representative of the investors/co-owners (síndico) and has the primary responsibility of inspecting the business on behalf of the investors/co-owners.
III. The operation of condo hotels
The CICs can take on different characteristics. The most common is the model of autonomous real estate units, in the traditional manner of a mixed-property condominium (Condomínio Edilício), whereby the investors buy autonomous real estate units, with individual registration and enrollment in the General Registry of Immovable Property (Registro Geral de Imóveis - RGI)3.
However, the agreement of purchase and sale of autonomous units is linked to a set of contracts that form the CICs, to which the investor must explicitly join by purchasing the unit. Through CICs, units acquired are transferred to the Hotel Operator, which will commercially exploit the project for a period determined in the agreement4.
One of the contracts usually used is the Constitution of Silent Partnership (Sociedade em Conta de Participação - SCP)5, in which the Hotel Operator figures as the ostensible partner (sócio ostensivo) and the investors of the units are the silent partners (sócios participantes). Each investor will receive a share in the results of the hotel according to his/her/its participation, which usually is fixed and proportional to the optimal unit fraction relative to the project.
Under Brazilian law the definition of "securities" comprises, whenever offered publicly, any collective investment agreements or instruments that creates the right of participation on profits or remuneration, including as a result of the provision of services, and whose profits derive from the efforts of the entrepreneur or third parties6.
The CICs offer to the investors an alternative to invest their financial resources in the expectation to participate in the results obtained in the operation of the project, which is administered by a third party, the Hotel Operator. Therefore, public offerings of CICs of condo hotels are subject to the CVM rules.
IV. The CVM regulation
Currently, public offerings distributions of securities are regulated by CVM Instruction No. 400, of December 29, 2003 (ICVM 400/2003). Therefore, as a general rule, any public offering of CICs of condo hotels has to be registered with CVM. However, article 4 of ICVM 400/2003 provides for the possibility of CVM, at its discretion and always considering the public interest, the adequate information and investor protection, to exempt the registration or some registry requirements.
In this regard, the offerors of CICs in condo hotels, taking into consideration the conditions established in CVM Deliberation No. 734, of March 17, 2015 (Del. 734/2015), as amended, can apply to CVM for exemption of the following: (i) public offering registry; (ii) registration of the issuer of securities; (iii) the hiring of the intermediary institution and member of the securities distribution system; and (iv) compliance with the deadlines for the duration of the offer. Among the conditions laid down in the decision are the characterization of the type of investor who can participate in the offer, the set of information that should be available to the public and the advertising material.
For the purposes of Del. 734, 2015, the offerors are the Hotel Operator jointly with the Developer or, in the absence of a Developer, the company responsible for the offer of the ideal parts of the condominium.
Considering the features of CICs in condo hotels, including the risks arising therefrom, and as a form of protection to retail investors, CVM restricts public offerings of this investment to a particular profile of investor. If the operating model of condo hotel is for autonomous real estate units, the public offering will be exclusively restricted to investors who have an equity of at least R$1 million or alternatively to investors who invest at least R$ 300 thousand in the offer. If the model is for ideal fractions, the public offering will be made exclusively to qualified investors (as defined by CVM)7 and cumulatively with at least an equity of R$ 1,5 million or an investment of at least R$ 1 million in the offer.
As to information to investors, one of the foundations of CVM regulation is that true and complete information must be periodically available to all investors indistinctly. Even when registration exemption is granted by CVM, the offerors of CICs in condo hotels have a series of obligations in relation to disclosure of information. During the period of the offer, the offerors must make available to the public, among others, the summary prospectus, the economic feasibility study of the project and all the contracts template of the CICs.
The summary prospectus is the document that contains all the information related to the project and to the offer. It identifies the Construction Company, the Developer, the Hotel Operator and other participants, if any. In the prospectus, investors also will be presented to the risk factors related to the business and a summary of the contractual provisions regulating relations between investors and the offerors and among investors and other counterparties involved in the transaction.
The economic feasibility study of the project must contain: (i) trends and macroeconomic perspectives; (ii) the hotel market analysis by segment and prospects of its evolution; (iii) revenue, expenditure and results projection for a period of at least five years of the hotel operation; (iv) calculation of the internal rate of return of the project for the period of ten years; and (v) other relevant information that enable the investors to evaluate the offer. This economic feasibility study will have to be prepared by an independent professional or company.
These documents, including the contract templates, will be made available by the offerors in their webpage. In addition, the Realtors that participate in the offer intermediation must possess a copy of the summary prospectus.
During the existence of the hotel enterprise, the offerors will prepare and make available to the public, on the internet: (i) annual financial statements audited by independent auditors registered with CVM, within 60 days from the date of close of the financial year; and (ii) quarterly financial statements regarding the three first quarters of each year, accompanied by a special review report issued by independent auditors registered with CVM, within 45 days from the closing date of each quarter.
V. The condo hotel as an alternative of investment
In order to invest consciously in condo hotels, it is paramount to know their profitability and liquidity characteristics.
A condo hotel is a variable income investment. The return on investment in condo hotels depends on the operating results of the project. In the course of a given period, such as a calendar, for example, the hotel will operate managed by the Hotel Operator. During this period, the hotel will have revenues, fruit of the leases, or as it is said in the market, the occupancy rate of the hotel, and will also have costs. The result available to the investor is, in short, the difference between revenue and expenditure in proportion to their participation. But revenues from a hotel are not fixed, not guaranteed8. These revenues can range enough over the course of a period for a variety of reasons. Around the vacation, holidays and regional events, when demand increases, the revenues tend to improve, and they can be reduced in other periods of the year, with low demand. Other factors, such as location, competition (including new technologies, such as apartment rental applications), quality, etc. may also affect the revenues.
Even if the intent is to get return from the sale of the investment, the yield is variable. This is the case, for example, of the investor who buys his/her participation in the offer of the condo hotel, for a given price, expecting to resell it for a higher price in the future. However, there is no way to know exactly if the future price will be higher, equal or even less than the paid at purchase. So, whatever the form of profitability, the condo hotel is characterized as a variable income investment, and therefore brings with it risks that are only suitable for investors who have the ability and propensity to support them.
The liquidity of a condo hotel is low and is related to the ability to resell the investment, turning it into money for a fair value or with a minimum loss in relation to the fair value. A deposited amount in a savings account, for example, can be withdrawn at any time. The Bank has the obligation to return to the investor all money applied, including the income to which he/she is entitled. Therefore, it is said that the savings account is an investment of high liquidity.
To better understand the liquidity of a condo hotel, one must remember of its nature. First, the investors of a condo hotel have a property, generally an autonomous real estate unit with individual record. By nature, buildings are low liquidity assets. In fact, it may not be as easy to sell a property for its fair price. Although the scenery changes in accordance with the market conditions, in general those who wish to sell fast need to offer a discount in relation to the price considered fair. In the case of condo hotels the situation is a little more challenging because the autonomous real estate unit acquired in a condo hotel is linked to a set of contracts (CICs) that limit the right of property. To dispose of a condo hotel, the investor will have to find someone willing to accept all the conditions of the contracts to which the unit is bound, including the willingness to accept restrictions on the property. So the investment in condo hotels is seen as of low liquidity. Therefore, it is more suitable for investing the equity portion of resources that may be unavailable for a long period, without undermining the financial security of the family.
Regarding the resale of real estate units linked to collective investment contracts in condo hotels, it is worth remembering that the efforts for sale, if public as the advertisement in a newspaper of great movement, are considered public distribution of securities and, therefore, are subject to the provisions of ICVM 400/2003. However, pursuant to item II of article 5 of ICVM 400/2003 the public offering of a single and indivisible lot of securities is exempt from registration with CVM.
VI. Main risks for investors
Considering its operational characteristics, profitability and liquidity, the condo hotel investment is considered risky9. There are several factors that contribute to it. Without the pretension of exhausting the analysis, the main risks that the investors of condo hotels may be exposed are indicated below:
- pre-operational investment-related risks: in general, public offerings of CICs in condo hotels occur even before the works begin. It is important to consider, therefore, the possibility that trouble in the works would happen, including that the hotel be delivered with delay. This can impact the expected results and, therefore, the remuneration of the investor. In addition, the financial analysis presented in economic feasibility studies based on estimates of revenue and expenditure may not be achieved. There are estimates that depend on unknown variables. For example, the demand designed for future would come true? Other hotels would settle in the region? Operating costs would remain in the projected levels? The response to all these questions can negatively impact on future profitability of the investor.
- risks related to the market: even with the hotel in operation, there are risks that need to be evaluated. The conditions of supply and demand, for example, can change at any time, and may cause decrease in the hotel occupancy rate or amount charged by the day, adversely affecting the results of the project. Increased operating costs, difficulties in obtaining credit, rising interest rates and other changes in the economic conditions can also occur.
- risks related to the capital contribution: in the event of losses, especially if recurring, additional capital contributions to the hotel operation will be required to cover the cost of the activity. In this situation, if other alternatives are not possible, it is important to be aware that the investors/co-owners may be called upon to contribute capital to the project.
- liquidity-related risks: the low liquidity of the CICs in condo hotels can make investors who need to dispose of the business to have to sell it at a price below the fair value, which can represent a loss in relation to the amount paid for the purchase. Still, even at a low price, there is no guarantee that the investor can sell it within the required time.
- risks related to leverage: in some cases, investors acquire a condo hotel using Bank financing. There is no guarantee that the future profitability of the investment will exceed the rate of the contracted financing.
- risks related to the market price of the purchased units: regardless of the liquidity, the value of the real estate units of the condo hotel are subject to variations. What determine the price are the conditions of supply and demand, which are intrinsically related to the economic conditions. This represents a potential risk to the investor, to the extent that there is no way to predict if the purchase price will be recovered or not. There is also the risk that the business model of condo hotels loses attractiveness over time, reducing the demand and consequently the prices.
- risks related to Hotel Operator: condo hotels are managed by Hotel Operators, by means of long-term contracts. There is no way to ensure that the hotel services will be rendered exactly with the quality expected by the investors. Problems in the management or execution of the contract may negatively affect the results of the investment. In addition, the contracts with the Hotel Operator have a fixed term, at the end of which the may be renewed or not.
VII. Final Considerations
In order to determine the cost of the investment, one should realize that investors in condo hotels tend to pay, for example, fees related to decoration and the furniture of the hotels, as well as their remodeling. So, it is paramount to check the value of any taxes and when they must be paid.
Furthermore, it is highly recommended to become aware of the real estate market and the hotel industry before purchasing CICs in condo hotels, as well as to visit the area of the hotel enterprise and to know, among other relevant information, the potential competitors, the average daily rate charged in the region, the average cost of the square meter of real estate in the region, the guest profile to be drawn to the hotel, the attractions of the region and its economic potential.
1. The information contained in this article is based on the recommendations made in the 8th edition of the Consumer/Investor Protection Bulletin (Boletim de Proteção do Consumidor/Investidor) issued on January 25, 2017 by the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM) and by the Brazilian Secretariat of the Consumer of the Ministry of Justice (Secretaria Nacional do Consumidor do Ministério da Justiça - Senacon/MJ), which deals with investments made in condo hotels and presents the main features and the risks involved in this type of investment. This publication is available on CVM's webpage at the following link: http://www.portaldoinvestidor.gov.br/portaldoinvestidor/export/sites/portaldoinvestidor/publicacao/Boletim/BoletimCVMSENACON-8.pdf.
2. To participate in a condo hotel, the investors sign a set of contracts which, together, define the investment model. In the financial market, this set of contracts receives the name of collective investment contracts (contratos de investimento coletivo - CICs) in condo hotels.
3. The acquisition is very similar to any property such as a house, an apartment or a store, governed by Law No. 4,591, of December 16, 1964, as amended (the Condominium and Units Development Law).
4. During this period, the investor cannot exercise the right of usufruct on the unit. In practice this means that the investor does not have the freedom to live, lend or rent the unit separately, as in general it is possible in a traditional investment in real estate. In the case of the CICs in condo hotels, the acquired unit enters the "pool" of units administered by the Hotel Operator. In some cases, the investor has the right to use the unit for a few days each year.
5. The SCP is governed by articles 991 to 996 of the Brazilian Civil Code. The SCP is formed by at least two partners by means of a private instrument executed by the parties interested in carrying out a specific activity. Although it is not vested with legal capacity, the partnership is treated as a legal entity for income tax purposes. Only the ostensible partner, in its own name and account, can perform the activities of the partnership. The silent partners are liable only for their obligations with the ostensible partner, but share in the results of the partnership.
6. Article 2, item IX of Law No. 6,385, of December 7, 1976 (the Brazilian Securities Law), as amended by Law No. 10,303, of October 31, 2001.
7. Pursuant to CVM Instruction No. 554 of December 17, 2014 (ICVM 554/2014), the following entities are considered professional investors: (i) financial institutions and other institutions authorized to operate by the Central Bank of Brazil; (ii) insurance companies and capitalization societies; (iii) private welfare opened or closed capital organizations; (iv) individuals or legal entities that hold financial investments in an amount superior to R$ 10 million and that additionally attest in writing their qualified investor condition according to an own term, set forth in Annex 9-A to CVM Instruction No. 539, of November 13, 2013 (ICVM 539/2013); (v) investment funds; (vi) investment clubs, provided they have the portfolio managed by a securities´ portfolio administrator authorized by CVM; (vii) autonomous investment agents and securities´ portfolio administrators, analysts and consultants authorized by CVM in relation to their own monies; and (viii) non-resident investors.
And the following entities are considered qualified investors: (i) professional investors; (ii) individuals or legal entities that hold financial investments in an amount superior to R$ 1 million and that additionally attest in writing their qualified investor condition according to an own term, set forth in Annex 9-B to ICVM 539/2013; (iii) individuals that have been approved in examinations of technical qualification or who have certifications approved by CVM as requirements for the registration of autonomous investment agents and securities´ portfolio managers, analysts and consultants, in relation to their own monies; and (iv) investment clubs, provided they have their portfolio managed by one or more unit holders, that must be qualified investors.
8. Even the fixed expenses can be difficult to predict with accuracy as a result of any increase in the costs of hiring, employment contracts, rates, tariffs, taxes and others. Thus, it is not possible to know in advance what will be the operating income of the hotel, and, therefore, what will be the return on investment.
9. It should be noted that some risks such as the liquidity risk, the risk related to the market price, among others, may be more significant in the model of ideal fractions of condominiums in condo hotels.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.