The good and bad: mixed-use hotel-development projects often ease financing, complicate operations

Hotel & Motel Management, March 1, 2004 by John P. Walsh

Developers face financial, operational and legal issues when building mixed-use projects. Demand for mixed-use originates from a project that someone wants to build but isn't feasible, according to Tim Marvin, v.p. of hotel development for Marriott International. The developer then thinks about what can be added or combined with it to make it work.

Tom Morone, principal with Warnick & Co., said he hasn't seen much urban mixed-use because there isn't much demand for office space. He said the number of mixed-use projects will increase based on the improving economy.

"Today, we're seeing hotel/residential mixed-use, which is popular in Chicago," he said. "What's needed are generators to supplement a high-end hotel to offset the development, land and infrastructure costs."

Some mixed-use hotel projects wouldn't be developed if it weren't for the profits from the residential units, according to Jerry Thoele, president and c.o.o. of the hospitality division of Garfield Traub Development.

Morone said one of the biggest issues regarding mixed-use is a hotel's positioning.

"If you want to sell $1-million lots, you need a luxury hotel; you need a proper positioning," he said. "You need to attract luxury-minded clients. It's foundational to everything [developers] do."

Brian Smith, a partner with the law firm Heller Ehrman White & McAuliffe, said upper-upscale brands are commonly associated with hotel/residence projects.

"You are unlikely to find much below first class," Smith said. "Logic is that the condo is in association with the hotel, which provides services. It also provides luster. It's the character of service that drives the relationship between the hotel and the condo. In the resort context, those benefits can be realized further down the [segment] chart."

Thoele said a hotel brand is critical, distinguishes the product and drives the value of the nonhotel asset part of the development.

"There's a 30 percent to 40 percent perceived value with a brand over an independent," he said.

Morone said most brands could sustain some type of mixed-use, but luxury brands have a good core of customers that pay for anything one puts in front of them.

Thoele said an urban center's retail component has begun to take a more dominant role.

"The size and quality of the retail component make it an urban destination," he said. "Between the hotel brand and the retail mix, the developers are creating barriers to entry, which create value over time. We're seeing no slowdown of mixed-use development."

Mixed-use projects are more complex than most.

"You need more time to design and develop the property, and all sections need equal access to things like the loading docks," Marvin said. "You have to think about things like how will the cost of the services be shared. From a financing point of view, they will have to be vertically subdivided at one point. There is additional design time and legal time, which all push up the cost."

Marvin said complexities also include sharing heating, ventilation and air-conditioning components, parking during peak hours, and creating a common generation plant to create efficiencies for the entire building. "If the project can get multiple uses out of a high-rise, for example, it lowers the cost of the foundation work," he said.

Thoele said there needs to be a complete package planned up front, especially when there are different uses. "The hotel needs to be sized to service the hotel guests and the residences," he said. "Management needs to recognize that a hotel guest checks out and a resident does not. You have to balance the needs of these uses in a controlled environment."

Smith said that if the residential part of a mixed-use project is going to be rented and managed by the hotel, there are significant securities restraints.

"That means, unless you go through a costly securities registration process, owners can not be required to go to the hotel for the management of the rental of their rented condos," he said. "From the developer's and operator's point of view, it's not ideal because you want not only the money from the management of the rental residences, but also control of them, so you can use the units as extra hotel inventory and make sure the quality and guest experience are consistent with the hotel brand."

Smith said other legal issues involve agreements with components of the project. For example, with shared parking, the hotel and the nonhotel aspect have different needs, and the costs need to be allocated in a fair and equitable way. Other examples are insurance, taxes and maintenance costs.

Thoele said an interesting legal issue will arise when management doesn't meet the hotel standards but is meeting the needs of the residences and the owner wants to change flags.

"It's an intriguing subject that will eventually come to a head," he said.

jwalsh@advanstar.com