23 September 2021 - Article
Branded residences are urban apartments and resort villas which are conceived, designed, and sold to individual buyers under a hotel brand. These projects are typically next door to a branded hotel or resort development in a premium location run by the same operator.
Benefits of branded residences projects
The benefits private investors are seeking from branded residences differ depending on their motivation. If the investor aims to acquire a residence purely as an investment, a mixed-use project consisting of a hotel and branded residences has various advantages:
1) With the hotel operator almost certainly offering a rental programme in this scenario, the branded residences can be used to generate income. Through the rental pool, the unit becomes part of the hotel inventory and is managed by the hotel operator in the same way that it manages the hotel rooms. The rental programme can be structured with a fixed rent, variable rent (based on the gross revenue or net operating profit), or a combination of both. The ultimate rental pool structure will depend heavily on market fundamentals and the developer’s overall offering. Destinations which combine both business and leisure tourism in particular can drive strong rental demand through branded residences.
2) The operator can maintain the residences year-round (in return for maintenance charges), which saves hassle for individual owners and ensures that the residence is ready for use at any time.
3) To enhance the appeal of the rental pool structure, some developers may offer guaranteed returns to investors, usually limited to a ramp-up stabilisation period with a transition to pure profit sharing (either on gross operating revenue, net operating profit level, or a combination of both) once the project enters stabilised trading performance.
4) The investors are usually entitled to use their unit on a free-of-charge or heavily discounted basis up to, for example, 2-4 weeks per year, whilst the property is generating revenue in the remaining months.
5) If investors follow a “buy-to-sell” strategy, the branded residences also have an edge where the profile (and usually location) of the project generates a resale premium over and above the market price of unbranded peers in the same location. These investors will target such projects off plan and look to drive a premium on a resale once construction is completed.
As illustrated above, the greatest synergy can be expected in projects where the branded residences are constructed as part of a bigger mixed-use development alongside a hotel and incorporated into a rental pool structure.
Rental pool arrangements
The rental pool structure can be optional or mandatory. In many cases, the developer will need to offer a mandatory rental pool due to arrangements with a selected hotel operator. Under an optional rental pool scheme, a unit buyer/owner is free to choose whether to keep the unit for personal use or place it in the hotel inventory (subject to furnishing in accordance with the operator’s brand standards). However, the operator may seek the right to reject the placement of units into the rental pool if it estimates that the existing hotel inventory will not be utilised in full.
The terms and conditions of the rental pool scheme are set out in a Rental Pool Agreement attached to the Unit SPA. For a “mandatory” rental pool, the Rental Pool Agreement is either executed simultaneously with the Unit SPA, or where the local law requires. Instead of the Rental Pool Agreement, the unit buyers and developer may be required to enter into an “agreement to lease” first (as a preliminary binding agreement, in force during the project construction), to be replaced with a definitive Rental Pool Agreement (to be attached to the “agreement to lease” as a schedule) upon completion of construction.
To appreciate the risk and reward profile, unit buyers should be mindful of and carefully consider the following terms in the Rental Pool Agreement:
- the term of the contract and the unit owner’s right to prematurely terminate thereof;
- budgeting, reporting, and fees due to the developer and operator;
- profit sharing mechanism (either on gross operating revenue or net operating profit level or a combination of both) if any;
- events of default and remedies available to the developer in case of breach of contract by the unit owner;
- working capital top-up obligations;
- capex requirements; and
- insurance requirements.
Where foreign investors are prevented from acquiring an ownership title, the developer may offer long-term lease arrangements instead, in which case the Rental Pool Agreement becomes a sub-lease agreement by nature.
In certain markets, rental pool arrangements are regarded as a collective investment scheme/syndication regime/managed investment scheme (or similar local equivalent). In these circumstances, developers may need to structure the project in a way that the funds generated by an individual unit and related operating and non-operating expenses are accounted separately (i.e. without pooling with other unit owners). Unit owners joining the rental pool arrangement would need to accept the risk that the rental profit of their particular unit may not be the same as that of other units in the same development due to a number of individual factors, such as view, type of room, number of bedrooms etc.
With regards to operating expenses of the projects, all expenses will first be centrally incurred by the hotel with a charge-back mechanism applicable to all units placed in the rental program. The allocation formula would need to account for the duration of the accommodation period if any was taken by the unit owner, as well as the season in which such accommodation entitlement was used by the unit owner. The hotel may also charge back a share of capex expenses and FF&E spending incurred for public areas in the hotel to which guests of the units in the rental program have access.
In summary, the branded residences model may not be the easiest to embrace. However, if structured properly, these projects can create ample synergies and opportunities for all stakeholders involved.