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Still Unsure About Condotels? Stay Tuned for ’06

San Diego’s lodging industry has coasted along, showing slight increases in both occupancy rates and room supply for the past few years.

However, hotel development could change radically in the near future if the new condotel trend, which is making hotel owners out of average investors, spreads as quickly as some expect it will. While corporations and pension funds have traditionally been the mainstay of hotel financing, condotels derive much of their financing by selling guest rooms and suites to individuals.

There are only two 100 percent condotel developments under construction in San Diego: the 400-room Hard Rock Hotel San Diego and the 185-room Diegan Hotel.

Both properties began construction in Downtown San Diego last year and won’t be completed until late 2007. The Diegan is expected to sell out soon. Lee Mullinax, the president of Vertical Properties, the Diegan’s real estate broker, said 75 percent of the hotel’s units starting at nearly $400,000 and going up to $4 million for the penthouse suites have already been spoken for. He also said he anticipates that sales contracts will be signed for at least 70 percent of them by the end of January.

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Meanwhile, the Hard Rock’s rooms and suites, priced from about $400,000 to more than $1 million, have generated a list of about 2,000 interested parties. Yet sales reservations will not be taken until mid-February, said Greg Casserly, the president of Tarsadia Hotels, the Hard Rock’s manager. Contracts will follow.

Under California real estate law, sales of condotel units, like those of standard residential condos, cannot go through escrow until the properties are finished and receive certificates of completion.

Both hotels are encouraging prospective investors to consider their purchase a vacation home and not a short-term investment that could be flipped within a year or two. Contracts vary as to how long an owner can occupy a condotel unit yearly, and there are management fees as well as homeowner association dues involved. But buyers could be able to offset some of their expenses with revenue realized from putting their units into the hotel’s general inventory.

Analysts warn that buyers need to study contracts and market comparisons carefully and they need to be conscious of what the property’s flag, or brand name, can do for them in terms of marketing and advertising to attract visitors. Analysts also caution that condotels favor developers because such deals leave them with the equity they need to pursue other deals.

One of the chief reasons that a projected 30 hotels exchanged hands in San Diego during 2005 is because hoteliers have continually enjoyed the ability to raise their rates, said Alan Reay, the president of Costa Mesa-based Atlas Hospitality Group, one of Southern California’s largest hotel brokerage firms. Another reason, Reay said, is that “the cost of replacement exceeds the price of buying existing properties.”

The cost of construction, which has increased dramatically in the last two years, doesn’t change just because a project is a condotel vs. a standard hotel. However, with condotels, individual buyers put up much of the equity that is needed for construction. And the way Reay sees it, some projects won’t get off the ground unless they are condotels.

“There’s no question in my mind that without going the condotel route, the Diegan and the Hard Rock San Diego simply would not have gotten built,” he said. “I think condotels will be the big story in 2006 and into 2007.”

Large metropolitan areas in California , San Diego in particular , will soon catch up with such cities as Miami, New York and Chicago, where the trend started, he added.

As far as San Diego’s landscape is concerned, Reay expects that condotel developers will likely target Downtown, and that some B-grade buildings there might be razed in the process.

“If condotels can sell for an average of $400,000 to $600,000 a room, then it would make sense that a lot of existing structures in Downtown, which are valued lower, would be torn down,” Reay said.

Reint Reinders, the president and chief executive of the San Diego Convention & Visitors Bureau, agrees that Downtown is top a candidate for new condotel development.

“I’ve seen interest in the condotel trend for years,” Reinders said. “In fact, I’ve met with people who came to talk about condotel development in San Diego. This is a hybrid real estate investment for an individual. It has to be both desirable as a vacation home and successful as a hotel.

“The beauty of San Diego is that it’s a year-round marketplace. Good hotels in good sectors run 80 percent occupancy all year. So if a condotel can do that, then people will want to invest. They have to realize they’re not going to get rich on it. But it’s a brilliant concept for a strong market and I think we’re going to see more.”

He disagrees, however, with the notion that some buildings Downtown would be razed to make room for condotels.

“Those would be in less desirable locations for a hotel,” Reinders said. “A typical condominium might work at Fifteenth and Market, but a condotel wouldn’t. Condotels need to be in the center of town because people want to stay where the action is, or they’d need to be on the waterfront.”

Reay projected that hotel sales will remain robust in 2006. He performs yearly and midyear reports that look at hotel sales and construction throughout the state. Within San Diego, 16 hotels sold during the first half of 2005, for a total of $229.3 million, compared with 13 properties during the same period of 2004 that totaled $64.6 million, and the county led the state in price appreciation.

The year-end total for individual hotel sales in 2005 is likely to reach 30, he said, adding that he wasn’t sure of the total dollar value of the transactions. His report will be compiled within the next few months. Yet he said he thinks the property sales will total 30 during 2006 as well.

According to Smith Travel Research of Tennessee, which tracks the hotel industry nationwide, San Diego’s room occupancy rate, which stood at 70.1 percent through the end of October, was up 3.9 percent from the like year-ago period, placing the county fifth in a ranking of the nation’s top 25 destinations. The national average was 64.7 percent

The average daily room rate of $123.62 was up 7.6 percent, placing the county in the No. 7 spot in view of increases during the 10 months ended in October vs. the same period of 2004.

A visitor industry forecast by ConVis projected that overall spending would reach $6.1 billion , an increase of 6 percent from the projected spending figure for 2005. Room supply is expected to increase by 1 percent from 54,033, the projected year-end total for 2005. Occupancy, projected to reach 72.4 percent by year-end, is anticipated to increase 0.7 percent. The average daily room rate, projected to be $121.61 for 2005, is expected to increase 4.5 percent to $127.09.

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