Condominium Hotel Development: Beware the Securities Law Minefield
By Bart E. Bartholdt
June 2 , 2005
You're in the early phases of developing a hotel/condominium project, with a hundred issues, large and small, to consider. Chances are that complying with federal and state securities laws is not at the top of your list. But if your development will involve a rental arrangement for those condominium units when they're not being used by the buyers, you should be asking a series of questions from the earliest planning stages.
1. How can a real estate sale involve the sale of "securities"?
Obviously, the mere sale of a condominium unit, without more, is not a transaction involving the sale of securities. However, a series of court decisions and SEC pronouncements has made clear that when the sale is combined with a rental arrangement that causes the buyer to "look elsewhere" (that is, other than to appreciation) for a return on his or her investment, the securities laws may apply. In a general sense, the SEC's position is that this arrangement isn't different from an investment in stock, where the purchaser looks to another party (the issuer) to provide a return on his or her investment.
2. What's the downside of not asking the right questions?
If your rental arrangement is not structured properly, or if it is sold in the wrong way, you may find yourself in the securities business. That means that unless an exemption from registration exists, the offering will need to be registered with the SEC, and probably with various states " a lengthy and expensive process. Your sales staff will need to be registered as securities salespersons. And dissatisfied condominium buyers will have a new range of remedies, such as recission and actions based on fraud, under the securities laws.
3. What are the major "don't do's" if I want to avoid the securities laws?
Although they have been fleshed out in considerable detail by the SEC over the years, the primary things that you should not do were established over 30 years ago:
- Do not offer a rental arrangement that pools rental revenues;
- Do not place significant restrictions on the buyer's use of the unit; and
- Do not emphasize the economic benefits of the rental arrangement.
4. How can legal counsel help?
Your counsel should be closely involved in structuring both your rental arrangement and your sales and marketing program. As summarized below, avoiding the securities laws can require carefully choreographed actions, particularly in the sales and marketing program.
5. What questions should I be asking in terms of the rental program itself?
- What, if any, restrictions can I put on the use of the unit by the buyer?
- Can I require the buyer to make the unit available for rental during particular months, or for a particular number of days a year?
- Can I require a rental arrangement, or require that if a rental arrangement is desired, it be with a particular company?
- What do I need to do to assure that my sales program and my (or my affiliate's) rental program are sufficiently separated?
- When and how can a purchaser safely enter into a rental agreement in connection with the unit purchase?
6. What questions should I be asking in terms of sales and marketing?
- What can I say in written marketing materials about the rental program?
- What can my sales staff tell prospective buyers about the rental program?
- What answers can my sales staff give to questions about the potential economics of the rental program?
- What economic information (projections, etc.) can my rental management staff provide to prospective buyers, when the almost inevitable questions arise?
- What safeguards can be included in my training program to assure my salespersons don't say the wrong thing?
Asking the right questions, and working with your legal counsel to answer and address them, is a process that should begin at the earliest stages of planning of your condominium-hotel development.
For a more comprehensive review of the current state of the law in this area, and steps to take to assure that you do not inadvertently end up in the securities business, click here to see an article entitled The Condo-Hotel: When Might the Securities Laws Apply?. [Link to Bartholdt_securitylaws_June2005 article]
If you would like more information on this issue, contact Irvin W. Sandman (206.340.9641 or isandman@grahamdunn.com) or Bart E. Bartholdt (206.340.9647, or bbartholdt@grahamdunn.com).
