Branded real estate and mixed-use developments

In the real estate boom that recently ended, the number of branded hospitality projects available for investment grew rapidly. However, there is now an equally dramatic shakeout as a result of the global downturn.

In a hospitality project, the brand identity, consisting of design and operating standards, names, phrases and business systems, is associated with the product (such as a hotel) from the pre-opening phase of development through to the end of the contractual period specified in the hotel management or license/franchise agreement. In return for the brand association, a hotel pays a percentage of its revenues (typically its room revenues) to the brand as a licence fee.

Upon the expiry or other termination of the agreement, all use of the marks ceases and the hotel is disassociated from all centralized services of the brand, including, most importantly, the reservation system.

Associating a brand with a “for-sale” product creates some issues that are different from those raised by the traditional hotel model. The owner of the brand typically charges a fee for the use of its marks in connection with the sale of the product. The royalties on sale represent an additional source of revenue, which is realized before operations even begin. Further, the activities required when sales have been completed and the product is operational are sometimes quite different from those of a traditional hotel and therefore entail different fee structures. Moreover, the branded product may not be managed by the brand at all and may be less easily subjected to clear brand operating standards than is the case with a traditional hotel product.

Branded lodging products

The following are the primary types of branded real estate product.

Branded residences. Branded residences such as “The Ritz-Carlton Residences” should be thought of as a true residential real estate project. Hotel guests and residents share certain services and facilities, even if some are accessible only by residents.

Whole ownership with a branded rental programme.

Whole ownership products are for-sale real estate products in which all of the interests in the unit are conveyed in a single transaction, as opposed to shared ownership (discussed below). They are designed and intended for a more transient form of occupancy. The residence typically participates in a branded rental programme whereby the brand uses the power of its reservation system to arrange transient occupancy of units on a basis similar to traditional hotel rooms.

Shared ownership (timeshare, fractionals and private residence clubs).

Shared ownership products entail a sharing of ownership of a residence or lodging unit. Broadly speaking, the asset acquired under a shared ownership regime is either an interest in real estate, commonly referred to as a “deeded interest” or a “timeshare estate”. In Asia, it is more common to transfer a bundle of contractual rights that do not entail a transfer of an interest in real property. This is referred to as a “right to use” product.

Destination clubs. Destination clubs are generally non-equity clubs in which the member acquires a certain amount of annual guaranteed occupancy of the club’s various residences.

Serviced apartments. Although not a for-sale product, serviced apartments represent a lodging product that is common in Asia and increasingly branded by major hotel companies.

Mixed-use developments

A number of factors have recently contributed to a high level of interest in branded real estate in mixed-use resort projects. Pressure on the capital structures of resort projects frequently necessitates the inclusion of one or more for-sale lodging products to defray land and development costs.

Governance documents are the legal infrastructure upon which a mixed-use project rests. They include covenants and restrictions that provide for such matters as the maintenance and repair of common elements of the project (roads, utilities and landscaping), impose architectural restrictions, establish permitted uses of various components of the project, create a right to impose service charges on all properties within the project, and address the rights to use and enjoy various facilities within the project such as clubhouses, golf courses, open spaces and other common elements.

Most brands require that both the governance and offering documents contain a statement indicating that the brand affiliation is for a limited time, may be terminated by the brand or the developer, and that purchasers do not acquire any right to the brand names.

Potential pitfalls in China

Although mixed-use developments, such as branded resort projects, are not an entirely new concept in China, shared ownership remains a relatively new concept in China and one which may face cultural barriers with Chinese investors.

More fundamentally, China prohibits the freehold ownership of real property. Cooperative ownership, the transfer of leasehold interests and the sale of right-to-use interests may be utilized as an alternative to the sale of deeded freehold interests.

Generally speaking, in China the product types have expanded, and issues associated with branding for-sale offerings are frequently considered in the absence of clear market standards, or even clear answers to a wide variety of legal issues.

Costs of branding, enforcement of brand standards, disassociation of a brand from a project, compatibility of project components, resales and regulations are just a few of the more challenging issues.

James Chapman is a partner at Proskauer and the principal of Chapman & Co, a Hong Kong law firm that practices in association with Proskauer Bernice Yung is a senior associate at Chapman & Co