Real Estate Developers Beware: United States Securities Laws Often Apply in the Condo/Hotel Context
For purposes of this post, condominium hotels, or “condotels,” are essentially real estate projects or properties that combine the convenience and control of condos with the amenities of a hotel (room service, maid service, valet parking, etc.). Condotels often include a rental and/or management component that allows a third party to rent the condo owner’s unit in exchange for a portion of rental income being transferred to the unit owner.
Financing can be easier to come by for Condotels than “hotel only” or “pure hotel” properties in certain markets and the consumer demand for condotels is currently increasing in larger markets. In certain situations, the sale and marketing of condotel units can make developers and other parties involved in the project subject to United States securities laws.
Although the Supreme Court of the United States denied a petition for review of the matter, Salameh v. Tarsadia, 726 F.3d 1124 (2013), decided by the United States Court of Appeals for the Ninth Circuit provides guidance for developers creating condotel or similar projects that seek to avoid the application of United States securities law when selling condominium units. According to the Ninth Circuit’s decision in Salameh, a developer seeking to avoid having condo sales treated as sales of securities under United States law should, at a minimum, consider the following factors:
- PERSONAL USE: Emphasize that the condominium units are for personal use.
- NOT FOR INVESTMENT: Don’t emphasize investment purposes or potential profits when selling condo units.
- NOT A PACKAGE: Don’t offer a purchase agreement and a rental and/or management agreement as part of a single package.
- TIMING OF NON-PURCHASE AGREEMENTS: Ensure that any rental or management agreement is signed well after the sale. In Salameh, the Ninth Circuit Court of Appeals found that the 8-15 month gap between the execution of the purchase agreement and the “Rental Management Agreements” underscored the holding that the transactions were separate and, therefore, the plaintiffs were not offered a security.
- USE INDUCEMENTS CAREFULLY: Don’t use a rental or management agreement as an inducement to sell condo units.
- MARKETING: Don’t refer to investment factors or rental and/or management agreements in any marketing materials, to avoid such marketing materials from being used as evidence that the condo offering was an investment –like offering or package.
Although the Salameh decision is only binding in the Ninth Circuit, the above analysis should be considered by condotel developers anywhere within the United States. Otherwise, developers may find themselves in discussions (or worse) with the U.S. Securities and Exchange Commission and/or face private litigation or class action claims from condo unit purchasers for fraud or securities law violations.
Other resources for developers to consider on this topic:
- Guidelines as to the Applicability of the Federal Securities Laws to Offers and Sales of Condominiums or Units in a Real Estate Development, Securities Act Release No. 33-5347, 1973 SEC LEXIS 2120, 1973 WL 158443 (Jan. 4, 1973).
- SEC-OGC Opinion No. 11-49: Sale of Securities; Investment Contract (Dec. 21, 2011).
- Securities and Exchange Commission v. W.J. Howey Co., 328 U.S. 293 (1946).