The result is a relatively new breed of real estate: condo hotels or condotels — an incredibly lucrative business opportunity for investors and developers alike. What is a condotel and how does it differ from the traditional condominium?

“Navigating the intricacies of condotel financing requires a strategic approach that includes consideration of different financing options, property locations, management companies and local laws.”

When it comes to real estate investments, two of the most popular options that come to mind today are condos and condotels. While each offer attractive investment opportunities and give owners the freedom to live in a unit or rent it out, there are important differences for mortgage originators to understand before delving into the world of condotel financing.

Unique characteristics

A condotel is essentially a condominium that operates as a hotel. It is typically a five-star complex with hotel-specific infrastructure such as restaurants, bars, spas, beauty salons, swimming pools and conference rooms. Like hotels, condotels are managed by an operator, but some if not all units are owned by individuals rather than the management company.

Investors do not buy blocks of shares but separate units — studios or apartments with several rooms and a kitchen, which can be used as temporary accommodations or rented out. Condotels are often operated by qualified managers under a single brand — including chains like Four Seasons, Hyatt and Hilton.

In addition to owning their units, condotel owners benefit from the provision of hotel services such as housekeeping, maintenance and rental management. In a condominium building, on the other hand, the unit owners collectively manage the property through a homeowners association.

Since condominiums are viewed as residential properties, they can be financed more easily with traditional mortgages. Financing a condotel, however, is more challenging because lenders often classify them as commercial properties. This requires an alternative option such as a commercial loan or special-purpose program.

Owners of condotel units are subject to restrictions on how long they can reside in the complex. The management contract specifies the amount of time the owner may stay at the property. This is usually about four weeks per year. The rest of the time, the units are rented out.

Preferred destinations

Combining the features of a hotel and a condominium, condotels have become a preferred option among people who seek a hotel-like experience along with the comfort and privacy of a home. The first condotels appeared in Miami in the 1980s.

Condotel owners can benefit from excellent rental yields as well as capital appreciation. Because condotels are often found in prime tourist destinations, such as beachfront or downtown areas, these desirable locations tend to experience high demand, which can drive up property values over time. Furthermore, condotels offer a hassle-free investment option for those wishing to enter the real estate market without taking on property management responsibilities.

For a private investor, buying a condotel unit is generally a low-risk investment. These types of properties tend to be high quality and in high demand. Often, all of the apartments are sold out before the construction of the building is complete. The hospitality chain that owns the condotel controls compliance with all standards during construction, and it ensures that all necessary documents are certified by legal and financial organizations.

Financing intricacies

Condotel loans function similarly to traditional mortgages, but there are a few key differences to consider. Lenders evaluate the property’s financial performance, occupancy rates and the management company’s track record before approving a loan.

Borrowers may need to meet specific requirements such as higher credit scores and downpayments (20% to 30% of the purchase price). This is due to perceived risks associated with condotel investments. Condotel borrowers may face higher interest rates or different terms and conditions (e.g., a condotel unit must be managed by an approved hotel management company).

When it comes to choosing the right type of loan for condotel financing, borrowers have several options, but nonqualified mortgages (non-QM) provide the most options and flexibility. Non-QM loans cannot be purchased by the government-sponsored enterprises or federal agencies.

One popular non-QM choice is the debt-service-coverage ratio (DSCR) loan. With these programs, lenders evaluate the property’s income potential to determine the borrower’s ability to repay the loan. This is particularly beneficial for condotel buyers who intend to generate rental income from their property.

Another option is the bank-statement loan program. This allows borrowers to qualify for a mortgage by using their bank statements as proof of income, making it ideal for self-employed individuals or those with unconventional sources of income. This flexibility can be especially helpful for condotel buyers who may have unique financial situations.

Profit-and-loss mortgages can also be advantageous for condotel financing, especially for individuals with diverse income streams. These loans are designed for borrowers who own a business or multiple investment properties. Lenders analyze the borrower’s profit-and-loss statements to determine their income stability and ability to repay the loan.

Industry network

While condotel loans offer a range of benefits, they also come with their fair share of challenges. One of the primary challenges is finding a lender that specializes in condotel financing.

Unlike conventional financing, condotel loans have limited availability in the mortgage market. Mortgage brokers with a strong industry network can help clients identify lenders that specialize in this niche market and effectively navigate the complex landscape.

Condotel loans often carry higher risks for lenders compared to conventional residential mortgages. As a result, lenders tend to impose stricter requirements and be more cautious when underwriting these loans. Determining the value of a condotel can also be challenging due to the property’s dual nature as a residential unit and a commercial establishment.

Accurate appraisals must consider rental-income potential, projected occupancy rates and revenue streams. Mortgage brokers should work with experienced appraisers who are authorized to evaluate condotel properties, enabling borrowers to obtain a fair and accurate appraisal that is essential for loan approval.

Condotel financing requires an understanding of the unique business model underlying these properties. This includes analysis of the revenue potential, vacancy rates, resort management fees and the overall success of the property’s rental program. Prior experience and knowledge in this area is instrumental in securing favorable financing terms.

Thorough research

Navigating the intricacies of condotel financing requires a strategic approach that includes consideration of different financing options, property locations, management companies and local laws. The various non-QM financing options available should be thoroughly researched and evaluated.

It should be noted that different lenders will have specific criteria for financing condotel properties. By considering various options, you can identify lenders that specialize in condotel financing and are willing to work with such buyers.

Condotels located in popular tourist destinations, business centers, transportation hubs or areas experiencing rapid construction activity are more likely to attract buyers and vacationers, thereby generating higher returns. Lenders consider the investment potential of the property when determining the financing terms and conditions. Locations with a stable and growing real estate market should also be considered. This reduces the risk of property depreciation and loan default.

Efficient property management is essential for maximizing returns on condotel investments. Strong property management ensures proper maintenance, marketing and guest services, leading to higher occupancy rates and increased rental income.

Condotels, with their unique characteristics, may be subject to specific legal considerations. These include zoning and land-use regulations, licenses and permits, tax and insurance implications, and condo association rules such as restrictions on rentals or operational limitations. They may also include requirements related to various aspects of the financing process, such as downpayments or interest rates. Since all of these regulations and requirements can vary from one jurisdiction to another, it’s important to know the local laws.

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As the real estate landscape continues to evolve, the condotel phenomenon offers a unique blend of luxury, convenience and profitability. For those willing to embrace the challenges and complexities, condotels can open the door to a new and lucrative dimension of real estate investing.

With the right knowledge and a strategic approach, mortgage brokers can turn their clients’ dreams of owning a fully serviced accommodation with the potential for high rental yields into a reality. Equip your clients with the information and strategies outlined here to help them embark on a journey that could redefine their real estate portfolio and financial future. ●

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“Projects in need of critical repairs or that have significant deferred maintenance can result in unsafe living conditions, evacuations and uninhabitable homes,” a Fannie Mae spokesperson writes in an email. “In addition, special assessments for these types of issues can result in a substantial financial hardship for homeowners — especially low-income or first-time homebuyers — which can put them at risk for loan default and foreclosure.”

One of the practical effects of these changes is that more condo loans are being rejected or delayed, says Dawn Bauman, chief strategy officer for the Community Associations Institute, which advocates for condo associations as well as the 74 million people living in these developments. Her organization sent a survey to members last year. Of the 541 respondents, about one-quarter said that loans in their condominium developments were denied due to the new requirements while more than one-third experienced significant delays.

Bauman says that she’s concerned that the new rules apply to all condo projects with five or more attached units. Bauman also says that her membership learned that Fannie Mae maintains a list of condo projects for which they won’t purchase loans.

“The ineligible blacklist came to the surface after all of this,” Bauman says. “It was like, ‘Wait a second. There’s a list, actually?’ While it existed before, it wasn’t as big of a deal before because there weren’t that many projects on that list. It then became just a bigger deal after the new requirements came out.”

The Boston Globe reported last year that the number of U.S. condo projects on this list had grown to more than 2,300. Data and technology company CondoTek told the newspaper that the list numbered fewer than 300 projects the year before.

Fannie Mae reports that only 1.2% of condo projects were labeled as “unavailable” as of this past June. The agency also says that condo loan acquisitions totaled 9% of its single-family conventional business in both 2021 and 2022, an increase from 8% in 2020.

“Most projects that are currently listed as unavailable have other eligibility issues, such as active or pending significant litigation, hotel- or resort-type characteristics with transient occupancy, too much commercial space, or inadequate insurance,” according to Fannie Mae.

The Community Associations Institute, the Community Home Lenders of America (CHLA) and the National Association of Realtors asked the GSEs and its regulator, the Federal Housing Finance Agency, for more transparency about the list of nonwarrantable projects. This past December, the GSEs annnounced plans to create an online tool for homeowners associations to identify whether they are on the list and what they need to do to be removed.

CHLA executive director Scott Olson applauds the move for increased transparency, saying that if the GSEs identify problems with a condo development, the association should be made aware so it can fix them. Olson says that his organization has been focused on prevention of overreactive policies. He hopes that the GSEs and other regulators scrutinize the underlying causes of the Champlain Towers South disaster. 

“You should worry about older buildings; you should worry about high rises,” Olson says. “You should worry about areas where there’s a lot of water. That was a big problem with Surfside — the water erosion. You shouldn’t just overreact and be really tough on everything.”

Bauman notes that condominiums tend to be an affordable option for first-time homebuyers, retirees and everyone in between. She remains concerned about what could cause the GSEs to reject loans from condo developments. Those could be everything from insurance requirements to special assessments. She notes that homeowners associations commonly levy assessments for such things as lobby construction or common-area improvements. What types of assessments could cause more delays or denials for condo loans?

“Transparency is awesome, of course,” Bauman says. “The next step will be to really evaluate whether these are reasonable requirements, or addressing liability concerns for Fannie Mae and Freddie Mac, while making sure they’re doing what they’re supposed to be doing for the American people, which is putting liquidity into the marketplace.” ●

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A nonwarrantable condo is part of a development that falls short of meeting eligibility standards set by the government-sponsored entities (GSEs) Fannie Mae and Freddie Mac, as well as government-backed programs from the Federal Housing Administration and U.S. Department of Veterans Affairs. These standards exist to minimize risk for lenders and ensure that loans supported by these entities remain secure investments.

“Nonwarrantable condos introduce distinct living advantages for homebuyers, but they also come with financing intricacies.”

Understanding whether a condo is warrantable or nonwarrantable holds immense importance as it directly impacts the borrower’s ability to secure financing. Mortgage originators who know the differences between warrantable and nonwarrantable condos can gain a competitive edge in their markets, especially if they work with lenders that are willing to finance nonwarrantable units.

Undesirable designation

Typically, nonwarrantable condos falter in meeting one or more criteria set by the GSEs or government agencies. For instance, at least 50% of the units in a condo community must be owner-occupied. A failure to meet this threshold means that the community will be labeled as nonwarrantable.

If a substantial portion of the condo complex is designated for commercial use, it might lose its warrantable status. If a project includes hotel, motel or resort elements like a booking desk, the GSEs might not endorse it.

If at least 25% of the condo owners aren’t up to date on their homeowners association (HOA) dues, the complex may become nonwarrantable. When HOAs fail to allocate 10% of their revenues toward reserve funds, the GSEs may remove their warrantable designation.

Condo complexes embroiled in unresolved legal disputes might be deemed nonwarrantable. When a condo complex lacks sufficient insurance coverage or faces an open insurance claim, these can prove to be roadblocks to the warrantable tag.

Potential advantages

Many mortgage lenders hesitate to lend on nonwarrantable condo purchases because Fannie Mae and Freddie Mac won’t underwrite these loans. But other lenders, armed with portfolio loan products for a nonwarrantable condo, may step in to provide financing.

This can be advantageous to a borrower. A nonwarrantable condo may sell for less than market value, depending on the issues that are causing it to be considered nonwarrantable. Therefore, if the issues are resolved and the property may be treated as warrantable in the future, the value and future resale appeal could increase significantly. Nonwarrantable condos also may provide the unit owner with access to better amenities and increased security, especially if it’s part of a resort or hotel.

Still, nonwarrantable condos tend to be riskier for lenders due to their noncompliance with GSE guidelines. Consequently, obtaining a mortgage for a nonwarrantable condo can be more challenging and often comes with additional financing costs.

Lenders may impose higher interest rates to counter the heightened risk associated with a nonwarrantable condo. They also might require borrowers to make a more substantial downpayment, often surpassing the standard 20% for a conventional loan. Nonwarrantable condos may restrict the borrower’s selection of lenders, as not all financial institutions are willing to underwrite loans for such properties.

Well-versed professionals

A borrower contemplating the purchase of a nonwarrantable condo must be well prepared. They will need the advice of an experienced originator and, preferably, a real estate agent who are well versed in nonwarrantable transactions.

Originators should work with lenders that have expertise in financing nonwarrantable condos. Savvy originators can guide clients through the lending process and secure favorable terms. They should thoroughly scrutinize the HOA documents to identify potential concerns like pending litigation or delinquent dues. Originators can also investigate alternative financing avenues such as portfolio lenders or private lenders, which may be more open to funding a nonwarrantable unit.

Selling a nonwarrantable condo also requires a nuanced approach. Given the potential financing hurdles for buyers, it’s essential for an owner to understand that interest in their property may be limited. Experienced real estate agents and originators can be a valuable resource, connecting these sellers with lenders that cater to nonwarrantable condos.

Lawmakers, both locally and nationally, have been working to protect condo buyers. The city of Chicago, for instance, has revised its municipal codes to bolster consumer protections. Key changes include enhanced rights for prospective buyers, who now receive a straightforward, standardized disclosure document that contains critical information about the condo.

Developers are legally obligated to furnish this document when offering condos for sale, whether during open houses or other presentations. Tenants who reside in buildings undergoing conversions into condos also enjoy expanded rights under this rule. Chicago’s ordinance stipulates that a developer overseeing a conversion must formally notify existing tenants through both mailed correspondence and prominently displayed postings.

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Nonwarrantable condos introduce distinct living advantages for homebuyers, but they also come with financing intricacies. If you’re working with a client who is contemplating such a purchase, diligently prepare them and be ready to address potential challenges on their path to homeownership. With your guidance, they can confidently navigate the realm of nonwarrantable condos and make informed decisions. ●

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