Battle of the luxury brands

Branded residences have been a key component of luxury hotel developments for decades and, until recently, the luxury hotel brands have largely owned the branded residential space. But that has begun to change in recent years as companies synonymous with luxury outside of the lodging sector have been on the hunt for new, untapped revenue streams. One area that they have turned to is lending their name and branding star power to residential projects. From a developer’s standpoint, there are both pluses and minuses associated with developing your residential project with a luxury hotel brand as distinct from developing it with a luxury non-lodging brand. Qualities of a luxury hotel brand These include: Decades of experience offers proven results Lodging companies have now been active in the branded residential space for many decades, and they have a proven track record of success. This success can be measured in more than one way. Luxury hotel brands active in the residences space, such as Four Seasons and Ritz-Carlton, have been doing this for a long time and their track record of bringing a lift to the sales prices of residences is demonstrated consistently over time. The real estate development industry is excited about what non-lodging brands will bring to this space and how they will differentiate themselves from the hotel companies. But there is not yet enough of an established track record over an extended period of time to indicate the future success that these projects will have. This makes them much harder to underwrite. Perhaps unsurprisingly, over the same period of time, lodging companies have largely delivered in fulfilling the expectations of purchasers of hotel-branded residences regarding the lifestyle and level of luxury that will be delivered. Because lodging companies already have experience in providing luxury living over the short term to hotel guests, they are in a good position to translate this into providing luxury living in the residential context. This has resulted in consistent levels of satisfaction of residents in project after project, which has largely translated into consistent lifts in purchase prices for these units, both in the initial sales by the developer and thereafter on resales. Symbiotic relationship between a hotel and residences An adjacent hotel with an experienced staff that knows how to make guests happy and is equipped with the amenities to do so (such as spas, restaurants, clubs and the like) is very well positioned to be able to offer the luxury living experience to those who will be in the property for the long term. Because the “hotel-style” services – both basic services and á la carte services – provided by the hotel to residents are often provided through the facilities and staff of the hotel, they often provide an additional ongoing revenue stream for the hotel owner as well as a way to share some of the fixed costs of operating the hotel with the residents. An experienced hotel brand will know how to take advantage of economies of scale to make the provision of these services profitable over the long haul. Luxury hotel brands think for the long term As most who have ever negotiated a hotel management agreement with a luxury hotel brand will know, these agreements are designed to be long term. Because of the interconnectivity often woven into a project between the hotel component and the residences component, the hotel brand begins with the mindset that the branded residences will remain branded for the same 40 to 80 years that the hotel branding will be in place. And they are often well incentivised to do so – most luxury hotel brands will require that they have the right to manage the residences component of the project for as long as it is branded with their name and intellectual property. This is consistent with the mindset of high-net-worth individuals who are most often the purchasers of these units with the expectation of passing them along – branding in place – to future generations. In contrast, the luxury non-hotel brands often see these projects as a profit centre through initial sellout, and thereafter largely as a headache to be managed, with problems to be solved for which they are not compensated – in other words, risk without reward. The first major project to fail because of the disalignment over the long term between the brand and the residents’ long-term interests will be a significant blow to this sector of the market. We advise luxury non-lodging brands to think early on about how to work through this inherent tension before it becomes problematic. It may only take one significant failure to give this important and up-and-coming part of the industry a black eye. Potential of a non-lodging brand Of course, there are also the advantages of branding your residences project with a luxury non-lodging brand. Because this part of the industry is still much younger than the traditional development of lodging-branded residences, some of these considerations are still somewhat theoretical, and only time will determine how they play out. Here are the advantages that we think are most significant. Thinking outside the box for a new generation of buyers Luxury lodging brands such as Four Seasons and Ritz-Carlton will always be first choice for many buyers purchasing luxury branded residences. The consistency of experience that they can provide will always be something that makes them attractive. But many studies indicate that a new generation of consumers has different expectations of what branded residences should be able to offer. The latest buzzword in the industry is “experiential” real estate. If you ask five people what this means, you are likely to get five different answers. This highlights the potentials risks and rewards of this change in attitude and expectations. Historically, purchasers in this space were looking at the physical characteristics of a residence and related facilities and amenities. Today, they are looking for “unique, curated experiences,” or “projects that create immersive experiences”. The list of distinctive responses goes on. The buzzwords are all great, but we believe that the developers and the luxury brands with whom they partner, who can actually deliver on this in unique ways that meet the differing expectations of many subgroups of consumers, have the potential for unparalleled growth and success. We are not yet sure ourselves exactly what this means. But it is estimated that in the US the current size of the experiential economy is around $5.2tn (£4tn), and will reach $12tn by 2028. So we will all soon need to learn what an experiential offering means or risk being left behind in the dust of others who have figured it out. Perhaps the best explanation of the concept that we have heard is that it is the creation of communities that bring residents out of their shell to meet and interact and connect with one another and to develop healthy bonds without compromising on their own personal spaces. This seems like a likely and healthy outgrowth of the pandemic. But we also see risk here. The connectivity between developers and the luxury non-lodging brands that put their names on their developments is very transactional, beginning when a branding deal is signed and largely ending on sellout of the project. An Armani residences project or a Dolce & Gabbana residences project will need more than just putting the appropriate trademarks over the front door and maintaining a fancy interior space. Where is the long-term engagement in these relationships that will be needed to first create and thereafter sustain these “experiential” communities if that is indeed where this part of the market is headed? We believe that the long-term success of this part of the market will rise or fall on the answer to this question. More flexibility/escaping the “brand standards” One of the biggest areas of tension between a hotel brand and a branded residences developer often centres on brand standards. The hotel brand will have a book on a shelf with all the rules for developing the project, and the developer will have unique and creative ideas for the project that are not always consistent with what is in the book. Perhaps because it is a newer area of the market, non-lodging brands often can be more flexible than hotel brands. Uniqueness can be valued over consistency – often anathema for hotel brands. Of course, there can sometimes be an unanticipated pitfall in this. While non-lodging brands are often less beholden to brand standards, that does not necessarily mean they are more reasonable or less demanding in areas of design. In some instances, we have found the reverse to be true, with brands otherwise without real estate development or brand experience being more mercurial than most hotel companies. It is important early on to learn as much as you can about your development partner, including from others who have done deals with them. Having a partner that can be flexible and that is known to “play well in the sandbox with others” is often equally as important as having a partner with a flair for detail and design. Fee structures are often more flexible/aligned to developer’s interests Perhaps because they have been doing it successfully for so long, there is increasingly less flexibility in negotiating business terms for branded residences projects with luxury lodging brands. There is also often little flexibility in structuring terms designed to align the interests of the parties. Most lodging brands with strong power in the marketplace will today require a fixed percentage branding fee regardless of the ultimate success of the project. We have found the non-lodging luxury brands will often be much more flexible in this regard and are more likely to tie branding fees to a sliding scale, designed to reward the brand for the actual lift that it provides to the sales prices on residences. Many clients will come to us after they have signed a term sheet and already baked unfavourable business terms into their deal. Counsel should provide much more than just technical legal advice, but also business advice based on what we are seeing in the marketplace. We encourage developers to speak with experienced counsel early on in the process and before broad business terms are agreed to make sure money is not being left on the table. Through the funding lens As an asset class, luxury hotels and branded residences (both hotel-brand and non-hotel brand) are enjoying continued strong interest from investors and lenders, who are attracted to the positive growth in the hotels sector coupled with a relatively low-risk profile compared with other parts of the wider real estate market. Investors and lenders look favourably on luxury hotel brand-managed residences and their long-term approach to the underlying development – but there is also significant interest in financing luxury non-brand residences in gateway cities or destinations where the hotel-brands are already well-represented in the market. In both cases, investors and lenders can readily understand the economic drivers, including typically higher comparable returns in revenue from a long-stay branded residence development driven by premium pricing. They have confidence in the luxury brand appeal and the uptick in value-add that brings to the investment. Those developments that don’t require significant capex spending or refurbishment costs can be particularly attractive to investors and lenders, and that’s often reflected in pricing. It is clear there are multiple considerations to take into account when deciding whether to brand a residences project with either a luxury hotel brand or a luxury non-lodging brand. Whichever route is chosen, this trend for collaboration between luxury brands (whether of a lodging or non-lodging heritage) with the residences market is finding a strong place in the market and brings risks and rewards for all the players in luxury residential real estate projects. Michael Kosmas and Katie Gill are partners in the hotels and leisure practice at Hogan Lovells Image © Adobe Stock