Why It's a Bad Idea to Invest in Luxury Real Estate (from WSJ.com)
ANGUILLA, British West Indies -- Robert Sillerman amassed a
billion-dollar fortune buying and selling media and entertainment
companies. Among his most successful deals: the purchase of television
franchise "American Idol."
on this tiny Caribbean island. His luxury hotel, condominium and golf resort here, Temenos,
languishes half-built and out of money. "American Idol" creator Simon
Fuller and novelist Dan Brown, among others, have put down deposits on
million-dollar villas. It's not clear when or if their vacation homes
will be completed. For some ultrawealthy Americans like Mr. Sillerman, trophy hotel
investments made during the real-estate boom have turned into major
burdens."I do feel remorseful, and I do feel regret," Mr. Sillerman
said in an interview at his Manhattan office. He said he no longer
expects to recoup the $180 million he personally invested in Temenos.
"I think that I exhibited an element of hubris," he said. Resort
development "was not my area of expertise by any stretch of the
imagination." Some newly opened properties aren't generating enough cash to cover
operating expenses. Construction of others is being halted as lenders
and investors pull out. During the first nine months of the year,
developers postponed or canceled 43 luxury hotels totaling about 9,300
rooms in the U.S. and the Caribbean, according to research firm
Lodging Econometrics. While veteran hoteliers are accustomed to booms and busts, the
newcomers are getting a sobering lesson in the risks of owning and
developing high-end lodging, which has been hit hard by the
real-estate bust. An investment group headed by Dell Inc. founder Michael Dell teamed
with Rockpoint Capital LLC to acquire the Four Seasons Hualalai in
Hawaii in 2006. Since then, the 243-room hotel's annual cash flow has
fallen to $7.9 million, from $20.6 million, and its occupancy rate
declined by 33 percentage points to 54%, loan documents indicate. A
hotel executive says part of the decline was due to a renovation that
temporarily closed some rooms. Ty Warner, the Beanie Baby mogul, might lose his slumping Four Seasons
New York and three other luxury hotels to foreclosure unless he can
land a one-year extension on the properties' $345 million securitized
mortgage, which comes due Jan. 9, according to credit-rating company
Realpoint LLC. Microsoft Corp. founder Bill Gates has run into several problems on
the hotel front. In 2007, his personal investment company teamed with
Saudi Prince Alwaleed bin Talal to acquire Four Seasons Hotels &
Resorts, which manages 82 luxury properties, for $3.4 billion. Since
then, revenue per available room at those properties is down 25%. In
addition, his investment company is foreclosing on the 582-room
Terranea Resort in Palos Verdes, Calif., which defaulted on a $110
million loan from Mr. Gates's firm shortly after opening in June. EBay Inc. founder Pierre Omidyar is a major investor in Montage Hotels
& Resorts, which owns two luxury hotels in California and one about to
open in Utah. At its new Beverly Hills boutique hotel, occupancy is
running about 60%, and only four of its 20 residences have sold so
far. Wealthy investors sometimes view high-end hotels and resorts as a way
to highlight their personal approaches to luxury living, says Jim
Taylor, vice chairman of the Harrison Group in Waterbury, Conn., which
tracks the spending and investing habits of the wealthy. "It's a
business...where they'd have a distinctive idea of what works," he
says. "There's also ego value in ownership of a hotel."Years ago, most
large hotels and resorts were owned by companies such as Hilton
Worldwide Inc. and Marriott International Inc. But in the late 1980s,
the big hotel companies began selling off their properties to focus on
managing and operating hotels owned by others. The industry is now in a major slump. Since 2007, revenue per
available room at North American luxury hotels, including in the
Caribbean, dropped 26%, to an average of $141.58, according to Smith
Travel Research. That compares with an 18% decline to $56.53 for all
U.S. hotels. This year, occupancy rates at North American luxury
resorts have declined 10 percentage points to 60.3%, outpacing the
eight-point slide for all North American hotels, according to Smith
Travel. Potentially making matters worse, luxury hotels begun in the final
years of the boom are now being completed, adding to the supply. "I
think we're looking at seven to 10 years before luxury can get back to
where it used to be," says Bjorn Hanson, an associate professor of
lodging at New York University. Mr. Sillerman also has problems in Las Vegas, where one of his
companies bought 18 acres on the Strip to build a casino-hotel. The
project never got started, its $475 million mortgage is in default,
and the land is slated to be auctioned as part of a prepackaged
bankruptcy filing. Mr. Sillerman, a New York native, started buying radio stations in the
1970s, teaming up on some deals with disc jockey "Cousin Brucie"
Morrow. Over the next two decades, he bought many radio and television
stations. In 1998, he sold his 120-station company, SFX Broadcasting,
to Capstar Broadcasting Corp. for $1.2 billion. "It's hard to script
anything that went better than SFX Broadcasting," he says.Prior to
diving into the hotel industry, Mr. Sillerman had a sterling track
record building businesses and selling them. A slender, balding
61-year-old with a thick mustache, he speaks in a halting rasp due to
a battle with cancer in 2001. He then began expanding a business that bought concert venues and
music-promotion companies, betting that greater scale would give him
more clout in booking pop and rock musicians. He sold that company,
SFX Entertainment, to Clear Channel Communications Inc. in 2000 for $3
billion. He even had good luck on Broadway. After meeting entertainer Mel
Brooks in 1998, Mr. Sillerman agreed to chip in $2 million to help
finance Mr. Brooks's "The Producers." The musical went on to become
one of the highest-grossing productions in decades. Mr. Sillerman formed his latest venture, CKx Inc., in 2004. It spent
$100 million for an 85% stake in Elvis Presley Enterprises, which
includes management of Graceland, the late singer's Memphis, Tenn.,
estate. He bought the marketing rights to boxer Muhammad Ali's name.
In 2005, after the third season of "American Idol," CKx bought 19
Entertainment, producer of that hit program and the dance-competition
show "So You Think You Can Dance," for $190 million. Its shows and
related business lines generated $224 million in revenue and $75
million in operating income for CKx in 2008, the company reports. Jonathan Knee, a former banker at Goldman Sachs Group and Morgan
Stanley who has negotiated with Mr. Sillerman, says the investor has
an "incredible instinct for good business" and always was careful not
to let star power influence entertainment-business decisions. "My
guess is real estate is an area that requires some industry-specific
knowledge," Mr. Knee says. "And I'm not aware that that was Bob's
particular expertise." Mr. Sillerman first set foot on Anguilla in 1982, and over the years,
visited often, completing a home there in 2007. The island -- a small,
flat area of limestone, coral and scrub vegetation -- has a population
of only 14,000. Its pristine beaches and coral reefs don't draw as
many tourists as other Caribbean islands. Anguilla's government has positioned the island as a destination for
wealthy vacationers, restricting the size of resorts to little more
than 150 hotel rooms. A handful of luxury retreats dominate the
tourist trade, including the 102-unit CuisinArt Resort & Spa opened in
1999 by Leandro Rizzuto, owner of the Cuisinart and Conair Corp.
home-goods brands. In 2002, Mr. Sillerman proposed to Anguilla's government that he build
the island's first golf course. Anguillan Chief Minister Osbourne
Fleming suggested that Mr. Sillerman build a five-star resort to
accompany the course. The politician envisioned the resort providing
500 permanent jobs and hundreds of construction jobs. He committed to
waive taxes on imported furnishings and building materials for the
hotel. Mr. Sillerman pitched the idea to Flag Luxury Properties LLC, a hotel
developer in which he is an investor. Flag Chief Executive Paul
Kanavos warned him that hotel development in the Caribbean is risky,
often hinging on the whims of local governments, recalls Mr.
Sillerman. In addition, since most building materials and labor have
to be imported, developments in the Caribbean often take twice as long
to build and cost at least 30% more than in the U.S. Messrs. Sillerman and Kanavos decided to proceed despite the risks. "I
guess it was a combination of wanting to do even more for the island
and believing it would be a productive investment," Mr. Sillerman
says. Mr. Fleming's government cobbled together 200 acres to lease for
Temenos and its golf course, and Flag purchased an additional 80
acres. Construction started in 2005. Some of the 78 planned villas and
estate homes sold to Mr. Sillerman's friends and associates, including
to Mr. Fuller, the "American Idol" creator, and Mr. Brown, author of
"The Da Vinci Code." According to Flag, by last year, three-quarters
of the units were under contract, with buyers paying deposits of up to
30%. The golf course and clubhouse opened in 2007. The developers planned a 32-unit hotel, to be run by Starwood Hotels &
Resorts Worldwide's St. Regis brand, with nightly rates from $900 to
$1,500. Temenos -- a Greek word meaning sanctuary -- was soon beset with
problems. Fuel and freight costs rose sharply during construction.
Building-material costs rose by 30% from 2005 to 2007, says Flag's Mr.
Kanavos. Anguilla had stipulated that first consideration for construction jobs
go to Anguillans. Mr. Kanavos says that requirement led to labor
shortages and inefficiencies, which produced delays. Flag didn't get
the government's permission to import workers until two years after
construction began, he says. Anguilla also required that construction
equipment be leased from local companies, which Mr. Kanavos says added
millions of dollars to costs. Mr. Fleming, Anguilla's chief minister, denied in an interview that
government construction guidelines had led to the cost overruns.
"There were deficiencies" in Flag's planning, he said, declining to
elaborate. Flag officials note that the company has completed
construction of several U.S. resorts on time and on budget. St. Regis, the Starwood Hotels brand, demanded an expansion of the
resort's manor house, slowing development further. St. Regis pulled
out of the project in November 2007, and was replaced last year by
Baccarat Hotels & Residences, a luxury-hotel brand launched by Barry
Sternlicht, Starwood's former chief executive. With costs mounting, Flag turned to Mr. Sillerman repeatedly to
contribute more capital, asking for $5 million to $10 million each
time. Mr. Sillerman says he met many of the requests, but eventually
stopped. "I had to adopt a more objective approach to it," he says.
"It seemed like there was no end to the requests, and the best choice
was to reorganize" by seeking outside investors. Mr. Sternlicht's Baccarat pulled out, citing the project's failure to
land additional financing. Mr. Sternlicht sued Mr. Sillerman in New
York state court in June, seeking to recoup $25 million his company
invested. Mr. Sillerman denies that he owes that money. Recently, Mr. Sillerman paid $21.4 million to satisfy a personal
guarantee on the resort's $180 million mortgage, which is in default,
adding to the $180 million he already has sunk into it. The golf course, designed by Greg Norman, has closed. Flag estimates
that up to $120 million more is needed to complete construction of the
resort. But after more than a year of searching, Flag and Mr.
Sillerman haven't yet found new backers. With the project stalled, it hasn't produced the expected local jobs
and tax revenue. That contributed to Anguilla's need to make spending
cuts such as reducing government salaries by 5% to 15%, Mr. Fleming
says. "That project was the most important project Anguilla ever had," Mr.
Fleming says. "Every person in Anguilla has been affected negatively
by its nonperforming." Mr. Sillerman says Temenos eventually will be completed. "I'd like to
get it finished, more for the villa owners and the people of
Anguilla," he says. "I've long since written off any possibility of
getting my money back."
