Industry Trends and the Future of Fractional Residence Clubs

By Wallace Hobson CRE
Hobson Real Estate Advisors, Formerly Hobson Ferrarini Associates
www.hobsonferrarini.com

Author Profile
Wallace Hobson is a real estate advisor and President of Hobson Real Estate Advisors in Portland, Oregon. He is a member of the Counselors of Real Estate and specializes in the resort industry. Mr. Hobson is a leading international expert in private residence clubs, having completed more than sixty feasibility and business planning assignments for Residence Clubs throughout the world.

Within the resort industry there is confusion and misuse of the term "fractional," which most commonly refers to residence clubs or private residence clubs. A fractional is a general term that depicts any type of fee simple home ownership with multiple owners.

There are three different types of fractional products. The first is timeshare vacation clubs selling fixed weeks. Second, there are a variety of fractional rental products at varying price points and densities. Much of the purchase incentive is rental income through a managed rental pool. More recently, large condominium hotels have begun to sell individual units to multiple owners, primarily one-quarter fractions.

Residence clubs are the newest entry into the fractional ownership arena. The majority of the residence clubs on the market today are five-star quality with hefty purchase prices, often exceeding $300,000 for a one-eighth share. Fraction size generally varies from 1/6th to 1/12th. Members receive three to eight guaranteed weeks, depending on the fraction size. About 20 to 30 percent of the weeks are open access or float time. Members have the opportunity to supplement their guaranteed time with open access time at no additional cost. These additional days are an attractive marketing tool that creates a use structure more similar to whole ownership.

Residence club homes tend to be large, usually with three or four bedrooms. Building types vary from a dense hotel type of structure to detached single-family homes. Hotel concierge services are provided.

Members interact and form social relationships much like a private golf country club. Privacy, privilege, exclusivity, and a sense of belonging are important attributes of the experience. The market is affluent and sophisticated and is seeking an alternative to a wholly owned second home. With a residence club you only buy what you can use. Rental income is not a factor in the purchase decision.

The luxury residence club industry is in its infancy. Currently there are only about 24 projects completed or under construction. These projects total 860 units, an average of 36 units per project. The majority, (58%) are in ski areas, and 37 percent of the total are in Colorado ski areas. However, the concept is spreading rapidly to other areas of the U.S, Canada, the Caribbean, Mexico and other global resort destinations. Ritz-Carlton dominates the market with four projects totaling 274 units and a market share estimated at somewhere between 40 and 50 percent.

A residence club is an emotional purchase, like a primary or second home. Affluent buyers are focused on the size, the quality of the design and finishes, and the use program. Price is secondary. Markets must be carefully defined and targeted. A shotgun approach will have disastrous results.

The depth of the market for residence clubs has yet to be determined and market penetration has been insignificant. Financing has been a severe constraint on the supply. This constraint on supply has had positive effects on the residence club industry by preventing overbuilding.

Approximately 70 to 80 percent of income qualified U.S. households do not own a second home or timeshare. Thus, if one were to assume even a modest 1 to 2 percent penetration of these households every year, the demand in relation to the current supply is staggering.

With the exception of Ritz-Carlton, residence club sales in general began slowing in the second quarter of 2001 after the resort boom of the late 90's. This trend continued through the balance of 2001 and bottomed towards the end of 2002. There has been a strong resurgence in 2003, in parallel with the recovery of the U.S. economy and greater consumer confidence. However, there are some resort locations that have yet to experience better times.

There are many factors that determine the profitability and level of success of a residence club. The most important is the location. Residence clubs will not work anywhere. Locations where land scarcity drives real estate prices extraordinarily high, where a difficult entitlement process limits competition, and where the wealthy congregate, make the best venues for a residence club. The site should also be located on a major amenity like a golf course, a beach, some other large body of water, or a ski-in/ski-out site in a national ski area.

A second success factor is a product design appropriate for the target market. This usually means homes that are at least as expensive and large as new comparable whole ownership real estate in the area. Density and the size and number of the buildings will be driven by the land cost.

There have been some failures in the market. Problems in most cases are attributable to the economy. However, other mistakes include various combinations of an inappropriate location and/or poor execution with respect to product design, pricing, usage programs, and marketing and sales plans and strategies.

The residence club industry is changing and evolving rapidly. As more projects come on line, the product, pricing, and marketing strategies become more refined and effective.

Expect to see a growing inventory of urban fractional residence clubs. The Phillips Club in New York City is the pioneer. There are currently planned urban fractionals in Miami, San Francisco, London, Paris, and other major metropolitan areas. The markets are large and include repeat business travelers as well as urban tourists.

With the exception of Ritz-Carlton, most of the fractional residence clubs have been developed by individual entrepreneurs on free standing sites. Residence clubs are now getting the attention of major resort development companies. A fractional residence club as a component of a large mixed use destination resort diversifies the market and increases absorption and profitability.

In summary, the future of the luxury residence club is assured and residence clubs will occupy an increasingly important place in the resort industry. Changes will continue at a rapid pace as the industry matures. Residence clubs will gain market share against whole ownership because shared ownership is more practical for the majority of American households. The industry will become increasingly competitive as industry sales grow and as major corporations enter the market with there own sources of financing.