This post was written by Joe Marger and Leah Speckhard
The Supreme Court’s refusal in February 2014 to hear the real estate driven Ninth Circuit case, Salameh v. Tarsadia, provided Condo-hotel owners and developers with relatively clear guidelines on how to avoid securities issues and/or litigation when selling Condominium units. The determination of what constitutes a real estate investment versus a security investment were laid out in the Ninth Circuit’s decision, and that court’s analysis was left standing as legal precedent by the Supreme Court.
To bolster the argument that the sale of a unit at a hotel-condo real estate development project is not and should not be treated as a sale of a security, consider these factors:
- Timing: Make sure that if a rental management agreement is signed, it is done so well after the sale. The court’s ruling found that the 8-15 month gap between buyers signing the sale agreement and the management agreement made it clear that the two were separate transactions, and therefore not a security.
- Entities: Use separate entities to sign the sale agreement and any rental management agreement. Even if the two entities are related, this will help distinguish the transactions. Marketing Materials: Make sure that marketing materials do not treat the property as a money-making investment. Marketing materials should also avoid mentioning any rental management agreements. If they do, the sale and management could be treated as an investment-like package – making them a security. It’s important that buyers are not incentivized to buy because of the offer of any upcoming management agreement, even if there is a gap between the two.
- Personal Use: Emphasize that the properties are being sold for personal use: if so, they cannot be treated as securities.
- Limits on Disclosure: Of course, one should never willingly mislead buyers. However, the court found that an owner or developer is not required to make buyers aware of all items that may affect the value of the purchase. In this case, the court ruled that although zoning regulations kept buyers from living in their condos more than 28 days per year, that did not necessarily mean that buyers were forced to rent out their apartments for the rest of the year (again, making the sale one of personal use, and not a security).
Hopefully, this decision will allow developers of mixed use hotel-condo properties to invest with more confidence, simply by following these straightforward strategies to avoiding problems with the U.S. Securities and Exchange Commission.