Wading through current condotel entanglements

Investors and buyers will be much aided through more stringent regulations regarding the condotel segment

Over the past couple of years, we have witnessed the identification and attempts to solve the condotel issue in Vietnam with limited success.

There has been confusion over the term “condotel” and what it really means in practice.

Kevin B. Hawkins, co-executive partner from Zico Law Vietnam

The prime minister issued a directive in April 2019, charging various ministries with developing clear regulations and procedures with respect to the condotel market, urging the resolution of the condotel issue by the third quarter of last year.

However, we still do not have any clear guidelines. Unfortunately, the situation has actually become worse. Developers have seen projects stall, condotel sales have dropped considerably, and buyers are seeing their promised revenue streams evaporate as developers renege on their promises to pay 10 per cent (or more) per annum. These buyers then face even more hardships trying to make mortgage payments based on the expectation of such income. Serious problems require a serious call to action.

I will set out five potential actions to help unravel this tangle and move forward. These actions are by no means exhaustive and not all of these are legal measures – some are just practical steps – but all require some measure of political will and public fortitude in order help solve the condotel problem.

What’s in a name?

For condotels, the short answer is “everything:”

Condotels are commonly thought to refer to the combination of condominium and hotel. The problem here is that while a condominium is often thought to refer to a titled property, a hotel is a hospitality service provider.

The simplicity of this definition underscores the inherent problem of how it should be regulated – as a property interest or as an investment in the hospitality sector.

A specific law, or even a government decree, needs to define condotels and delineate it and other similar investments such that condotels only refer to actual titled properties within a resort project that also has the right to sell residential housing.

For all other cases where the resort/hotel only has a service licence and therefore limited operations period (for example 50 years), these should be “non-condotel” investments.

These may be referred to as investment participation properties (IPP) and could include: (a) membership in hotel clubs which provides the buyer the right to use a condo or villa in a resort for a certain number of days each year; (b) usage rights attached to a specific condo/villa in a resort with a share in the revenue stream of the condo/villa; and (c) long-term lease of a condo/villa in a resort with the investor receiving a revenue stream from the rental income from placing the unit in the hotel’s rental pool (essentially, a sub-lease).

Note that the third option is not available to foreign investors, who would not have the right to sub-lease such a lease agreement. Legislation that would make this distinction clear may help to resolve the confusion and improper use of this term to the detriment of both buyers and developers.

Full disclosure of the investment and the rights and obligations of buyers and developers will ensure a more efficient market for both condotel and IPP products.

A condotel is not a camel

There is a familiar aphorism that a camel is just a horse designed by a committee, criticising the process by which inputs from various committee members result in an awkward, ungainly, and possibly ugly creature compared to the intended sleek, agile, and beautiful stallion that we might find adorning the hood of a Ferrari.

Although the prime minister’s directive issued last April was well intended, it assigned ministries various obligations to resolve the issue.

The Ministry of Construction (MoC) was supposed to provide “amendments to regulations and standards for construction”, the Ministry of Natural Resources and Environment (MoNRE) was charged with “amending the land use regime” and issuing land use right certificates for properties like condotels, and the Ministry of Culture, Sports and Tourism (MCST) was directed to “promulgate regulations on the sale and management of condotels”, with the MoC taking the lead in co-ordinating and “urging and checking the implementation” of the prime minister’s directive. With this combination of authorities, each vying to have input into the final result, it is no surprise that the third quarter of 2019 deadline went past without any final solution.

It may be that the government or the National Assembly need to elevate this issue for it to be resolved with a law or decree that will specifically detail a framework for condotels and other IPPs, and assign relevant authorities with responsibilities for their respective obligations, for example the MoNRE for condotels and the MCST for IPPs. Only with a clear delineation of supervisory responsibilities will this market move forward with better regulation.

Unrealistic expectations

If it sounds too good to be true, it probably is. It is often alluring to see advertisements for condotel projects where the developer is offering “guaranteed” annual returns of 10 per cent or more.

For most investors, this return on investment within 10 years while still retaining rights to the underlying asset property seems very attractive. If the investor can obtain bank financing for rates under the promised return then this is truly a win-win investment.

The problem here is that these promised returns are not really guaranteed and are contractual obligations, which may be difficult to actually enforce if necessary.

The recent case of Cocobay Danang is a prime example, where the developer has already reneged on its obligation to make such payments to buyers. This case is occurring with other developers who over-promised to entice buyers and now cannot pay these returns. This has had a chilling effect on the market with buyers losing trust and developers then unable to sell units.

Developers need to restore trust in the process. Before the Law on Real Estate Business (REB) came into effect in 2015, there was a loss of confidence in the apartment construction sector.

Apartments were being sold off the plan, before certain construction milestones had been achieved and there was no guarantee for the amounts advanced by buyers to developers. Projects went unfinished and developers absconded with advance payments.

Aside from required construction milestones, Article 56 of the REB law requires that developers obtain a bank guarantee for the amounts paid in advance by buyers. If the developer cannot complete the project, then the bank guarantee could be drawn upon to return the funds to the buyers.

If such a bank guarantee obligation was included in the law/decree to regulate condotels and IPPs supporting the promised returns to investors then there should be renewed confidence in the process. However, the cost of such a measure may be difficult for developers to shoulder, who may need to reconsider both the rates of returns and the period for payments. Restoring confidence and trust is essential to moving the market forward.

The anecdotal accounts from condotel investors all seem to have the same thread: the investor relied upon the promised guaranteed returns from the developer in order to finance the purchase with a mortgage.

Once the developer cancelled the expected revenue stream, the investor is no longer able to afford mortgage payments and is liable to the bank for the borrowed amount. This is because Vietnam’s civil law allows for such mortgage obligations to be a full recourse against the borrower, as per articles 305(3) and 307(3) of the Civil Code 2015.

This is different from mortgages in most western countries, which are non-recourse, and only allow the bank to step in and satisfy the loan obligation by selling the property asset.

For the IPP cases mentioned, where the bank is not taking an interest in the underlying property but rather on the promised income return from the developer, this financing could be considered. With the suggested bank guarantee obligation to be included in a revised law, there should be little risk for the banks to lend on such basis.

It may not be common for many property buyers in Vietnam to engage legal counsel to review their documentation and advise them of the risks and obligations.

However, just because a famous football player endorses a particular project as a great place to live should not be the basis of a significant financial investment. Buyers should alter their practice and factor-in the relatively small cost of having their investment and documents reviewed by a lawyer before entering into any firm commitment.

Dialogue needs to move forward and legislation needs to be put in place to regulate the market and restore confidence of buyers and developers alike.