September 01, 2002

Beyond Terrorism and Recession: The Timeshare Industry Looks Ahead (2002, 16:05)

Beyond Terrorism and Recession: The Timeshare Industry Looks Ahead

Probate and Property, September/October 2002, Volume 16, Number 5

By William C. Guthrie

During the week to ten days immediately following September 11, 2001, the prevailing concern of the timeshare industry was the significant decline in the number of vacation travelers.  

During the week to ten days immediately following September 11, 2001, the prevailing concern of the timeshare industry was the significant decline in the number of vacation travelers. Like the hotel and gaming industries, for the timeshare industry fewer travelers means lower occupancy rates, fewer prospective purchasers touring a resort, and therefore lower sales. Based upon both anecdotal evidence and recent studies, however, it is becoming quite clear that the timeshare industry has withstood the blow of September 11 and the recession much better than have the hotel and gaming industries.

Such resilience is not surprising. Historically, the timeshare industry has thrived during recessions. The timeshare industry began in the United States during the recession of the early 1970s. During 1991, the year of the Gulf War, the timeshare industry grew at a 5% rate. Scott Burlingame, After September 11—Where Do We Go From Here?, Vacation Ownership World, Oct. 2001, at 17. During the economic downturn of the early 1990s, the timeshare industry enjoyed a 15% growth rate. Randy Golkin, Lenders See Light at End of Tunnel, Developments, Jan. 2002, at 34. The industry has shown similarly amazing results this time around. Occupancy rates for timeshare resorts, which were hardly affected by the recession, were not nearly so affected by September 11 as was the rest of the lodging industry, and sales of timeshares did not drop as dramatically after September 11 as had been expected. See Ernst & Young, 2002 National Lodging Forecast 14 (2002), available at www.ey.com/global/vault.nsf/US/2002_National_Lodging_Forecast/$file/NLF.pdf.

This article initially examines the business environment that has resulted in a minimal impact from the recession and September 11. Next the article explores some of the business and legal challenges that are currently being addressed by the timeshare industry. The article then addresses the business and legal concerns facing hotel operators and discusses the applicability of these concerns to timeshare operators.

Why So Little Impact?

Several factors explain the ability of the timeshare industry to endure despite events of terrorism and recession.

Self-qualification

The consumer reaction to September 11 has created a “self-qualifying process,” in that the individuals who are traveling rather than canceling their trips appear to be more concerned about vacations and lifestyles than others. Such people are more likely to be a demographic fit for the timeshare product and are more likely to purchase a timeshare.

Values

The events of September 11 forced developers to adopt a different mindset for their marketing strategies, and the psychology of the sale has changed. After September 11, many consumers underwent a process of reevaluating their priorities and values. Developers found that consumers were now particularly responsive to the message that purchasing a timeshare would enable their families to enjoy high-quality vacation experiences for years to come. In response, developers moved away from “hard sell” tactics of the past and successfully redoubled their efforts to focus their sales presentations on these positive aspects of timeshare.

Human Resources

The slowdown forced hospitality companies in general to scale back on operations in order to curtail excess costs. Burlingame, supra, at 17. The labor force was downsized in a form of economic Darwinism in which the weaker performing or higher cost employees were “cut out from the herd.” This left companies in a leaner, more efficient position and better able to deal with the post-September 11 economy. On the sales side, it could be argued that this “trimming of the fat” left higher qualified salespeople who were better able to focus on more qualified tours, which in turn led to higher closing percentages. But because the timeshare resorts maintained significantly higher occupancies than most hotels, management staffs had to be maintained. This bodes well for the future of the industry, as existing qualified employees are retained and qualified applicants are attracted to the industry. The retention of employees also should play well to politicians in the various jurisdictions where the industry is promoting legislative or regulatory changes.

Ownership

During the week following September 11, the timeshare industry experienced an increased level of canceled owner reservations. But this lasted only for a week or two at most resorts. The reason for such a quick return of high occupancy rates is that timeshare owners already have expended money for pre-paid, quality accommodations and leisure vacations. Because timeshare owners already own their accommodations, they are more likely to visit their resorts, whether during a recession or not. Moreover, the vacation location is often familiar, making travel to the destination more probable in uncertain times.

Ownership helps timeshare sales as well. The industry’s best customers for the purchase of new timeshares are its existing owners (numbering 3.2 million in the United States and 5 million worldwide) who already know and enjoy the product. The average timeshare owner owns 1.7 timeshare interests, and one in six timeshare purchases is made by an existing owner. Yesawich, Pepperdine & Brown, Future Timeshare Buyers: 2001 Market Profile 5 (2001), abbreviated version available at www.resortdeveloper.com/home/market_profile.htm. These numbers continue to increase. Despite the negative sentiment about the way the product was historically sold, the industry maintains an 85% to 90% satisfaction rate. This high satisfaction rate also tends to generate a high volume (at a low cost) of sales from owner referrals. After September 11, developers have placed an even higher emphasis on owner satisfaction and owner referrals.

Lack of Dependency on Business Travel

The segment of the travel industry that was hardest hit by the terrorist attacks of September 11, and also the recession, was the business travel segment. According to a recent report, three out of ten business travelers plan to take fewer business trips in 2002. D.K. Shifflet & Assoc., Ltd., USA Travel Recovery Monitor: A Blueprint for Rebuilding Travel 13 (2002). The timeshare industry, however, is not dependent on business travel, so the effects of decreased travel in that segment did not affect the timeshare industry as drastically as it did the hotel industry.

Management

The owners’ associations and management companies that operate timeshare resorts are not so dependent on rental revenues as are other types of lodgings. Instead, timeshare owners pay maintenance fees that include fees for the management of the resorts. This factor further fosters the “it’s paid for” mentality and enabled timeshare resorts to operate at the same standards after September 11 as prevailed pre-September 11.

Challenges Still to Be Faced

Despite the timeshare industry’s ability to endure, the recession and September 11 still had negative effects, and the industry still has its challenges. Growth in 2002 is expected to slow to the 6% to 8% range from the 15% annual growth rate that the industry experienced in the 1990s. Golkin, supra, at 34. There are several reasons for reduced growth; numerous challenges are to be faced, as discussed below.

Access to Capital

The industry historically has had a small number of lenders that were in the business of lending to timeshare developers and associations. After the largest such lender, The Finova Group, Inc., declared bankruptcy in March 2001, this number dwindled further. Without Finova writing new loans, Heller Financial and Textron, two of the most prominent industry lenders, faced significantly increased demand from borrowers. This reduced competition permits these companies to be more particular in their lending practices, principally providing loans to existing developers in markets with successful track records, and offering loan agreements with additional covenants and restrictions, increased discount rates, and lower loan-to-value thresholds. The bankruptcy of Sunterra Corporation, one of the largest timeshare developers, caused potential lenders to reconsider their entry into the market and eliminated them for the time being as a source of capital. Many lenders, painting with a broad brush, viewed timeshare loans the same as other components of the hospitality industry and shied away from lending to timeshare developers.

Although some developers and associations may still be able to obtain loans from smaller lending institutions or brokers, the access to capital dwindled dramatically. The lending situation was particularly a problem for independent developers without a brand behind them. The situation has recently begun to improve with the entrance of several new lenders into the industry.

Brands/Public Hotel Companies

For the large hospitality brands, the problems were different. Despite how well-positioned the industry is in these market conditions, the mindset at many hotel companies was to cut back on operations, cut costs, and not spend capital. Cuts were ordered across all segments of the companies’ divisions, including timeshare. Many of these companies put development of new timeshare resorts on hold.

Receivables Performance

Typically in the timeshare industry, developers provide purchase money financing to purchasers. The profit that a developer can earn on the spread between the developer’s cost of capital and the interest rate charged to consumers can be as much as 50% of a developer’s total profit. Throughout 2001, developers and their receivables/hypothecation lenders were noticing a slight increase in the default rate of receivables. Developers who had miscalculated and under-reserved for a potential increase were forced to refinance their loans. After September 11, in the short term, revenues derived from collections on the receivables financing dropped (the drop may also have been partly a result of the problems with mail delivery in September and October). Although collections were back to normal by the end of 2001, lenders have altered basic loan agreements to require delinquency reports and static pool reports from servicing agents to permit lenders to analyze and manage their portfolios. Lenders have also increasingly focused on the developer’s sales and marketing costs and demanded that significant steps be taken to reduce these costs.

September 11 raised a dormant legal issue for lenders providing purchase money financing. A purchaser who is called to service in a National Guard unit, in a U.S. reserve unit, or as an active armed forces member, has special rights under the Soldiers & Sailors Civil Relief Act of 1940. 50 U.S.C.S. Appx. § 501 et seq. (2002). This act grants persons in active military service certain procedural and substantive protections for obligations entered into before active service. For instance, financial obligations may not bear interest in excess of 6% per year during such service. Id. § 526. In an industry with interest rates typically between 12% and 18%, such a reduction is significant. The Act also includes restrictions against the developer’s/lender’s exercise of recission and termination rights under installment contracts and against the foreclosure of mortgaged property during military service or three months thereafter. Id. §§ 531, 532.

Insurance Costs and Related Issues

Many insurance companies significantly increased the cost of insurance as a result of September 11. Throughout the industry, associations have received notice of significant increases in insurance premiums for 2002, resulting in higher operating costs for their resorts. Ernst & Young expects that insurance premiums may increase up to 50% in 2002. Ernst & Young , supra, at 11. Furthermore, developers, management companies, and associations must contend with insurance companies’ revamping their policies so that the clauses of the contract that exclude acts of war from coverage also exclude terrorist acts. Given the lack of availability of certain insurance, increased premiums, and increased deductibles, counsel for the timeshare developer and management company must look closely at the provisions of loan agreements and management contracts to ascertain whether the insurance provisions are being violated. Counsel for the owners’ association and management company should also consider recommending that the association maintain a reserve for payment of the larger deductibles.

Destinations Dependent on Air Travel

Immediately following September 11, there was a decided lack of desire to travel by the public. As time has passed, the public’s willingness to travel has increased. Studies have shown, however, that individuals are more likely to take vacations closer to home and would prefer to drive rather than fly. See Yesawich, Pepperdine & Brown, supra, at 9. Although many developers of regional “drive-to” resorts have seen their numbers increase, markets dependent on air travel, such as Hawaii and the Caribbean, have faced a much harder time. Moreover, reduced travel may continue for some time in destination markets given that the airlines have cut back on available flights to meet reduced demand. The disparity in the markets will lessen as airline travel increases, provided that the costs of flying, in terms of time and money, do not increase disproportionately.

Labor Issues

The call-up of National Guard units after September 11 to assist in the war on terrorism has caused employers in all industries to examine their obligations to provide leave, reinstatement, and other benefits to certain employees serving in the uniformed services. The Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA), 38 U.S.C. §§ 4301-4333 (1994) (which amended the Veterans Reemployment Rights Act (VRRA)), protects veterans and members of reserve units from adverse employment consequences as a result of service obligations. Attorneys representing developers, associations, and management companies should understand the responsibilities imposed by both USERRA and its predecessor VRRA on their employees who may be affected.

Legal counsel should also note that some of the same labor issues raised in Stephen Barth and San San Lee’s article , Threats of Terrorism: Practical Implications for Day-to-Day Hospitality Operations (see page 43 of this issue), apply to the timeshare industry as well. Employee selection processes need to be examined in light of the potential for negligent hiring liability. Any background checks must comply with the Fair Credit Reporting Act, and consent of the potential employee must be obtained.

Regulations promulgated by the Occupational Safety and Health Administration (OSHA) require employers to have in place an evacuation and fire protection plan. These procedures should take into account the possibility of terrorist threats. Procedures should be established and publicized for reporting suspicious behavior and handling suspicious packages. Legal counsel may wish to examine the underlying regime documents and consider amending them to include specific provisions governing what happens if a resort is evacuated or damaged as a result of terrorism. Similar provisions were included in documents after several resorts were affected by hurricanes (usually after the event had taken place and the need for the provisions realized).

Hotel Operations

In addition to providing accommodations for timeshare owners, timeshare resorts run a rental/hotel operation from unsold or unreserved rooms. The lower number of travelers and corresponding diminished occupancy rates affected this aspect of the timeshare business, resulting in lower cash flows. Reduced rentals can be particularly significant to a developer with a large number of unsold interests. Again, some of the issues discussed in Threats of Terrorism (see page 43) can be examined for the timeshare industry. For example, bailment issues will generally not be a concern at most timeshare resorts, as valet parking and luggage services are not generally provided, but the high-end resorts that do provide these services will need to look at these issues. The issues related to access to rooms and guest records for hotel guests will be largely the same; however, these issues need to be carefully examined for timeshare resorts in light of the fact that timeshare owners, as owners of the property, will likely have even more legal protections than business invitees. In addition to constitutional right-to-privacy concerns, legal counsel should examine state timeshare statutes that protect the privacy of timeshare owners as well.

Looking Ahead

The industry is poised to take advantage of the economic recovery that appears to be on the horizon, and many observers expect timeshare to lead the hospitality industry out of its slump. Americans’ concern over the economy and terrorism significantly decreased during January 2002. D.K. Shifflet & Assoc., Ltd., supra, at 5. The pace of recovery will depend on the state of the economy, consumer confidence in travel, air capacity, and the scope and length of military action. Ernst & Young , supra, at 13.

Similar to what occurred in the 1970s, it is likely that many hotels that are currently suffering will be converted, at least partially, to timeshare. For new projects, mixed use projects that include a timeshare component will continue significantly to increase. Consolidation in the industry will continue as the smaller, independent developers that are being affected the most are subsumed within larger companies. Developers may find borrowing increasingly difficult in the short term and refinancings/workouts may increase if the recession lingers. Given the circumstances, however, the industry appears to be in a very favorable position.


William C. Guthrie is a partner in the Orlando office of Baker & Hostetler LLP.