Purchases of so-called "condotel" units — rooms in hotels that are sold individually to buyers who typically continue renting them to vacationers — have dramatically multiplied in the last few years with close to 2,000 sold. The Ala Moana Hotel became the most recent convert last week, announcing it would add its 1,150 rooms to the condotel market.

Hotel owners have found that selling a property one room at a time can increase their profit, and buyers are responding to the offerings in rushes.

But are condotels a smart investment?

They can be if a buyer understands the costs of ownership — including management fees and maintenance costs — and has a good estimate of the revenue a room is capable of earning.

A major challenge lies in calculating potential income. Rental rates and occupancy can rise and fall with the unpredictable nature of the state's visitor market — uncertainties that make condotel investing inherently speculative.

Condotel brokers and managers say buyers typically don't research potential financial returns in depth before buying.

"People look at it as a real-estate play first," said Mike Paulin, managing director of local condotel management firm Aqua Hotels & Resorts. "Then they realize, 'I own the property. What kind of cash can I get out of it?' "

Paulin said buyers might start asking about room rates and occupancy about two weeks before purchases are final. But most don't.

Prices affordable

Demand is surging for condotels in Hawai'i in part because of strong tourism, low interest rates, an expectation that rooms will appreciate in value and because prices for a furnished hotel room can be half that of a larger residential condo with parking and a full kitchen.

"It was an affordable way for me to (own) another property in Hawai'i," said Metzker, who also owns a home in Kaimuki. "I'm a novice at all this, (but) I know real estate in Hawai'i is a good investment."

Hawai'i, particularly Waikiki, is one of two epicenters of the recent condotel trend, along with South Florida. The trend is now making its way to other tourist markets, including Las Vegas and parts of California.

Condotels often appeal to frequent visitors such as Bob and Barb Bruder, who said having a place would make trips to Hawai'i easier.

What has been selling recently in Waikiki are mostly renovated small studio units without kitchens or parking that make them generally unsuitable for long-term living. Some conversions are combining rooms or entire floors into bigger suites, while others include kitchens and parking.

Industry followers credit the Diamond Head Beach Hotel conversion in 2001 with kicking off the recent hotel-to-condotel conversions that include the Ohana Ala Wai Towers, Aston Waikiki Beachside, Aston Waikiki Parkside, Bamboo Hotel, Kaua'i's Islander on the Beach, part of the Royal Garden at Waikiki, part of the Hawaiian Monarch Hotel and part of Kuhio Village.

Condotel units have proven popular among airline employees who make frequent visits, frequent vacationers and parents seeking dorm rooms for their children.

Others are out for the potential financial gain. Some speculate they can resell their unit for more. Others seek rental income and perhaps occasional personal use.

Potential payoff

Condotel brokers and managers said buyers are more or less evenly split between local and Mainland residents.

Hawai'i residents sometimes buy a unit so they have a room when they're in town and rental income when they're not.

Calculating potential financial return is difficult. Sales agents cannot discuss occupancy, rental rates or otherwise make representations as to potential investment returns. A sales agent who even suggests what income a condotel may generate could be violating laws governing regulated securities.

Hotel management companies also closely guard or highly qualify room data.

John Ferguson, a San Diego real estate broker and apartment building investor, said he was surprised at the lack of detailed rental rate and occupancy information he could find after he bought two rooms above Metzker's unit in the former Waikiki Terrace last summer. "I was a little apprehensive about that," he said. "I didn't know much about (condotels)."

The best Ferguson said he could do was refer to published reports on average room occupancy and rental rates from a survey of many unidentified Waikiki hotels.

Ferguson paid $150,000 each for his two studio units in what's now called the Outrigger Luana Waikiki between Kalakaua Avenue and Fort DeRussy, and signed up with Outrigger Hotels & Resorts to manage his units in return for 50 percent of room revenues.

The real estate investor said he figured he needed 72 percent to 74 percent occupancy to break even, or about $1,100 a month per unit. In July, as his purchase closed, average occupancy hit a statewide record, reaching 90 percent in Waikiki.

But before Ferguson saw any rent checks, someone offered to buy his rooms for $250,000 each — a combined $200,000 gain that he seized.

Afterward, Ferguson said he was stunned when he saw the first revenue checks from Outrigger that were about $1,800 apiece, earning him a $1,400 profit in one month. "It was quite phenomenal," he said. "I thought, 'Man, I should have kept them.' "

So Ferguson bought three more at Kapa'a's Islander on the Beach and four at the Waikiki Parkside now known as the Palms at Waikiki in deals expected to close soon. He also said he'd like to buy 10 or 20 units at the Ala Moana Hotel.

At least a dozen other original Luana buyers sold their rooms last year for gains between $63,000 and $100,000, property records show. Three one-bedroom Luana units were on the market last week for $500,000 to $590,000 each.

The combination of high occupancy rates and rising real estate prices made Ferguson's investment look good. But some experts warn that those kinds of returns happened as a result of fortunate timing and should not be seen as an indicator of future performance.

Place to visit, rent out

Observers point out that most condotel prices can't keep pace with the current rate of rising home prices because hotel room rates are rising more slowly. And the condotel price is based in part on how much rent the room will bring in. Also, as condotel prices rise, it tends to reduce the potential for earning a return on the unit.

Not all buyers, however, have profit on their mind. Barb and Bob Bruder, a retired couple from Minnesota who typically spend a month or two in Hawai'i every year, recently stopped by the Palms to consider purchasing a room to use when they're visiting Hawai'i and rent out when at home. "It'll be easier for us to come," Barb Bruder said.

Metzker, the AT&T engineer, said he isn't interested in reselling his unit or hiring a management company to rent it to visitors.

Before he took possession of his $160,000 Luana unit in August, Metzker had lined up a tenant paying $1,500 a month through December. Then he let friends and family stay over until this month, when he rented it to a business traveler in town for 45 days. Metzker plans to build a Web site to market his room directly.

Purchasers of condotels can choose to manage the room themselves, like Metzker, or turn it over to the seller-designated on-site manager that usually operates units for 50 percent of room revenue. Another option is to hire an off-site manager that typically costs less but delivers fewer services.

Most buyers opt for the on-site manager that staffs the lobby, housekeeping and other hotel functions.

Lenders are wary

One hurdle for investors interested in condotels is qualifying for a loan. Few lenders make loans because Fannie Mae and Freddie Mac — who usually end up buying loans from mortgage lenders — can't buy loans of a commercial nature. So lenders in the business typically take the extra precaution of requiring a 35 percent down payment. For a $175,000 hotel room, the downpayment and closing costs can come to about $68,000.

Furthermore, some lenders require a buyer seeking a loan to have the ability to pay the mortgage without relying on rental income from the room. Others might consider rental income only on a comparable long-term rental rate.

"We don't count the hotel rental rate as income to offset the mortgage payment because it's too unstable," said Iris Toguchi, executive vice president of Pacific Access Mortgage.

"The market is so narrow, so new and so few — that's the challenge everybody's trying to work through," added John Gray, executive vice president of mortgage banking for Bank of Hawaii.

Hence most condotel unit buyers are those with cash, typically from selling other real estate or tapping the equity in their primary residence.

Ferguson, the California investor, is sold on condotels. "Investment-wise, they're great," he said. "There's just lines, and lines, and lines (of people waiting) to buy these things."

But Jim Butler, a hospitality industry expert with the Los Angeles-based law firm Jeffer Mangels Butler & Marmaro LLP, said condotels remain a tricky investment that most people don't fully comprehend.

"In a well-run, attractive property there should be cash flow to reduce your cost of ownership," he said. "If you're doing it to get rich, that's more of a crap shoot. You may be better off in Vegas."