The Fairmont Southampton project will work for investors only if 250 additional units are approved for the site, according to a document filed with the Government.

Capital probably cannot be raised, the document contends, under a hotel-only scenario.

The SDO Justification Memo — prepared by the applicant, Westend Properties — argued that even if a special development order allowing for the tourism and residential units is approved, returns will be minimal, though sufficient for a capital raise.

In the analysis, dramatically higher costs, negative perceptions about investing in Bermuda, changing demand patterns and investors who have become more selective were noted.

Uploaded last month to the Department of Planning website, the five-page memo said: “The ‘hotel-only’ scenario does not provide sufficient revenue to attract capital at this time — investor return criteria have shifted since the 2009 SDO was granted.

“However, the ‘hotel plus proposed SDO residential development of 250 units over time’ scenario is projected to meet minimum investor return thresholds.

“In short, investor commitment to the project is contingent on the granting of the SDO.”

The plan outlined in the SDO is for 159 tourism and 91 residential units, almost double the number of fractional tourism units, residential villas and town homes in the 2009 SDO.

In the recent SDO Justification Memo, the applicant explains that more capital is needed because of increased costs.

It said: “Since the property was acquired in 2019, the estimated costs for the redevelopment have increased by 70 per cent.

"As a result, additional capital needs to be raised.“

The document said Westend Properties planned an extensive renovation of the island’s iconic hotel as well as the development of tourism and residential units on the Fairmont Southampton site.

It added: “An enhanced SDO is integral to bringing this plan to life.

“Several factors are having a direct impact on the overall redevelopment strategy.”

Asserting that reopening the hotel, which was closed earlier than expected for refurbishment in 2020, was “the first priority”, the memo added: “Though the building itself is structurally sound, extensive renovations are required.

“These would typically take place over several years. However, in the interests of reopening as soon as possible, that work will be completed up front, all at once.”

An SDO granted in 2009 gave planning permission in principle for 71 fractional tourism units, 37 residential villas and 22 town homes.

The latest request from Westend Properties — revised from an earlier application made in April — proposed a development with up to 250 units in buildings of two to four storeys.

“It's important to note that the residential market has shifted drastically since the 2009 SDO was approved,” the justification memo said.

“Larger units and fractional ownership are no longer in demand.

“Instead, buyers are seeking turnkey residential solutions, particularly in Bermuda where foreign buyers face barriers to entry.

“In addition, the appeal of living within close proximity to restaurants and other resort amenities has only increased since the pandemic as many residents continue to work from home.”

It added that the strategy of Gencom — the Miami-based investment company of which Westend Properties is an affiliate — was to build the residences only after meeting presale thresholds of 50 per cent-plus “and not to build on speculative demand”.

The memo explained: “Based on our internal analysis, building based on the approved 2009 SDO will not generate the investor returns required for a project with this risk profile.

“However, based on the proposed project metrics associated with the revised SDO outlined herein, we are confident that investor returns will meet the required thresholds, with little to no erosion in the project’s achieved multiple of capital.

“At acquisition in 2019, total costs for this project were estimated at $310 million.

“Today, that estimate has skyrocketed to $530 million — a 70 per cent increase.”

It added that the spike in anticipated expenditure could be attributed to several factors, such as “the extended closure of the property and associated costs resulting from the Covid-19 pandemic”, higher construction costs, rising interest rates and modifications to the overall business plan.

The document said: “Under the total project capitalisation of $530 million, a significant amount of equity is required — approximately 43 per cent of the total capital stack, or $230 million.

“Minimum equity investor returns for a project of this calibre start at 2.5x the original investment.”

Listing further considerations, the memo said: “Market knowledge of failed Bermuda projects, such as Elbow Beach and Morgan’s Point, has made raising capital more challenging.

“There are negative perceptions about operating hotels in Bermuda given higher operating costs, the bargaining strength of local unions and nuances associated with the island’s remote location.”

It added that investors were “generally more selective” in the present market environment and that backers wanted to "participate in situations where they can envision the desired outcome“.

Comparing three different scenarios, the memo said that in the case of a “hotel-only” investment without a residential SDO, “returns generated will not be sufficient to meet investor expectations”.

It explained: “By way of example, under a simplified view, if the hotel sells for $540 million in ten years, the estimated profits are projected at 1.3x multiple of capital based on the equity investment upfront.

“Given the level of project debt, annual carrying costs and estimated growth in income year to year, the profits to investors are roughly half of what would be expected for a deal of this nature.”

Another scenario used the same hotel metrics as well as projected net residential proceeds based on the 2009 SDO.

It was calculated that "investor returns still fall short, as investors are projected to recover less than twice their original investment“.

Using the same hotel assumptions coupled with the projected net residential proceeds of the latest SDO, the memo said that “total investor returns are estimated to reach the minimum 2.5x recovery for investors”.

It added: “While right at the minimum investor threshold, we are confident that anticipated returns coupled with endorsement of the project’s overall business plan will precipitate success in the current capital raise.”

The document concluded that “the proposed residential SDO at the Fairmont Southampton is required for the overall long-term success of the development”.

It said: “As a primary driver for capital raise efforts, a catalyst to accelerate more immediate investment in the hotel and an enhancement to the project’s cashflow underwriting (ie, incremental rental income from rental programme participation), the contemplated residential SDO will improve the overall viability of the investment.”

• To read the SDO Justification Memo in full, click on the PDF under “Related Media”.

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SDO Justification Memo from Applicant