I.Introduction

Recently, in domestic and international real estate development projects targeting wealthy individuals, developers are increasingly engaging in mixed developments that incorporate branded residences (residences branded with luxury hotel names) centered in major domestic cities and resort areas.

These branded residences can expect unit sales to reflect a premium associated with the hotel brand, allowing developers to anticipate early and high return of funds. For purchasers, in addition to comprehensive hotel services, there are benefits such as maintaining and improving asset value through the brand and obtaining income opportunities through rental programs (as discussed below). It is expected that branded residence development will accelerate with the increase in the number of domestic and international wealthy individuals.

Although branded residence development is increasing year by year, there are cases with legal ambiguities from a Japanese law perspective. Accordingly, I would like to briefly describe some typical legal issues with introducing recent updates on relevant laws.

II.          Act on Building Unit Ownership, etc. (“Unit Ownership Act”)

The Unit Ownership Act is relevant to branded residence development in many respects. One particularly important issue concerns how to secure management and operation in compliance with the hotel’s brand standards in a branded residence where multiple unit owners are involved following the sales of the units.

It should be noted that the management association established under the Unit Ownership Act differs from the homeowner’s association in the U.S. or a similar association in other major foreign countries, and therefore management and operation matters in Japan cannot be structured in the same way as solutions to these matters in those foreign countries.

(i)                Common Area Management

In “majority type” ownership, where the developer continues to hold more than half of the voting rights in the management association, the developer can continue to have control over common area management through the following methods:

    • Specifying in the management bylaws that the developer itself or its affiliated companies shall be the managers, and that common areas will be managed by the manager.
    • Setting necessary restrictions on the use of common areas in the management bylaws. Since the management bylaws are binding on unit successors under the Unit Ownership Act, stipulating matters necessary for maintaining the hotel brand standards in the management bylaws will be helpful for stable management and operation.
    • Ensuring that purchasers cannot change the bylaws contrary to the developer’s intentions, as the developer holds the majority of voting rights. Thus, purchasers cannot abolish or modify the manager’s provisions or common area usage restrictions.

In addition, the developer can pass ordinary resolutions (such as an annual budget approval) without purchasers’ cooperation, and this mechanism contributes to the smooth operation of branded residences.

On the other hand, if the developer’s voting percentage after unit sales is less than a majority, while the developer will have veto rights regarding management bylaw changes, the developer cannot pass ordinary resolutions with only its own affirmative votes (as it could were it the majority owner), so cooperation from purchasers will be essential for operations such as budget approval.

In cases where the developer’s voting percentage falls below 25% after sales, management bylaw changes contrary to the developer’s intentions become theoretically possible, and there is a risk of abolishing provisions regarding manager selection and their authorities. While it may be possible to include provisions in contracts between individual purchasers and the developer or operator that they should not agree to any management bylaw changes, the validity and enforceability of such provisions remain unclear.

(ii)              Restrictions on Exclusive Area Usage

The use of exclusive areas under a rental program does not necessarily present issues on management. In a rental program, a purchaser allows a hotel operator to use its exclusive area in exchange for compensation. Under these programs, exclusive areas will be used and managed exclusively by the hotel operator based on contracts with each purchaser (lease agreements or management contracts), and accordingly it would not be necessary to impose restrictions on exclusive area usage by each unit owner.

When rental program participation is optional, exclusive areas can be freely used by purchasers. In branded residences, restrictions on usage of exclusive areas may be necessary from the perspective of maintaining uniformity and aesthetic appearance, particularly regarding decorations affecting the exterior, and it will be important to determine whether such restrictions can be established in the management bylaws.

(iii)             Manager

The manager preserves common areas, executes unit owner’s meeting decisions, and has rights to perform actions defined in the management bylaws. The manager’s actions are effective for all unit owners, and the manager has the ability to represent unit owners in matters related to their duties. The manager also has the right to convene unit owner’s meeting and is typically the chair. Managers need not be owners and can be corporate entities.

Selecting hotel operators or developer-affiliated companies as a manager and stipulating this selection in the management bylaws can contribute to establishing a stable structure that prevents manager replacement by the purchasers.

(iv)             Unit Ownership Act Amendments

Recently, amendments to the Unit Ownership Act have been under discussion. The “Outline Proposal Regarding Unit Ownership Act Revisions” published on January 16, 2024, includes: (i) a proposed mechanism allowing majority decisions by attendees (excluding non-attending owners from the quorum) and (ii) the introduction of a domestic representative for overseas owners. Both appear to contribute to smooth branded residence operations, but it will be important to monitor any further developments with respect to the contemplated amendments.

III.         Recent Updates on Natural Parks Act

In recent years, in response to the rising needs for condominium-type hotel developments, the Natural Parks Act Enforcement Regulations have been amended to allow the competent authorities issue approval on a condominium-type hotel development as a national park project under certain conditions. The approval requirements include the following:

    • Not establishing rooms for exclusive use by specific individuals, and ensuring that 70% or more of the total annual guest room nights are available for general use; and
    • Setting up a fixed-term land lease corresponding to the depreciation period of the hotel building, or implementing measures expected to facilitate large-scale renovations or rebuilding of the hotel.

IV.         Act on Specified Joint Real Estate Ventures and Financial Instruments and Exchange Act

The Act on Specified Joint Real Estate Ventures and the Financial Instruments and Exchange Act both restrict certain collective investment schemes. Relevant to our considerations in this newsletter is whether rental programs, which have the character of collective investment in that the revenue generated by the hotel is received by each unit owner, are subject to the terms and restrictions of these laws. There is no established, consensus view as to this matter, which requires careful consideration on a case-by-case basis.

View original article here.

Author: Takahiro Kitagawa

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