There are great guesthouses and hotels in Old Town Key West, where you want to be during Fantasy Fest, if you want to be near the action. There is usually a 4 night minimum stay... sometimes 5 nights, and the rates are at their maximum, so be prepared to pay more if you're going to be in Old Town... the whole island fills up for this event.

I heard that Pier House is already full, but I think there are still some rooms at the Hilton, Ocean Key House and the Hyatt which are all on the water. Holiday Inn La Concha is right in the HEART of the action, overlooking the parade route, but I hear that all the rooms with views of Duval are gone already.... this hotel is not on the water, however.

It's also fun to stay at the Wyndham Casa Marina - they have several events there, and it's a great old hotel, right on the Atlantic Ocean.

Hope this helps!