Pandemic travel bans shut down many old, obsolete hotels for good. Now, investors are creating a new product—from temporary shelter to affordable and market-rate housing.
This article appeared in the Summer 2022 issue of Urban Land.
Historically, older hotels have played an important role in the hospitality industry, providing a lower-rate alternative to four- and five-star hotels for families and business travelers on a budget. But many of these lodging facilities will not be around on the other side of the COVID-19 pandemic because their owners are calling it quits.
The fate of this older hospitality product was decided by the combined effect of the pandemic-induced travel shutdown and an oversupply of new hotels that includes an abundance of modestly priced lodging that has rendered older hotels obsolete.
The good news is that many of these outdated properties are being reborn as residences as multifamily developers and investors looking for a quick and cost-effective way to produce more housing snap them up for conversion to apartments.
While this idea is not new, the hot multifamily market has set in motion a new wave of this type of adaptive use to help meet the high demand for affordable and attainable housing in urban markets.
What Is Driving Hotel Conversions?
Owners of obsolete hospitality assets are embracing the opportunity to sell their properties to multifamily investors, because strong competition for well-located hotels is generating bidding wars that drive pricing up 25 percent to 35 percent above market hotel values, according to Geraldine Guichardo, head of global research for JLL’s Hotels & Hospitality Group and Americas Hotels Research, Living Platform USA.
Guichardo notes that investor activity in this space intensified in 2021 and is expected to continue for the foreseeable future due to compression of multifamily capitalization rates to 3 percent to 4 percent or even lower. “Even though they are paying above market for assets, investors feel like they’re getting a bargain because it can be cheaper to convert a hotel to apartments than to acquire or build multifamily projects,” Guichardo explains.
The average cost per unit for hotel-to-housing conversions in California, for example, is $130,000, compared with the $380,000 to $570,000 per unit for new construction, according to the California Department of Housing and Community Development.
A Global Market
The United States is not the only place where hotel-to-housing conversions are happening.
“Everyone is doing some version of this,” notes Qaiser Mian, senior director of research, valuation, and advisory at Toronto-based Atlus Group, a global software, data solutions, and independent advisory services firm. Atlus Group provides feasibility studies and cost analyses for clients doing hotel conversions across Canada, Australia, the United Kingdom, and Asia, as well as in the United States.
Guichardo says that investors can easily finance conversions, because multifamily is an outperforming asset type with income and operational stability.
Los Angeles–based George Smith Partners’ Davies Group, which advises clients on construction, bridge, equity, and permanent financing, offers investors all-in-one financing for conversions if the property is well located in urban or urban-suburban markets. The company recently capitalized conversion projects in Sacramento, Phoenix, Houston, Colorado Springs, and Salt Lake City.
Malcolm Davies, principal and managing director for the GSP Davies Group, says that the firm’s investors have a strong appetite for acquiring functionally obsolete hotels for conversion because rents can be priced below market rates. Considering the dire shortage of affordable and attainable housing, he adds, “I think there is a significantly long runway for this product type.”
Soft Money Funding
In addition, the availability of soft money funding, or nonfederal funding, for affordable housing is driving hotel conversions in the affordable sector, which represents the largest share of conversions in both the United States and Canada.
Typically, U.S. affordable housing development is driven by the availability of low-income housing tax credits (LIHTCs) combined with soft money funds or grants from state and local governments and other sources, says Seattle-based Jeff Arrowsmith, managing director of CBRE’s affordable housing division.
California, for example, set up the HomeKey program in 2020 specifically to create affordable housing through adaptive use of existing properties because it is a quick and cost-effective way to create affordable housing compared with new construction, Arrowsmith says, noting that other states have similar programs or provide grant dollars for affordable housing.
HomeKey provides grants to local governments to acquire assets for conversion to housing. The program, which has already provided 6,000 housing units, is part of an overall $12 billion initiative to produce up to 16,000 homes to help eliminate homelessness.
“Soft money is a big driver of value in conversion projects,” Arrowsmith says, noting that for-profit corporations like Apple, Google, Amazon, and Microsoft provide low-interest loans in certain geographies for affordable housing projects to help offset the cost of acquisition and rehabilitation of conversion projects.
Arrowsmith notes that soft money often makes projects viable that otherwise could not be built using only LIHTCs and other traditional hard-debt financing. “When soft money is incorporated into the capital stack, tax credits can be leveraged to a broader degree to help finance more projects,” he explains.
Michael Massie, chief housing development officer at Jamboree Housing Corporation, a nonprofit affordable developer/owner based in Orange County, California, says that the amount of soft money a project brings to the table is a major factor in the state awarding LIHTCs. California holds a competition for LIHTCs, with selection based on a point system. Points are awarded on various criteria, such as the project’s proximity to schools and parks, developer expertise, and the amount of soft money the developer has secured.
Working with Local Governments
Local governments are supportive of affordable housing conversions, which makes the entitlement and/or rezoning processes quicker and easier than for market-rate projects. Some local governments also provide incentives to increase the stock of affordable housing. San Diego, for instance, implemented a package of incentives for affordable housing projects that includes a 50 percent density bonus, the elimination of all fees for projects that are 100 percent affordable, and fast-tracking of approvals.
Over the last two years, Jamboree has done eight hotel-to-housing conversions, totaling 755 units, in partnership with local governments in Sacramento, Orange, and Milpitas counties using LIHTCs, HomeKey, and other soft money sources. Jamboree also has three applications pending for the next round of HomeKey funding.
“We are pursuing hotel conversions as an asset class, focusing on extended stay because we can get them done quickly and cost-effectively,” Massie says. “We got into this and now know what we don’t know.” For example, he says that no mechanism was in place in Anaheim to convert hotels or motels to housing, so Jamboree worked with the city to craft a citywide hotel/motel conversion ordinance.
Massie explains that community pushback is an obstacle to creating supportive housing for those living on the street, who often have mental health problems. He also emphasizes that the quality of supportive services is key to gaining community support for these projects.
Architect Manuel Salazar, managing director and senior associate at Los Angeles–based Y&M Architects, which specializes in affordable housing design, redesigned a 70-room Econo Lodge motel in Anaheim built during the 1970s for Disneyland tourists into Buena Esperanza, a Jamboree supportive-housing project for people experiencing homelessness. He says that the community initially had a negative reaction to this project, but the redesign was so physically transformational that it wowed the neighbors into acceptance, since visually the new structure no longer had any resemblance to a motel.
Overcoming Physical Challenges
Rehabbing 30- to 50-year-old hospitality assets into housing, however, also presents physical challenges, since they require code upgrades and “you really don’t know what you’ll get until you open the walls,” Salazar explains. Structural issues like dry rot and water damage pushed the cost of Anaheim project up to $410,000 per unit—well above the state’s $130,000 average.
This project was funded primarily with city bonds and LIHTCs, but the high cost left a funding gap of more than $2 million that was filled with help from the Orange County Housing Trust, a low-interest loan from the Disneyland Resort, and a gift from the Home Depot Foundation.
Salazar says that the biggest design challenges for architects tackling projects such as this are developing a vision and then translating it into a design that transforms an unattractive old asset with an institutional feel into a modern, welcoming, and comfortable home. He stresses that a peaceful, home-like atmosphere aids in rehabilitating residents with mental health diagnoses, since studies show that the environment affects human emotions.
The design retained the existing footprint to avoid moving walls, but rooms ranging from 150 to 325 square feet (14 to 30 sq m) were completely gutted and reconstructed with high-quality, environmentally friendly materials and products.
A new one-story, 1,800-square-foot (167 sq m) community center was also added to provide supportive services and a gathering place for residents.
“One of the things we aim for is sustainability,” Salazar says, noting that the roof was replaced using energy-efficient, “cool” roofing material; electrical and plumbing were brought up to code; Americans with Disabilities Act (ADA) upgrades were installed; and the entire structure was insulated.
Other sustainable features included energy-efficient appliances in the kitchenettes; new energy-efficient heating, ventilation, and air conditioning (HVAC) systems; low-E windows; bathrooms with low-flow plumbing fixtures; ceiling fans; light-emitting diode (LED) lighting; and vinyl flooring made from recycled materials. And the stormwater solution retains and percolates water runoff into the soil to lessen the burden on storm drains.
Conversions with New Construction
TWG Development, a private, full-service multifamily development, construction, and management firm based in Indianapolis, is converting a 30-year-old Best Western Inn & Suites in Durango, Colorado, into affordable housing for seniors.
The hotel was acquired by the city using funding from the Colorado Department of Housing. TWG was selected to convert the hotel into 71 apartments measuring 450 to 550 square feet (42 to 51 sq m) and add 40 new one- and two-bedroom units on the back side of the property.
Ryan Kelly, vice president of tax credit development at TWG, notes that the conversion and new construction will use LIHTC equity and local soft money support to secure construction and permanent financing.
Overcoming Zoning Hurdles
Conversion projects are new for many communities, so there are challenges in fitting them to the current zoning and entitlement process, Kelly points out, adding that TWG builds or renovates projects to the National Green Building Standard but meets any level of sustainability that state and local governments require.
“The physical challenge is mostly about the layout of each unit and ability to convert that to a livable apartment space,” he says. Kelly suggests that these projects work best in urban markets with high demand for studio apartments because it is difficult to make the hotel conversion model work in markets like the Midwest, where apartment units are significantly larger than 500 square feet (46 sq m).
The Durango project also required upgrades for residents with disabilities because the hotel was built before current ADA requirements were enacted, Kelly adds, noting that 5 percent of the units were customized for visually impaired seniors, so the project had to accommodate this need with features like oversized elevator buttons.
Like TWG, MRK Partners, a Los Angeles–based development and planning firm specializing in affordable housing, has faced zoning hurdles. The firm recently converted a 140-key Hyatt House extended-stay hotel into Hillside Senior Apartments in Gaithersburg, Maryland, which was funded with a combination of low-interest, tax-exempt bonds, and LIHTC equity.
“Obviously, extended stays with existing kitchens tend to work best from an overall financial and layout standpoint,” says Sydne Garchik, principal at MRK, noting that the cost to adapt Hyatt House, which provided 140 one- and two-bedroom units, was well below replacement cost. She says that her company is seeking similar opportunities in Maryland, Virginia, and South Florida in locations with access to transit and job centers.
MRK incorporates as many sustainable improvements into projects as possible. The Hyatt project switched units from gas to electric, installed solar systems, upgraded lighting to LED, and replaced plumbing fixtures with low-flow alternatives. “We believe in sustainability for the communities we serve and the economic benefit of transactions,” Garchik says, “and we will continue to push such initiatives going forward.”
The main challenge with this project was securing a zoning amendment from the city, but surprisingly it provoked a lot of pushback from the community due to its “affordable” status. Garchik says that lease-up also took longer than predicted because Montgomery County, Maryland, is very affluent, so there aren’t many low-income residents. “Luckily, we were able to take advantage of income averaging, which qualified households at a little higher income from nearby communities to improve pace of lease-up.”
A Workforce Housing Solution
Older traditional hotel properties are great candidates for conversion to housing because they have larger rooms than those found in new hotels. They also can have extensive amenities that renters are willing to pay a little extra to get but can be provided at a substantially lower price point than in new market-rate apartments. Davies suggests that this is helping to drive growth in hotel conversions to market-rate housing.
Last year, two luxury Sidney hotels with many amenities, for example, were sold to residential developers for conversion to housing. The Vibe Hotel in the city’s Rushcutters Bay area will contain a mix of residential and hotel uses and feature 125 for-sale units, and the former 203-key Bayview on the Park hotel in Melbourne is being converted to 300 residential units for essential workers.
As bargain-priced extended-stay hotels become scarce, U.S. developers are beginning to look at other options for creating market-rate workforce housing.
Charleston, South Carolina–based Blaze Partners, an attainable housing developer, has made hotel-to-housing conversions a long-term business strategy. Eddy O’Brien, cofounder and managing partner of Blaze Partners, notes that conversions allow rents to be priced $200 to $300 below market rates.
His company is focused on providing attainable urban housing for young professionals. The company, for example, partnered with Argosy Real Estate Partners to acquire and convert an extended-stay hotel in Charlotte to 124 studio and one- and two-bedroom floor plans. Built in the 1990s, the hotel was converted into a transit-oriented project and renamed The Spoke at McCullough Station, since it is adjacent to the Lynx Blue Line station that provides direct service to the central business district and the University of North Carolina campus in Charlotte.
O’Brien says that a conversion-to-attainable-housing strategy also is attractive because cities are supportive of attainable housing projects because they attract a young, vibrant, and professional demographic. While local governments may be reluctant to give up hotel tax revenue, he notes that city leaders take notice when a hotel loses its flag, since that starts its death spiral toward “hotel of last resort,” which attracts an undesirable element and becomes a blight on the landscape.
Blaze started out in 2020 converting extended-stay hotels to apartments as “an easy way to stick our toe in the water,” O’Brien says, noting that meaningful discounts on hotel acquisitions were available at that time, but that window has closed with the improving hotel market. With extended-stay assets now harder to find, his company is looking at converting traditional hotels.
“While a lot of groups are relying on distressed hotel markets, we find creative ways to keep it going—this is our sweet spot,” O’Brien says, though he notes that traditional hotels are a heavier lift than an extended-stay asset, because they are a redevelopment play.
To be economically feasible, O’Brien says that traditional hotels must have a minimum of 200 keys—250 or more is preferable—because rooms are small and must be combined to provide units measuring 400 to 600 square feet (37 to 56 sq m). The cost to upgrade amenities and services to meet the expectations of today’s renters also is key to a project’s feasibility, he says.
Beyond that, O’Brien looks for assets located in urban neighborhoods with access to public transit and nearby employment centers. He says that other considerations include the size of the community and city support for attainable housing projects.
Guichardo suggests that struggling big-box hotels that had depended on conventions for occupancy are among good candidates for market-rate conversions because they are still struggling and can be acquired below replacement cost.
She notes that these hotel assets have large open spaces that can easily be converted to gathering places for socializing or adapted for apartment living, as well as amenities that apartment and condominium dwellers desire.
Many in the industry view hotel-to-housing conversions as a sustainable, ongoing trend due to the need for quick solutions to the housing shortage and the high cost of new construction.
Garchik, however, notes that with travel returning and the hotel industry improving, there are fewer opportunities to acquire adaptable hotel assets. “If hotels need a substantial amount of reconfiguration, then the deal is more difficult to close, especially if going the affordable route. So, unless we see the micro-unit concept make a comeback and prove out, I see these deals working more on a one-off basis than as a trend,” she says.
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