The hotel real estate market has been upended by the COVID-19 pandemic — according to the American Hotels and Lodging Association, as many as 8,000 hotels might be closed by the end of September. But even amid this upheaval, there are opportunities for owners who are willing to consider adaptive reuse.
David Leopold is senior vice president and head of affordable housing at Berkadia; Kyle Stevenson a managing director with Berkadia’s Hotels & Hospitality.
Adaptive reuse isn’t a new phenomenon. In recent years, development firms have capitalized on the opportunity to create unique multifamily offerings from hotel properties, like Turntable Studios in Denver, which was converted from a hotel property to a 179-micro-unit multifamily property in 2015 and later traded for US$31 million in 2019. Mid-century hotels have faced fierce competition in recent years as newer, select-service properties have gained favor. Yet their prime locations, particularly in major cities where multifamily development lags need, make them attractive options for multifamily conversion.
The pressure facing hotels during the pandemic is hastening, and broadening, this trend. Not all properties that will be closing make sense for market rate conversion, like Turntable Studios, which is where affordable comes into play.
Recently, we had an owner come to us for advice on a potential sale of their beachfront property. In 2019, the property had been valued in the mid-US$20 million range, but with the onset of COVID, we valued the hotel property at US$14 million. We proposed that the owner consider an affordable conversion sale — a possibility they had not thought of — given the property’s favorable location in a strong rental market with a high need for affordable housing. When the seller went to market with this strategy, they received multiple offers in the mid-US$20 million range, allowing them to achieve pre-COVID value.
The need for affordable housing remains critical across the U.S., especially now as the pandemic has emphasized how essential safe, stable and affordable housing is for the health and wellbeing of communities. Adaptive reuse offers the potential to create cost-efficient new affordable housing while still allowing sellers the opportunity to achieve a sale value closer to pre-COVID levels.
Of course, not all hotel properties are suited to the opportunity, and owners need to evaluate the property type, location, and required experience.
Property type matters
Older hotels have found themselves particularly hard hit by the pandemic, including big, full-service boxes with lots of meeting space, and traditional extended-stay hotels that are perhaps leaving their franchise system. First-generation design has fallen out of favor and the attributes that may have initially made these properties attractive – like abundant meeting space — have been rendered obsolete by the rise of convention centers and dedicated event spaces.
With their primary function obsolete, these hotels could be a candidate for a conversion. Particularly all-suite and extended-stay properties lend themselves better to conversion, which often require less involved building’s system changes and overall lower cost for affordable developers.
Interestingly, formerly branded hotels, such as Residence Inns, which could fall into this category, were initially designed to resemble garden-style multifamily buildings because banks were afraid they wouldn’t work as hotels and wanted something that could easily be converted to apartments if necessary.
Another potential fit for a conversion is a historic hotel that could qualify for historic tax credits, which can be layered in addition to U.S. federal low income housing tax credits. Some states offer tax credits, which could be an additional consideration. More sources of funding allow for more rehabilitation cost for the tax credit partnership and a higher developer fee for general partner developer.
Location, location, location
Location has always driven a hotel’s success, and that’s no different for a conversion. Although contracting tourism and business travel may negatively impact a hotel’s bottom-line performance, the property could be in a thriving rental market. In this case, the location must also be viable for multifamily tenants — proximity to transportation, employment, goods and services is essential. A property that is well-placed in terms of market demand and tenant needs can make for a compelling conversion to market rate, seniors, workforce or affordable housing. Currently, we’re seeing the greatest viability for hotels in smaller urban metros or in more suburban locations outside of major cities.
A potential affordable conversion adds another layer of location consideration — in this case, a location will confer additional benefits in terms of tax advantages, higher tax credit equity pricing, potential for state tax credits, or Opportunity Zones benefits. An unfavorable location could create insurmountable hurdles that will make the sources and uses of a conversion unworkable.
Knowing the landscape
Divesting enables hotel owners to focus their core business, but positioning a property for affordable housing can be complex — there are legal and regulatory challenges both at a local and national level, redevelopment options and costs, tax incentives, etc. For a seller, understanding the layers of complexity that impact the marketing of their property to an affordable audience is crucial.
More practically, sellers need to be able to connect with these buyers. The affordable redevelopment audience is a niche group that falls far outside the traditional hotel market. It is vital that sellers are able to source a pool of buyers who understand the potential opportunity and have the background and experience to bring it to fruition.
In some cases, prospective buyers are recognizing these opportunities and seeking potential hotel partners as well. The timing to close an acquisition for a conversion can be longer because of the complexity of the execution but developers are getting creative with financing solutions to overcome that challenge.
The pandemic has had an unprecedented impact on the hotels market. Hotel values are down significantly, with a recent HVS report on hotel values projecting a 20% decrease in value in 2020 as a “best case scenario,” and the capital markets remain almost at a standstill, leaving owners struggling to service their debt or refinance. In a recent survey by the AHLA, of the more than 600 hotel owners surveyed, more than half said they are in danger of losing their properties to foreclosure.
But the creativity and the resilience of our industry has never been in question. In the case of a pivot to affordable housing, it’s not only good for hotel owners but also contributes to solutions for the affordable housing crisis.