Hotels continue to be a popular target for investors looking to convert them to other real estate classes, but there’s still plenty of competition for hotel deals overall and a limited amount of time to make these deals work.

The prospect of converting hotels to other uses, such as luxury apartments, affordable housing and senior living, is not new, but the practice has gained steam since the start of the pandemic.

The pandemic has created a challenging operating environment for hotels, and even now as the industry’s recovery has accelerated, some owners are struggling with profitability, said Geraldine Guichardo, global head of research, hotels and director, Americas living research, at JLL. In other cases, the owners put off capital expenditure projects, and they can’t afford the investment now as their hotels have gone through further wear and tear.

Some owners find they can’t continue to own their properties, and alternative investors offer an attractive opportunity to them, she said.

The U.S. is undergoing a national housing crisis, with an estimated undersupply of 5.5 million units, she said. The pandemic brought this issue to the forefront and reinforced the fact that both governments and private firms need to look for solutions to enhance the housing supply.

There’s a greater focus on this need in markets such as Los Angeles, New York and San Francisco. As a result, there’s been an uptick in such markets of hotels being converted to some type of housing.

Though it’s difficult to quantify the exact numbers, JLL has noticed an uptick in the number of investors interested in acquiring hotels to convert them to other real estate classes, Guichardo said. When looking over some internal deals on the market that closed in the last year to alternative investors, pricing was pushed between 25% and 35% above what traditional hotel owners were willing to pay.

“These investors were definitely attracted to the opportunity that converting the hotels presented to them,” she said.

Phil White, vice president at Hospitality Real Estate Counselors, said he has fielded weekly calls from buyers looking for hotel conversion opportunities. At this point in the recovery, though, the perception among many hotel owners is that the industry is starting a new cycle.

“I think people are going to be pretty aggressive with pricing at this point, so it’s hard to make those numbers work,” he said.

Big box hotels have been highly attractive for buyers looking to convert given how these hotels have struggled to recover, Guichardo said. Extended-stay hotels have also been a popular hotel type given the room size, kitchenette and other features common to this room type.

The conversions have spanned the housing spectrum, she said. Some have been converted to workforce housing, affordable housing, student housing or assisted-living spaces. Student housing was a particularly popular conversion type because universities realized they need to spread out their densely populated campuses during the pandemic.

Some of the buyers are private equity while others are larger real estate funds, White said. In some markets, though, there are regional investors who are converting hotels to apartments or senior-living facilities.

In the Detroit area, a couple full-service hotels were changed over to affordable housing, such as the Wyndham Garden Hotel that was acquired by Los Angeles-based Repvblik LLC, he said. In Dearborn, Michigan, Rhodium Capital Advisors out of New York acquired the 773-room Edward Hotel & Convention Center, closed since 2018, to convert to apartments.

“It just depends on the market and depends on the opportunity,” he said.

The multifamily sector held its own during the pandemic, compressing pricing on these units significantly, Guichardo said.

“Because pricing was so high, looking into the hotel space presents a really inexpensive option, sometimes even after taking into account the renovations needed,” she said.

Every deal is different, and it depends on what the buyers need, how easily they can obtain debt and what their return expectations are, she said.

While it depends on the market, investors are buying hotels at a discount compared to what an apartment would cost, White said.

“The risk is relatively low,” he said. “Their returns are going to be pretty high on these properties.”

Not every hotel is set up how they want, so sometimes the new owner will have to make bigger changes than a refresh, such as adding a kitchen to units, he said. It has to make sense from a numbers perspective if they can buy it for a low enough price per key. The extended-stay hotels generally are turnkey deals because they have everything already and are sizeable apartment units.

“Generally, these groups try to avoid construction,” he said, adding that some do have their own in-house construction business.

The window for further conversion deals is probably wider now than it has been in the past because the industry is still in recovery mode, Guichardo said. As hotel performance levels get closer to what they were before the pandemic, these deals will be harder to make, though.

“But the industry, frankly speaking, is going to take probably another 12 to 18 months to get on firmer footing, and so the window of opportunities will be there as wide as it is now for that time,” she said.

White said he expects there to be about half as many conversion deals this year as in 2021. The hotel industry’s recovery is going strong, and the price per key will go up, making these conversions less financially attractive to potential buyers.

“Everyone’s buying them now,” he said. “It’s kind of made the product run dry. There just aren’t as many deals to go around.”

California’s Project Homekey and New York City’s $100 million fund were two government programs to convert hotels into housing, but neither performed as hoped in 2021.

In 2020, local and county governments spent $890 million through California’s Project Homekey to buy 78 hotels to convert them to housing for the homeless. In 2021, the project paid for one hotel. There are several hotels under contract through the program currently, but the closing process is taking much longer than in 2020, Atlas Hospitality Group President Alan Reay said. He’s not aware of any of those pending deals closing so far in 2022.

The program ran into a number of obstacles in 2021, said Reay, whose hotel brokerage company puts out surveys tracking California hotel transactions and developments. The state moved quickly in 2020 to acquire hotels, but there’s been pushback on how fast these deals are made and how liberal the appraisals have been.

“People are looking a lot more closely at these deals,” he said. “The underwriting and the appraisals are having to go through a review process, and that’s causing some deals to be slowed down again.”

The argument had been that buying these existing hotels, even above market value, was still a less expensive option compared to buying land and building new housing, he said.

There’s also more pushback from local businesses and residents who are concerned about hotels in their neighborhoods being converted to house the homeless, he said.

Because of Project Homekey, there’s been more interest among private buyers in converting California hotels to other uses than ever before, Reay said.

Shortly after the start of the pandemic, state offices in New York conceived of a program to convert hotels to residential buildings, but that program hasn’t made much progress, said Sean Hennessey, clinical assistant professor at the Jonathan M. Tisch Center for Hospitality at New York University and CEO of Lodging Advisors.

The program wasn’t able to generate the conversions its creators had hoped for, he said. In New York City, many hotels are union operated, and there’s a law regarding compensating laid off or furloughed workers. The city has a new mayor, and the state has a new governor, but neither have indicated any significant new initiatives for the program so far.

“I think the possibility for conversions to apartments, to senior housing, to student housing remains pretty significant in New York despite the fact that there hasn’t been much action so far,” he said.

That’s mainly because of two factors, he said. Hotel performance metrics in the city continue to be subpar given the market has been one of the most affected by the pandemic, due in part to its heavy reliance on international travel. The other factor is potential conversion candidates are significantly older buildings.

“The cost of sustaining a viable hotel operation is problematic for a lot of those properties,” he said. “Conversion to an alternative use has got a running start in the feasibility if [the buyers] don't have to spend significantly to try to keep the property as a first-class hotel.”

Return to the Hotel News Now homepage.