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Converting a Hotel Into a Multifamily Asset

Jun 12, 2020 by Brad Cartier

According to Trepp, the May 2020 delinquency rate for commercial mortgages in the lodging sector stood at a substantial 19.13%. It's no surprise that the retail and hotel sectors have been the hardest hit in the current economic downturn, but this may present interesting opportunities for creative real estate investors.

Here's an overview of how to look at acquiring distressed hotel assets and convert them into a long-term multifamily asset, the pros and cons of this approach, and whether real estate investors should try to get in on the action.

The hotel industry is in trouble

The hotel industry took a double hit during the pandemic as travelers of all stripes -- leisure and business -- have been halting all movement for several months. Further, stay-at-home orders kept local or domestic travelers hunkered down in their homes. As a result, many hotel operators are feeling the pain.

Chip Rogers, President and CEO of the American Hotel and Lodging Association (AHLA), recently stated, "The hospitality industry is in a fight for survival … We are urging Congress to do even more to help the hotel industry so that our small business hotel operators can keep the lights on and retain and rehire employees."

Further, according to Oxford Economics, the pain felt in the travel industry will actually be much worse than the impact of 9/11. According to the report, "A $519 billion decline in travel spending in the U.S. this year will translate into a total economic loss of $1.2 trillion in economic output. This is more than nine times the impact of 9/11 on travel sector revenue." For lodging specifically, the estimated GDP loss will be $112 billion.

According to McKinsey, in the worst-case scenario, average daily hotel rates will still be down 20% even by 2023. Vic Krishnan, author of the report, concludes that "Hotels face the prospect of a long recovery. Over the coming months and years, properties' circumstances will vary based on a number of factors, including chain scale, location, and demand profile."

This long recovery, particularly for luxury and boutique hotels, presents acquisition scenarios for real estate investors who may be able to reposition the asset as a long-term multifamily asset.

Why convert?

Because people always need a roof over their heads. The same Tripp report that found a 19.13% May 2020 delinquency rate for lodging commercial loans also found a 3.25% delinquency rate for multifamily assets. There's a reason for this.

Multifamily typically outperforms lodging assets during economic downturns for exactly the reasons you imagine: people are traveling less and saving money, but they still require a home and are less likely to purchase one as employment becomes precarious. According to The National Multifamily Housing Council (NMHC), rent payments continued to come in during the current economic downturn:

  • April: 78% rent payments in 2020, vs. 82.9% in 2019
  • May: 80.2% rent payments in 2020, vs. 81.7% in 2019
  • June: 80.8% rent payments in 2020, vs. 81.6 in 2019

As you can see, there wasn't as much pain felt during the 2020 pandemic for the multifamily sector as one might expect. Time will tell on asset prices as real estate is a lagging indicator, but in terms of real estate assets, multifamily is one of the more robust.

Things to consider in conversion

Finding a boutique hotel for sale may be easier than ever in the coming 24 months. Using various commercial real estate search platforms such as Loopnet, take a look at the assets currently available in your state. Here are a few things to consider during your analysis:

  • Seller financing: Many sellers may be eager to rid themselves of poorly-producing assets to offload debt. Sellers may be open to some form of seller financing that could help offset your initial down payment and ultimately improve your cash-on-cash return.
  • Room amenities: Ideally, the hotel will have a mix of room types: one- to two- -bedrooms as well as studios. That said, what's most important is the presence of a full kitchen. You'll save yourself the cost of adding one to each unit after you make the purchase -- a costly addition. It's not a deal breaker, as you can factor the rehab cost into your proforma, but having it there already is a bonus.
  • Hotel amenities: Most hotels include amenities such as pools, common spaces, and some form of commercial space such as restaurant or cafe. These may be good to keep as you convert to a multifamily, but think about conversion opportunities for spaces that won't be necessary in a multifamily asset. This can include converting a breakfast area to a shared gaming room, or a restaurant to additional units or gym.

The bottom line

Downturns are painful. That said, creative real estate investors who are able to identify potential small hotel leads will find that the numbers on these distressed assets can make a lot of business sense.

Take some time to review potential deals in your state, applying the conversion model to reposition poorly-producing lodging real estate to long-term buy-and-hold multifamily.

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