Some hotels are well-suited for conversion, others are not. Here is how to tell the difference.
The lodging industry is still facing various challenges amid the COVID-19 pandemic. Being a people-centric, travel-dependent industry, it’s without a doubt that hotel owners and investors are starting to think more strategically about where the future of their assets lies.
The spotlight has recently been on hotel conversions, which refers to the redevelopment or conversion of a hotel to an alternative asset type. Although this was rarely top-of-mind for investors and potential buyers prior to the pandemic, it’s quickly gaining attention, especially for non-traditional hotel investors looking to diversify their portfolios and capitalize on new opportunities.
Converting properties to alternative asset types, such as an office building or multi-family property, can enhance investment returns or reduce risk exposure, if analyzed and executed properly. If you’re an investor and wondering if a property is convertible, ask yourself the below questions before committing to redevelopment:
Does the hotel have the right bones?
A hotel’s physical layout and structure, as well as its market positioning, should be considered when thinking about redevelopment. Extended-stay hotels are typically better suited for conversion to multi-housing properties because they’re already equipped with kitchenettes, although extensive plumbing work to expand them into full kitchens may still be necessary. Additionally, full-service hotels are typically larger in size with more guestrooms and significant but potentially underutilized meeting space that may ultimately provide for more rentable or sellable square feet if converted to an alternative use. It is, therefore, critically important to analyze a hotel’s layout and estimate how much rentable or sellable square feet can be realized following conversion. For example, the Holiday Inn Baltimore Inner Harbor hotel in Maryland contains 365 rooms and was purchased with the intent to convert it to an assisted living facility based on its suitable physical layout and conducive market conditions.
Other potential complications to consider include a hotel’s ceiling height and floorplans. Some older buildings may have inefficient floorplans that aren’t easily adaptable and low ceilings, which can impact rent or sales price potential following conversion. For example, older hotels featuring awkward layouts where guestroom floors lack double-loaded corridors can have efficiency ratios below 60 percent, while branded hotels’ newer prototypes can boast efficiency ratios as high as 85 percent.
Is the location positioned for success?
Hotels that are located in areas with heavy office or housing demand will have a higher conversion success rate. Hotels in markets experiencing population growth or revitalization may also present an opportunity to consider multi-family housing options.
If the location makes the checklist, keep in mind legal and zoning restrictions. The hotel may be landmarked, or redevelopment may go against city code, so it’s important to evaluate what is possible. On the contrary, if the hotel is located in a place that has historically benefited from strong tourism, it may be smart to ride out the current downturn and retain the property as a hotel.
What added costs do I need to consider with a hotel property?
Strong sales and marketing platforms and robust loyalty programs can be key success drivers for branded hotels. However, brand and management encumbrance can also result in substantial termination fees, which add to redevelopment costs for hotels that may be poised for conversion. Oftentimes, hotels that aren’t tied to third-party brand and management are more appealing to prospective buyers as a result. Similarly, hotel stakeholders should also be conscious of any labor agreements in place at the hotel, as their terms may confer substantial termination costs as well in the form of severance payouts to employees.
For example, the Hotel Knoxville sold with apartment conversions in mind, generating more than 400 executed confidentiality agreements with interest from multi-housing and student housing investors, given the property’s close proximity to the University of Tennessee, and independence of the property. Additionally, the Ramada Plaza Atlanta Downtown and Conference Center sold competitively for just north of $14 million with multi-family housing redevelopment in mind due to similar reasons.
Do the rewards outweigh the risk?
There are always risks when it comes to redeveloping properties for alternative use. The key is to carefully evaluate if the reward outweighs the risk. Investors must assess their own tolerance for conversion-related risks and consider the availability and cost of capital for this purpose in the current market environment. Depending on the amount of structural changes needed, it’s important to determine the redevelopment timeline as it will impact investment returns. Additionally, a thorough assessment of various alternative-use strategies is imperative in determining whether the potential benefits of redevelopment outweigh the inherent risks. Given that the pandemic has impacted every sector of the real estate market, speaking to a financial and professional services expert specializing in commercial real estate is critical to appropriately assess a given hotel’s redevelopment potential.
Source: “What Makes a Hotel Suitable for Conversion?“