Real estate groups are converting hotels into new housing. But such deals are getting harder to come by.

Real estate groups are converting hotels into new housing. But such deals are getting harder to come by.

New Jersey real estate firm Lucern Capital Partners considered more than 30 hotel properties across the country to do a residential conversion before going under contract on one in November.

The firm, which specializes in value-add apartment projects, in the next several months will convert a suburban TownePlace Suites in North Carolina into workforce housing units, after rezoning the property a couple of weeks ago.

It’s the latest example of a growing trend across the country. Hotels — many of which struggled through the Covid-19 pandemic — are more frequently being snapped up by apartment developers to be turned into housing units. Overland Park, KansasGreater Cincinnati and the Georgetown neighborhood of Washington, D.C., are just a few places where such projects are happening.

The space has, as a result, become competitive. Frank Forte, chief investment officer and managing partner at Lucern, said he thought he’d be lucky if the firm was able to pull off even one of these deals. If it manages to close on a couple more, he said he’d be beside himself.

“That’s how difficult it is to find ones that make sense,” Forte continued. “Most of them, there’s a disconnect between what the person wants to sell it for and what the market is to pay for it.”

As more real estate players wade into the space, finding the right type of hotel, in the right city, in the right submarket, at the right age and in the right condition to make a deal pencil out is becoming harder to do. Extended-stay hotels, which come equipped with kitchens and have somewhat larger unit sizes, are the preferred — sometimes the only — hotel type sought by developers for such projects.

In a May report, the National Association of Realtors found that among 1,936 survey respondents, 168 had been involved in selling, leasing, developing, managing or appraising a hotel or motel being converted into housing in the past two years. Sixty percent of conversions among that pool were for multifamily housing, and 82% of hotels converted into multifamily were in suburbs, small towns, resorts or rural areas.

Zack Streit, senior vice president at Los Angeles capital markets advisory firm George Smith Partners, said he’s working on three hotel conversion projects today, in Sacramento, Salt Lake City and the Denver metro.

For the right property, the strategy works extremely well, Streit said. There’s a lot of liquidity in the market now for multifamily deals, including hotel conversions.

“There’s strong interest in the space from both equity and debt capital sources,” he said. “They all seem to get that there’s a real play here: being able to identify assets in great locations … that offer a lot of walkability and a lot of access to amenities, and are often in places that it would be difficult to buy and/or entitle land.”

Many, but not all, hotel conversion projects also offer below-market rents because the cost to renovate a hotel into housing is usually considerably less than new construction. The NAR survey found 54% of operators involved in a hotel conversion deal acquired a hotel for less than $50,000 per room, and 53% paid less than $25,000 per room for the actual conversion.

Average cost to build a new apartment project ranges widely but is typically between $74,970 and $352,400 per unit, according to Fixr, an online marketplace for home remodeling and construction projects.

And apartments being built today are largely Class A properties with a lot of amenities, said Gay Cororaton, senior economist and director of housing and commercial research at the National Association of Realtors. That frequently makes them expensive places to rent.

“The conversions are lower cost, and that lower cost can be passed on to renters,” she said.

El Segundo, California-based Vivo Living, part of Vivo Investment Group, so far has eight Vivo-branded properties in its portfolio. All are hotels converted into affordable housing.

Akash Rohera, director of finance at Vivo Living, said the company has another six to eight properties it’s looking to go under contract on across the country. Like most operators, Vivo started out by targeting extended-stay hotels, but is now also buying and renovating limited-service motels, including an old Best Western in Colorado and a former Days Inn in Nebraska. Its first project, in Ogden, Utah, had been a full-service hotel — the toughest to do such a conversion on.

Since Vivo Living has gotten into the space, it has gotten more competitive, Rohera said. But Vivo has a team of more than 20 that focuses exclusively on hotel-to-residential conversions, including in-house property managers and a general contractor. That makes, for example, building out kitchenettes in limited-service hotel units lower cost and attainable.

“Our vision is to really help solve America’s affordability crisis,” Rohera said. He estimated Vivo units rent in the range of 50% to 80% of an area’s median income, or about $600 to $800 per month. Some units are fully furnished, which Rohera said is a popular option.

Frequently, hotel conversions into apartments require a rezoning, which can take six months to more than a year to complete. Streiter said a lengthy rezoning may dampen the appetite of capital providers so groups looking to take on a hotel conversion should investigate what a rezoning will entail.

Rohera said Vivo frequently encounters regulatory challenges from municipalities, like higher parking requirements and impact fees, when it seeks to change a property’s use from hotel to multifamily. For Vivo’s first couple of deals, financing was challenging, but Rohera said that may be starting to change as the strategy becomes more common.

Streiter said he thinks the sector still has runway and that hotel conversions into residential will continue as long as the housing market remains as tight as it is. Developers are having to get more creative in how they add new housing — and, particularly, affordable units — to the market, and converting an unused hotel is a way to do that, he added.

Many hotel operators wanted to sell underperforming properties, some even facing foreclosure, during the pandemic. Cororaton said hotel conversions could start to taper off as leisure and business travel starts picking back up again.

“That’ll mean more revenue and income for these hotels and motels,” she said. “They won’t face as much financial hardship.”