Turn Weak Hotels Into Multifamily Properties

The idea of converting offices to multifamily has attracted a lot of interest, given falling valuations, uncomfortably high vacancy rates, the ongoing popularity of hybrid office use, and the uncertainty of the future.

However, Trepp suggests looking at lower-performing lodging properties for the conversion potential. They are more naturally amenable to conversions, given that they were designed as residences, even if temporary, in the first place.

What brings lodgings up for consideration are recent changes in the markets. “Performance in the lodging sector has been interesting to monitor, as delinquency rose again and remains high in many of the country’s biggest metros,” wrote Vivek Denkanikotte, a research analyst at Trepp. “Speaking more broadly, the outlook for lodging properties in certain regions is somewhat pessimistic as some economists expect high inflation to curb travel spending.”

This may seem odd as so far in 2023, the property class is performing better than had been expected, “with elevated occupancy and room rate figures.” But delinquencies were up by 110 basis points in June and another 50 basis points in July to reach 5.85%.

It could be that some properties had been doing particularly well, throwing off averages. Or perhaps subtypes were the issue.

Some of the strongest properties are extended-stay hotels, which appear to have been offering stronger net operating incomes. “Regarding geographic distribution, distress is most concentrated in some of the largest metropolitan statistical areas (MSAs), where lodging delinquency dwarfs the national rate,” wrote Denkanikotte. “Consequently, some underperforming hotels in these metros that have sat vacant are finding new life by converting them into multifamily housing units.”

Regarding geographic distribution, distress is most concentrated in some of the largest metropolitan statistical areas (MSAs), where lodging delinquency dwarfs the national rate,” they wrote. “Consequently, some underperforming hotels in these metros that have sat vacant are finding new life by converting them into multifamily housing units.”

New York City has seen some successful hotel-to-multifamily conversions. Lodging delinquency there is currently 15.3% and there aren’t enough apartments to go around. A property called 90 Sands went became a conversion to low-to-moderate income families as well as formerly homeless.

The Housing Our Neighbors with Dignity Act (HONDA) has provided nearly a third of the $150 million for converting a Hilton near JFK Airport to 318 permanent apartments.

Looking at the ten largest extended-stay hotel brands by CMBS loan balance, Denkanikotte wrote, “The aggregate current balance for the top ten exceeds $13.7 billion, with the top five accounting for nearly 80% of this.” Performance overall is “quite positive,” with debt yield and DSCR “very strong” at “14.79% and 2.34 respectively.” Weighted average delinquency figures of 3.24% were lower than the national average 5.85%.

Unfortunately, while extended-stay hotels offer the best structures for conversions, full-service hotels are in greater need having the “lion’s share of underperforming loans.”