The real estate market has two growing problems: a serious short-age of affordable housing, especially for renters, and hospitality and office buildings in distressed states because of COVID-19.
Could the second challenge offer a solution for the first?
“We should convert vacant commercial space to supportive and affordable housing, and we should do it now,” New York Gov. Andrew Cuomo has said.
Retrofitting real estate for a new purpose is not a new concept, but the strains of the pandemic bring new light to the concept.
“Adaptive reuse is as old as real estate,” said Richard Rubin, CEO of Repvblik, a Los Angeles–based developer that converts commercial real estate into housing.
Hotels are one ‘affordable’ solution
Repvblik bought a 400-room former Days Inn complex in Branson, Mo., for conversion into studio and one-bedroom apartments. Since the property was purchased in April 2018, the company has completed two of the six residential buildings as well as a clubhouse with a gym and a pool. The property, called Plato’s Cave, is approaching 50% occupancy in its completed portions. Rents range from $495 for a studio apartment to $625 for a one-bedroom unit.
Rubin’s company has recently acquired a shuttered Ramada Inn in northern Alabama that it plans to convert into 120 one-bedroom housing units as a joint venture with Drever Atelier Partners. Repvblik is targeting late summer 2021 for the first phase to open, with rents below $600 a month. Repvblik plans to begin under-writing deals on office conversions as well. Rubin expects there willbe significant distress in the office market starting later this year into 2022 and beyond, bringing buying opportunities.
Prior to COVID-19, real estate investment crowdfunding marketplace RealtyMogul Co. had tracked a lone transaction featuring a hotel-to-multifamily conversion, according to its CEO, Jilliene Helman. By February of this year, RealtyMogul had seen five additional transactions of this type submitted to its platform, though the company opted not to pursue deals in those cases. Earlier this year, the company had a deal go live featuring the historic mill Everett Mills, in Lawrence, Mass., which is being converted into a development featuring what it bills as affordable multifamily units and renovated office space and other mixed-use.
“We’re actively looking for hospitality-to-multifamily conversion,” Helman said. “They are going to be, in general, more affordable than other multifamily in the submarket, because the floor plates are smaller.”
According to Helman, it’s conceivable that a hotel could be purchased for around $40,000 a unit and the same amount put into refurbishments, and then be sold for $120,000 a unit. One factor making these conversions so affordable is the over-lap between hotel and apartment design: plumbing and unit layouts often remain untouched, so generally a kitchen update and overall refresh are all that’s needed.Hotel economics have shifted in favor of these projects in the wake of the pandemic.
“Most well-located hotels were not in distress pre-COVID — they were performing,” Helman said. But with tourists largely staying home, whether by choice or by government mandate, many hotel operators are struggling, particularly smaller, independent operators that do not have access to the cash reserves that chain hotels do.
Over 3,100 commercial mortgage-backed securities — representing some $87 billion in debt — are backed by hotel properties across the U.S., according to real estate data firm Trepp LLC. Lodging is the third- largest property type in the CMBS universe by outstanding balance. In June 2020, the lodging sector’s delinquency rate hit a record high of 24.3% before falling back to 19.43% by autumn. In some metro areas, the delinquency rate was much higher. In Houston and Chicago, Trepp reported, over half of the outstanding balance for hotels was delinquent as of November.
Over a third of the outstanding balance of lodging-related debt is scheduled to mature by the end of 2021, which could compound the sector’s issues at a time when revenue has dropped by upwards of 60% per available room on an annual basis.
While politicians may devote attention to converting office space into housing, the sector has remained relatively resilient for now. The delinquency rate for office CMBS was only 2.5% as of October. Companies continue to sign leases — but that is expected to change over time, on a localized level, analysts say. The pandemic accelerated a shift to the suburbs and an embrace of work-from-home technologies that could stress office-building occupancy in major cities.
“Companies are realizing that all work does not have to be done at the office,” said Nick Bailey, chief customer officer at RE/MAX.