Over the last few years, there has been a trend for property developers to purchase underperforming hotels and convert them into multifamily apartments.
When an unprofitable hotel is converted to apartments, there is suddenly a whole new wealth of potential. Here, we explore why property developers are choosing to convert hotels to apartments, and how to make this business venture work.
Why Are So Many Hotels Converted to Apartments?
This phenomenon is due to a decreased demand for hotels, and a shortage in housing.
The hospitality industry struggled during the pandemic. Many hotels do not have the capital to renovate and keep up with maintenance as needed, due to the high vacancy rates over the last several years.
Meanwhile, there is a shortage of affordable housing across many cities and counties throughout the United States.
Many developers can buy distressed or underperforming hotels at reduced prices and perform substantial rehabilitation at a third of the cost of new construction.
Developers are buying hotels located in historic and downtown areas where there is high demand for apartment units with little supply.
Key Considerations to Convert a Hotel to Apartments
Whether you’re a hotel owner or a property developer, this trend has its advantages. Here’s what you need to know:
- Most lenders prefer ownership and management with prior multifamily apartment experience. Operating a hotel is very different from managing an apartment community. There will need to be an experienced management company involved that specializes in the management and lease-up of apartments.
- It is important for developers to work with architects to understand the options for converting the hotel into multifamily apartment units. Determining unit sizes and planning for conversion can be complicated depending on the hotel’s structure, as well as the plumbing and bathroom locations. Suite hotels are the easiest to convert. The developer needs to gain a good understanding of the structural capabilities of the building or buildings. Having a contractor involved early in the process will help evaluate the costs involved to see if the conversion is feasible.
- The hotel owner needs to be sure that they can comply with zoning laws, ordinances, and other town or city regulations. You also need to make sure that the hotel is in an area that can absorb the demand for apartment units.
- Once the developer feels comfortable with the costs, they can have a market study completed to determine the average rents and expenses to complete the construction budget and pro forma. This information can then be evaluated by a lender for a loan analysis to be completed.
Financing Options for Converting a Hotel into Apartments
If converting a hotel into apartments is something you’re considering, the HUD 221(d)(4) program is an excellent financing option to consider. It can also be used by those looking to significantly update existing multifamily apartments. For market-rate apartments, you’ll benefit from a high leverage 85% loan-to-cost, and for subsidized apartments, you can expect up to 90% loan-to-cost. During the first 24 months of construction, you are able to benefit from making interest-only payments. After this, the loan is converted to a fully-amortizing 40-year low fixed-rate loan. Your property will continue to be marketable during periods of high interest rates thanks to the assumable mortgage.
The development team will need prior multifamily or HUD experience; this includes the borrower or developer, the contractor, and the management company.
You should have the following items ready for analysis by a lender:
- A detailed pro forma operating statement including as much information as possible on the number of units, unit mix, as well as rent and expense projections.
- The estimated construction costs of the project.
- Market research that demonstrates the demand for additional units that can be quickly absorbed into the market.
LSG Lending Advisors can help you find the right loan for your multifamily apartment project. Schedule a free phone consultation with our team today.