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REA
June 10, 2020  

Stressed Hotel Owners Eye Conversion Exits

As the hotel industry struggles through its worst-ever downturn, some owners are quietly examining whether it makes sense to shut their properties for good and market them as apartment-conversion plays.

Brokers say they’re receiving a growing number of requests to evaluate the potential of pitching hotels to multi-family developers. So far, few owners have been ready to pull the trigger, reluctant to sell at prices low enough to make the strategy work for a buyer. But market pros say that could change as looming debt payments increase the pressure to sell.

“Before the pandemic, whenever we looked at this, the numbers just didn’t pencil out unless you were targeting the uber-luxury [condominiums] or apartments,” said Jeff Sachs, senior managing director in JLL’s hotel group. But with many hotels shut down and others at rock-bottom occupancy due to the coronavirus pandemic, the calculation is shifting for a wider range of properties.

“Now, post-Covid-19, we have seen a decline in values,” Sachs said. “Hotels are simply not generating cashflow, they’re losing money and the owners are having to fund operating losses. While the hotel world will come back, conversions may be a good option for owners to maximize value.”

The travel restrictions, social-distancing regulations and economic downturn caused by the coronavirus crisis have slammed the hotel industry. As of June 3, nearly 60% of open hotel rooms were empty, according to the American Hotel and Lodging Association. On top of that, thousands of properties are shuttered completely. U.S. hotels have lost more than $31 billion in room revenue since the crisis began in mid-February, and at current occupancy rates and revenue trends, are on pace to lose up to $400 million per day, the industry group said.

The road to recovery is expected to be long and painful. Green Street Advisors, the parent of Real Estate Alert, forecasts lodging properties will take a 100% hit to income before interest, taxes and amortization this year, pushing down values by about 25% on average from pre-pandemic levels.

JLL’s Sachs said his team is fielding more inquiries from hotel owners asking them to study the feasibility of multi-family conversions. “In certain markets and for certain types of hotels, especially those that may have been struggling pre-Covid-19, the value reduction might now be enough to make a conversion possible,” he said.

The multi-family sector historically has proven to be more resilient during slow economic periods — and one of the first sectors to recover. A CBRE analysis of effective-rent changes found that apartments outperformed all other major property sectors in the 2008-2009 recession.

By their nature, with private rooms and extensive plumbing systems, hotels can be relatively simple to reposition as apartment properties. Mark Cohen, the Southeast managing partner at Woodland Hills, Calif.-based CGI Strategies, said the firm is “actively searching out” hotel conversion opportunities in a post-Covid-19 world. He said he’s particularly interested in properties with apartment-style units that have full kitchens or kitchenettes, because they are the ideal candidates.

“While there are challenges with converting a hotel to apartments, I do think there will be opportunities to make higher returns from these types of deals,” said Cohen, who is based in Atlanta. “Although we’re still in the early stages, I think you will start seeing more sellers on the hospitality side that are in distress and need to sell.”

In New York, a market that was already struggling with an oversupply of hotel rooms prior to the pandemic, pros estimate that thousands of rooms could be converted to other uses.

“We are anticipating that due to fragile market conditions, skyrocketing operating and fixed costs, and in some cases, functionally obsolete buildings, that a significant number of rooms in New York City alone will not be able to reopen and will likely have to be repurposed,” said Ron Danko, executive vice president in CBRE’s hotel group. “Obviously, multi-family is one of the primary alternative uses.”

Case in point: The 168-room Royalton Hotel in Midtown Manhattan is being pitched both to hotel investors and redevelopers. The owner, a venture between Rockpoint Group of Boston and Highgate of New York, paid $55 million for the property three years ago. What it could fetch now is unclear (see article on Page 13).

In California, meanwhile, some investors eyeing L’Ermitage, a luxury hotel located on a residential street in Beverly Hills, are contemplating a multi-family conversion. The property was among the holdings the U.S. government seized from fugitive Malaysian financier Low Taek Jho. A court-appointed special master has selected Keen-Summit Capital, a brokerage that specializes in workouts and receiverships, to oversee the auction.

As previously reported, CBRE is marketing the 300-room Embassy Suites Baltimore Inner Harbor as an apartment conversion. The seller is a partnership between Miami Beach-based Starwood Capital and Schulte Hospitality of Louisville, Ky. The venture acquired the 37-story upper-upscale hotel, at 222 St. Paul Place, in 2017 for $46.6 million, or $155,000/room. A current valuation couldn’t be learned, but market pros said it’s unlikely to reach its previous sale price.

Danko said the hotel market in Baltimore has been “extremely challenging for an extended period of time.” When testing the market for the Embassy Suites, “we got more interest and better pricing as a residential conversion,” Danko said. “It’s pretty much a foregone conclusion that the highest value in this particular situation is going to be realized as a multi-family conversion.”

Mike Muldowney, executive vice president in CBRE’s multi-family group in Baltimore, has consulted with a number of hotel owners evaluating the opportunity for conversion listings. Once investment-sales activity resumes in earnest, he said, “you’re going to see more of these in all major cities across the United States.”

That being said, some hotels aren’t viable candidates for a conversion, he noted. “There are a couple in Baltimore where we just walked away and said this needs to stay as a hotel because the layout is just not right. It’s really on a case-by-case basis.”

Even where the strategy makes sense, conversion offerings may take a while to emerge.

“We’re working with hotel owners confidentially,” said another hotel broker. “They don’t even want their lenders to know. It’s all on the hush-hush right now. Nobody wants to tip their hand that there may be a problem.” He added that the owners considering conversion plays today “had problems pre-Covid, and this crisis just pushed them over the edge.”