The Rush To Convert To Multifamily: Why Hotel Deals Are On The Rise, But Offices Are Lagging Behind

To meet the staggering demand for rental housing, the U.S. needs to build 4.3 million multifamily units by 2035. Add to that the fact that the National Low Income Housing Coalition estimates that the country currently needs 6.8 million more affordable units for families in need, and it would seem as though the time to start building more multifamily homes was yesterday. 

Vacant and underperforming hotels have long been touted as a possible solution to this problem. Today, as many companies have transitioned to work-from-home models, some cities are exploring the idea of converting underused office buildings into multifamily units. However, making this switch is easier said than done, said Peter David Ballance, a real estate partner at Stroock & Stroock & Lavan LLP, which among its many services, advises clients, including real estate lenders, on the legal issues surrounding asset conversion projects.

“Unlike hotels, office properties aren’t set up to handle the building systems that are required for multifamily housing,” Ballance said. “As a result, the high cost of making these conversions often gives lenders pause.” 

Bisnow sat down with Ballance and Stroock real estate partner Lorie Soares Lazarus to learn more about the trend of converting assets into multifamily housing, why more hotels may be making this switch and why offices can be tricky choices for these projects. 

Bisnow: Will we start to see more hotels converted into multifamily housing? Why or why not? 

Ballance: Single-family residences are no longer considered the 'end all, be all' when it comes to housing. Younger generation professionals more often want to be in cities, closer to work and the things they want to do, and increasingly, baby boomers are tired of taking care of big suburban houses and are moving into multifamily buildings in urban areas. This is driving the need for creative multifamily solutions, and as hotel occupancy went down during the pandemic, more owners considered making the switch. However, the hospitality industry has seen a rebound since the end of the pandemic, so it’s complicated. 

Lazarus: I do not think we would be having this discussion about hotel conversions if it were not for Covid, since prior to the pandemic, hotels were considered a pretty solid asset class. However, the growing need for multifamily and affordable housing in major cities, paired with low occupancy hotels experienced during the pandemic, is driving people to rethink how assets are being used. But as Peter said, it may already be too late, as travel and hotel occupancy continue to rebound. 

Bisnow: Are conversions of office buildings and hotels to multifamily housing financeable?

Ballance: There has been a lot of talk about office conversions, but the cost can be a prohibitive factor — the floor plates are often too large, the plumbing is different, necessary systems are not in place, the list goes on. For these reasons, from a financing perspective, many traditional lenders right now are only considering the worth of the land in their underwriting, not what the worth might be after a conversion. Older, historic office buildings may be physically easier to convert to residential, particularly to less traditional residential concepts, like 'dorm-style' living, which we are starting to see. It may, however, be harder to accurately predict construction costs for older, historical buildings because of unknown conditions.

Lazarus: If a lender is not considering the stabilized value after conversion and just treating the conversion as ground-up construction, office conversions often won’t pencil out when you factor in the significant improvement costs that come with those conversions. Potential cost savings, like tax credits and affordable housing programs, can make a conversion easier to pencil out by offsetting costs. Hotels and assisted living facilities, however, are already set up for residential occupancy so these conversions are much more financeable.

Bisnow: What are some of the unique underwriting issues for lenders?

Ballance: With respect to office, in addition the issues surrounding how lenders will value properties undergoing this type of conversion, they will want to see entitled properties. A bank client recently commented that they would have little appetite for lending on a property that is not entitled for multifamily use upfront, and if they did have any interest, it is likely that underwriting would only consider the land value. Along with that, there may be other diligence concerns that need to be managed, such as prohibitions on residential use in existing space leases, ground leases and CC&Rs. 

Lazarus: With hotels, however, lenders will typically look at it as a construction or renovation loan since it is already set up with many residential features. It’s typically a smaller loan, not as much is required in terms of renovation, and the time period to occupancy and income is shorter, so it’s easier for lenders to get their arms around it. 

Bisnow: Where are these conversions the most feasible?

Lazarus: If we’re talking about hotel conversions, it comes down to where people want to live. Our clients are seeing that younger residents don’t necessarily want to own a house; they want more flexibility and to be near a city center. So really, any place where that is happening you could have a successful hotel conversion. 

Ballance: For office, however, it is generally more feasible in big cities with higher land values. If you get into places where land values are lower it may not make sense given the high cost of conversion. 

Bisnow: What are some recent conversion deals you’ve worked on? 

Lazarus: We’ve worked on financing quite a few conversions of hotels and assisted living facilities into multifamily buildings in markets both large and small, across the U.S. including in California, Texas and Tennessee.  

One interesting trend we’re seeing is we have helped create some ‘dorm-style’ living buildings in certain markets like Southern California. These buildings feature bedrooms with private bathrooms and a common area that is shared between units. This is proving to be very popular for people transitioning from home or college to their first rentals.  

Bisnow: Where do you see this trend heading in the future? 

Ballance: I think as the world continues to reset from the pandemic, there will be a lot more discussion around these types of deals, but I don’t think we will see an avalanche of office conversions outside of large cities. Hotel conversions, however, may continue to rise. 

Lazarus: It really comes down to financing: You have to get lenders on board to make something broader than just a few one-off deals. For hotel conversions, lenders are open. They are not quite there yet when it comes to offices. 

This article was produced in collaboration between Studio B and Stroock & Stroock & Lavan LLP. Bisnow news staff was not involved in the production of this content.

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