Does it Pay to Convert?
I had recently received a lot of calls from investors wanting to convert motels and hotels into apartments. It’s a great idea and I want to talk about what you should look out for should this also be of interest to you. First, let's define the difference between a motel and a hotel. Hotels typically have hundreds of rooms and several different floors. They generally have staircases, elevators, and interior corridors that go to the front doors of the rooms. Extended stay hotels are the ideal conversion prospect because they're typically larger units, 400-500 SF, and they have kitchens. Motels on the other hand are typically one or two floors and the guests access their rooms directly from the parking lot. They have open-air corridors and staircases and usually only range from 200-300 SF. Most motels are smaller, older, owner-operated assets that are in secondary or tertiary markets. The big hotel brands typically won't put their names on these types of buildings, which is one of the reasons why a lot of motels struggle. There are several reasons why these motel/hotel conversions are a good idea. For one thing, they often have a lower acquisition price, especially since COVID, which has caused a lot of disruption in the hotel and motel world. Many of these smaller motels won't be able to recover. This of course increases vacancy, it lowers the per night rent stay and allows investors to pick up these assets at a reasonable enough price to compensate for the large cost to convert to apartments. Due to the high cost of homeownership these days, there’s a high demand for rental housing. This has caused a great shortage. That and a bunch of other reasons put us so far behind in building enough units to keep up with rental demand. The apartment projects that are being built are pricing many renters out of the market. Converting motels and hotels to apartments is a heck of a lot faster than building from the ground up. Most of these conversions, depending on the zoning hurdles, can take under six months to complete. New construction of apartments can easily take 18 months plus. Apartments are more stable than motels on the cash flow, which allows them to get better capital and trade lower on the cap rates when they go to sell in the future. Finally converted projects can deliver fully renovated units oftentimes up to 20% below comparable rental units. Now let's quickly go over 10 things to look out for when you're doing motel hotel conversions. You’ll probably need to register a change of use on the property, which means there are going to be building code changes and zoning changes. It's the very first thing you want to find out before you even get involved. If the respective planning department isn't going to allow the zoning or use change move on. You want to make sure the location is really good. Duh. But think about it. If a motel or hotel isn't doing well it's oftentimes not doing well because it's in a bad location. No matter how cheap you can pick up the motel or hotel, move on. Most hotels are set up as either studios or one-bedrooms. If the market is calling for more studios and/or one-bedrooms, great! But most markets really also like to have two bedrooms and depending on the construction and the location of the structural components, it might not be possible or will be cost-prohibitive. It can also be challenging if you're looking to combine units or add bedrooms if a hotel is two or more stories. Typically, they're built with the bathrooms stacked on top of each other for plumbing and venting purposes. So, if bathrooms have to be added or moved the challenge will come in lining them up. The biggest challenge in conversions is typically the kitchens. If they already have full-size kitchens with full-size appliances that make it easier. Unfortunately, that isn't usually the case. And you'll definitely want to have full-size kitchens because if you sell in the future the buyer can get institutional financing through Fannie and Freddie as that's one of their requirements. Many hotels will have amenities that don't make sense for apartments, like commercial kitchens, big meeting or conference rooms, commercial size laundry facilities, restaurants, and bars. Some popular apartment amenities to replace these are larger gyms, game rooms, 24-hour clubhouses, one-room home office rentals, a movie room, study areas, and even converting conference or meeting rooms into climate-controlled storage units. Another thing to look out for is fire sprinklers. Many of the motels under old building codes don't have fire sprinklers, and the change of use is going to require them. From my research, fire sprinklers are running anywhere from $2-$7 per square foot of sprinkled area. These deals are actually really hard to find. They're hard to find because the location has to work and a lot of these motels and hotels are in bad locations. The layouts have to accommodate a full kitchen and still be viable. Zoning has to allow it. The purchase price has to be low enough to make the conversion costs work. Oh, and you need to have an experienced contractor. Finally, one last thing you have to look out for is overbuilding. You need to do your homework. Check with brokers, planning officials, permit trackers, and local engineers to see what’s in the pipeline for new development and other motel hotel conversions. Don't get caught up in the craze. As a broker, I’ve seen it a million times where the new sexy thing is what everyone starts doing hotel to apartment conversions and then lots of folks get caught with their pants down.
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