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Transforming Distressed Hotels Into Affordable Housing
June 1, 2021

Transforming Distressed Hotels Into Affordable Housing

by The CE Shop Team

Check Out This Hotel-Based Solution to America’s Affordable Housing Crisis

As the COVID-19 pandemic hit the United States, prompting travel restrictions and stay-in-place orders, hotel stays plummeted. Hundreds of millions of rooms sat empty in 2020.

Meanwhile, communities across the country have seen “an acute undersupply of housing,” with renting becoming increasingly unaffordable, the National Association of REALTORS said in a recent report.

In almost every state, low-income households — those earning less than 80% of the median household income — typically spent more than 30% of their income on rent in 2019, NAR’s report says. And in 2020, 23% of multifamily rental units rented for over $2,000 compared to just 12% in 2017.

Building new affordable housing can present challenges, though. Land, labor and materials, all of which were pricey before the pandemic, are even more so now, CNBC reported.

“That is why some creative developers are now turning to hotels — and it appears to be a match made in real estate heaven,” the CNBC article says.

Many Hotels Struggled During the Pandemic

The pandemic hit the hotel industry even harder than it hit retail real estate, CNBC reported. The share of hotels behind on their mortgages rose to just over 18% in December, up from less than 2% a year earlier.

“The hotel industry experienced the most devastating year on record in 2020, resulting in historically low occupancy, massive job loss, and hotel closures across the country,” the American Hotels and Lodging Association (AHLA) said in its State of the Hotel Industry 2021 report.

In April 2020, shortly after COVID-19 hit the United States, only ~25% of hotel rooms were occupied, AHLA’s report says. Although occupancy slowly rebounded as the year went on, only about 44% of hotel rooms were full in 2020, well below the 2019 average of 66%. (In total, the number of occupied rooms fell by 458 million from 2019 to 2020.)

In 2021, hotel occupancy is expected to average 53%, still well below pre-pandemic levels. AHLA doesn’t expect the industry to fully recover until 2024.

“While some full-service hotels begin breaking even at 50% occupancy, this does not account for mortgage debt service costs, leaving most hotels still well below their break-even point,” the report says.

In 2020, hotel room revenue fell by nearly 50% across the U.S., to just $84.6 billion. It’s expected to increase by $25.9 billion this year, still 34% below 2019 levels.

In another sign that the hotel industry is struggling, jobs in the leisure and hospitality sectors didn’t rebound as quickly as in other sectors, says NAR’s report. The unemployment rate was 13% in March 2021, slightly more than twice the national unemployment rate of 6%.

Converting Distressed Hotels Into Housing

real-estate

An increasing number of developers see opportunity in the industry’s suffering.

“These buyers are trying to take advantage of the hospitality industry’s crisis by taking over struggling or foreclosed properties at bargain prices,” The Wall Street Journal reported.

“They are also looking to profit from rising demand for cheap housing from households forced to downsize during the recession. The small but growing number of hotel conversions … is a symptom of the turmoil the pandemic has caused in the hotel sector. Many properties are shut down or running steep losses because of a drop in travel.”

Many hotel-to-housing conversions create affordable housing, NAR’s report says. In 65% of hotels and motels NAR studied that were converted into multifamily housing, the rent was either entirely below market rate or a mix of below-market and market rate.

Turning hotels into apartments works best in markets where the price of studios in new buildings has surpassed $1,000 a month, said Elan Gordon, principal of real estate investment company SHIR Capital, in an interview with WSJ. Hotel rooms that have been turned into studio apartments can compete by offering a 20% discount on rent, he said.

Extended-stay hotels work best because while they might still be smaller than the average apartment, many already have bathrooms and kitchenettes built into them.

SHIR Capital has converted hotels into hundreds of apartments in South Carolina and Texas.

“We are working within the market circumstances to kind of solve an affordable-housing problem, even though it’s not our business plan to create affordable housing,” Gordon told WSJ.

Lee Stuart, a 32-year-old concert promoter, lives in a 300-sq.-ft. studio at the Hedge, a former hotel north of downtown Austin. He pays $700 per month, far cheaper than the typical rent in his neighborhood.

“The whole millennial thing of spending 40% or 50% of your income on rent, it just doesn’t make any sense,” Stuart told WSJ.

“A Win-Win Solution”

“The conversion of vacant hotels/motels is a win-win solution to address the underutilization of hotels/motels and help alleviate the housing shortage,” says NAR’s report, which includes five detailed case studies of hotels that were successfully converted into housing.

Brandon Hardin, a NAR Research Economist, elaborated in a blog discussing the report:

“Adaptive re-use is not only economical but also can be more environmentally friendly in comparison to new commercial developments as adaptive re-use emissions, for example, are lower.

In addition, new commercial construction costs more than re-use by about a two-thirds on a per square foot basis. While the hotel/motel to multifamily conversion is not new, as revenues and occupancy sharply decreased as a result of the pandemic, investors are increasingly utilizing this property to help alleviate the housing shortage whilst providing some affordable housing options.”

While turning hotels into multifamily housing has become increasingly popular, it’s not the only use for the distressed properties.

Of the 187 hotel or motel conversions that NAR members were engaged in recently:

  • 60% were for multifamily housing, workforce housing, housing for veterans, or housing for health care workers
  • 12% were for homeless shelters, either temporary or permanent
  • 11% were for senior housing or assisted living
  • 8% were for student housing
  • 6% were for health facilities such as hospitals or quarantine facilities

But despite the difficult year that the hotel industry has endured, experts do expect the industry to recover. The number of permanent hotel closures has been relatively small due to federal assistance, mainly from the Paycheck Protection Plan.

The number of distressed sales hasn’t come anywhere close to the level seen during the Great Recession, NAR’s report says. Distressed sales due to the COVID-19 pandemic have totaled $684 million, just a tenth of the $6.7 billion in distressed sales during the Great Recession.

“While the hotel industry has seen better days, we can now see the clouds dissipating as COVID-related restrictions are being eased with consumers feeling better about going out and returning to some traditional activities,” Hardin said.

The hotel industry is likely to experience dramatic changes in the years to come, whether it’s from distressed hotels being turned into affordable housing or from a resurgence of travel after a year of pandemic-induced isolation. Whatever we do, we shouldn’t discount the opportunities this space provides.

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