- Developers have long been converting offices and hotels into apartments.
- They promote the practice, called adaptive reuse, as borrowing and building costs soar.
- An investor plans to convert hotels in Washington into housing for low-income people.
Some property developers are increasingly targeting offices and hotels for conversion into apartments because, they say, these projects are the only ones that make financial sense at the moment.
Such conversions – known as “adaptive reuse” – are nothing new, but investors say they are becoming increasingly attractive as a strategy, especially for real estate sectors that have become underutilized or struggling in the pandemic economy.
For many developers, finding cheaper new projects is a priority as they are trapped by seemingly inexorable increases in inflation, construction costs and interest rates. Banks are also tightening their purse strings on riskier long-term projects that could be shelved in a recession, said Emily Hubbard, co-founder of Sage Investment Group, a real estate investment firm that does renovations and multi-family conversions.
What hasn’t changed, Hubbard added, is the need for housing across the country. “It’s in the forefront of everyone’s mind,” she said.
So Sage, which manages more than $50 million in real estate, is converting an Econo Lodge and a Travelodge in Tacoma, Wash., from extended-stay hotels to low-income housing, Hubbard told Insider. The company spent a total of $14.2 million to acquire the properties, which Hubbard described as “rundown”.
Hubbard said these opportunities arise more frequently.
Conversions can help rejuvenate run-down properties
“There are a lot of business owners who had to dip into their financial reserves during the pandemic and are now selling their assets,” Hubbard said. She added that with the motel purchases, “we’re also revitalizing something instead of building new, so it’s good for the environment and the local community as well.”
Sage oversaw very different projects before the pandemic.
In 2019, he acquired Sahara, a 173-unit student and short-term rental complex in Tucson, Arizona, for $8.5 million, and he spent an additional $2.7 million renovating the apartments. , which have been marketed to young professionals, according to The Sage site. That year, he spent $4.5 million buying and renovating the Olympic Village apartments in Tacoma, Washington, whose rents were raised to “market rate”, the website says. .
The website says both projects generated internal rates of return of 40% or more. Hubbard expects the Travelodge conversion to yield a similar rate of return once complete.
Conversions often satisfy the needs of developers and their lenders, as many projects can be completed quickly and relatively inexpensively. For example, Hubbard said Sage typically completes a conversion project in seven months, compared to three to five years for new builds.
Conversions were becoming more popular even before rising rates started hurting margins. Online rental marketplace RentCafe estimated that in 2021 developers completed more than 20,100 apartment conversions, nearly double the volume in 2020 and 2019 combined.
With conversions, developers also hope to capitalize on the increased demand for rentals as buying a home becomes less affordable.
The CoreLogic Case-Schiller Index shows the average U.S. home price rose more than 15% year-over-year in July, marking the 126th consecutive month of year-over-year increases ‘other. Meanwhile, financing these expensive homes has become more difficult – Freddie Mac said this month that the average 30-year mortgage rate exceeded 6% for the first time since 2008 and was more than double the rate of he a year ago.
Office properties with stubbornly high vacancy rates are prime targets for conversions
Sourcing these conversions could be easier in the years to come, especially as the offices remain empty. The CommercialEdge website reported in August that the average US office vacancy rate of 15.1% had not improved over the year through August, even as states eased restrictions for shared workspaces and that employers were begging their staff to resume their daily commutes.
By extension, the value of office space decreases, making conversion projects more profitable when financing can be obtained. A study by researchers at Columbia University and New York University released in June found that increased work-from-home opportunities may have destroyed more than $500 billion in future office value.
Tom Ralston, a developer who partners with Dwelling Place, a nonprofit housing developer in Grand Rapids, Michigan, said the office issues were an opportunity given the strength of the rental market. The company recently closed an 80,000 square foot office space in Wyoming, Michigan in August and plans to invest $32 million to convert the property into multi-family housing.
“It’s not necessarily repeatable in every vacant office building, but one that’s a creative reuse of a really well-built structure,” Ralston told the MiBiz website.
The same case could be made for hotels, which are still struggling to attract workers, Hubbard said. The Bureau of Labor Statistics said in September that the hospitality industry had lost more than 1.2 million workers compared to the February 2020 workforce.
Municipalities are pushing conversions
Developers are getting critical help from states and local governments, said Eddy O’Brien, co-founder of Blaze Capital Partners, a developer that has completed four conversions this year, including transforming a Homeward Suites hotel into The Spoke at McCullough Station, aa 124-unit multi-family project in Charlotte, North Carolina.
For example, Pittsburgh Mayor Ed Gainey launched a $2.1 million incentive program in July for developers to convert empty office buildings into housing. The program includes zoning reforms designed to facilitate conversion projects and funding from the US federal bailout, the Pittsburgh Post-Gazette reported.
But a lingering problem facing O’Brien and Hubbard is funding, which has become scarce since the Federal Reserve began raising interest rates to fight inflation. O’Brien said lenders originate loans but may seek projects that can be completed in a shorter time frame. He added that while conversions may meet this criteria, funding may still be difficult to obtain for developers without a track record.
Glenn Ebersole, commercial development manager at JL Architects in West Chester, Pennsylvania, speculated that construction finance problems would persist through 2023 and that developers who did not adapt would be “left in the dark.” dust”.
For the industry, it’s “the new abnormal,” he told Insider.
“There’s no going back to the way things used to work,” Ebersole said.