Metamorphosis – The Ongoing Evolution of Hotel Conversions

Industry Insights

Jack Pulvirenti and William Saya

7.25.22 | Industry Insights

The sputtering recovery of the hospitality industry was given another boost when New York Governor Hochul recently signed legislation to smooth the way for hotels to convert to affordable housing.¹ Aimed at Class B hotels, the bill cut down on the time-consuming review and regulatory process and eased the path to obtaining financing in order to address the critical housing problem in New York. While significant, this move by the state is only part of the puzzle facing a hospitality industry that does not yet know the shape or character of a post-COVID world.

Whether the choice is a condo or office conversion, a change to affordable housing, or some new hybrid form that is still formulating in the mind of an innovator, there are an array of considerations that need to be fully explored before such a formidable step is undertaken.

Zoning and Other Restrictions

The Hochul legislation addressed, in part, the cumbersome pathway to conversions, but there may be other legal and zoning restrictions that could inhibit the particular conversion being considered. The legislation, for example, is aimed at developing affordable housing and has very specific terms including a requirement that half of the units be set aside for the homeless population. Older properties might have landmark status which means a whole set of limitations that will need to be weighed and restrictions to be respected.

Navigating Labor Agreements and Union Input

Some labor agreements may be costly and limit operational flexibility. It will be necessary to factor in the cost of terminating these agreements — which can be time consuming and expensive. Hoteliers will need to weigh this against the cost of continuing agreements that can no longer be sustained over the longer term.

Hoteliers will also need to consider the position of hotel unions who will have their say under the legislation.² Receiving the support of union leadership is critical to moving forward with a hotel conversion in the City.³  Since the bill is specifically targeted at Class B properties, many of which are in the outer boroughs of the City, there is some daylight. The unions may be more agreeable to conversions in cases where the hotel is failing and rundown with low pay nonunion jobs. They may be more likely to balk if the proposed conversion is a midtown property where union jobs could be placed in jeopardy. Interestingly, the just-announced conversion of Chelsea’s Stewart Hotel has gone ahead — with a union-ratified buyout of the workers — because it was an as-of-right property which means it did not have to go through the City’s rezoning process.  It has been reported that all of the hotel’s employees will be laid off as part of the conversion but will receive multiple months of severance. Going further, the employees will have priority status in obtaining jobs at the residential building.⁴

Physical Design and Structure

The existing layout of the hotel can be a strong indicator of the type of conversion to consider. As an example, extended-stay configurations which probably already have kitchens and luxury bath facilities will provide something of a head start for condo conversions. Many older hotels have very high ceilings which will need to be addressed when attempting to develop a property and meet today’s standards for greater energy efficiency.

Location, Location, Location

Those three prime words from the world of real estate also apply to the conversion equation.  Hotels in major cities that have sustained themselves on income from international travelers, corporate meetings, conventions, and similar grand scale events have been damaged by the long reaching aftereffects of the pandemic, ongoing inflation, and the current jitters associated with a recession-spooked economy. These properties may be prime for a conversion. On the other hand, hotels that serve traditional resort towns and strategically-placed leisure travel spots such as those on major highway hubs adjacent to Washington, DC and Miami may have less of an urgency for conversion. Similarly, properties located in an area that has a long history of attracting regular tourism and international travelers may prefer to wait out the current downturn in the hope of an eventual full recovery.

Risk Tolerance

Before making any decision, it would be prudent to analyze the projected returns expected from the transition. For example, how would the short- and long-term financials differ if an operating hotel was converted to luxury condominiums? When performing this analysis, the following must be considered:

• The cost of closing an operating asset — even if that asset is not operating at an optimal level,
• Raising the capital needed for a conversion with special consideration for rising interest rates, and
• Reasonable projections for the market in the short- and long-term.

It might be wise to examine several other scenarios. Conversion to low-income housing? Testing out the rental market? Consider researching the market outlook for the asset class being considered for the conversion. These exercises will provide the information needed to help assess the level of risk and determine if the potential rewards outweigh those risks.

Play Out The Timing, Gauge The Costs

Entitlements and redevelopment issues and costs will play an important role in the decision to convert. In some cases, the entitlement process can take substantial time due to bureaucratic lethargy. Depending upon the property’s structure, condition, and current configuration, the cost of redevelopment could vary considerably. If the hotel requires fewer structural changes to achieve the established operational and financial goals, then its potential for conversion is more attractive than a property that requires more sweeping and fundamental reconfiguration.

If you have questions about hotel conversions, contact Jack Pulvirenti at 212.331.7514 | jpulvirenti@berdon.com or William Saya at 212.331.7588 | bsaya@berdon.com or your Berdon advisor.

¹ https://nyassembly.gov/leg/?default_fld=&leg_video=&bn=A06262&term=2021&Summary=Y&Text=Y
² https://therealdeal.com/2022/05/06/hotel-bill-is-unions-latest-effort-to-boost-marketshare/
³ https://www.nysenate.gov/newsroom/in-the-news/michael-gianaris/gov-hochul-signs-legislation-expand-hotel-housing-conversions
⁴ https://www.crainsnewyork.com/real-estate/developers-convert-stewart-hotel-chelsea-625-unit-apartment-building