Pandemic forces struggling hotels to convert to apartments



WASHINGTON (March 24, 2021)—For more than 40 years, the Georgetown Suites Hotel, located in one of Washington's most desirable neighborhoods, was a popular lodging spot for business travelers and tourists visiting the nation's capital.

But the hotel shut its doors in November, as demand for hotel rooms weakened due in part to the coronavirus pandemic. Soon, however, the property will reopen—but as an apartment building catering to affluent professionals.

"Housing is always a really good alternate use for buildings that are empty," said Donnie Gross, a principal at Bethesda-based Varsity Investment Group, which acquired the 224-room hotel in December. The Georgetown Suites is attractive as a conversion project, according to Gross, because the location is irreplaceable and the rooms were already sizable and included kitchenettes.

The office space and conference rooms that once served the hotel's guests will become a gym, game room and lounge area for apartment tenants. The building, currently under renovation, is set to open in June.

In many cities across the United States, the hospitality business is in crisis. That has prompted some struggling hotel owners to repurpose their properties for residential use, taking advantage of high apartment rental rates and strong demand for living space.

Operating profits for hotels declined 78% in 2020 when compared to 2019, according to Ben Klein, senior director at Coldwell Banker Richard Ellis (CBRE), a real estate services and investment firm. Falling profits are making it difficult for hotel owners to pay their mortgage debt. The hotel mortgage delinquency rate in December 2020 was 18.38%, up sharply from just 1.41% at the end of 2019.

Even though travel has started to pick up in recent weeks, some experts believe it will take several years for the hotel industry to fully recover. To survive the downturn, some hotel owners "may feel that they are better off converting into a more arguably predictable income stream," said Jan Freitag, a senior vice president at Smith Travel Research, which tracks the hotel industry.

Traditionally, hotels have been more profitable than apartment buildings because the daily cost of renting a hotel room was considerably higher than the daily cost of renting an apartment by the month. But in the current business climate, that formula has been turned upside down, in part because there's an oversupply of hotel rooms and an undersupply of apartments.

"The value of hotels has fallen enough and the value of apartments has risen enough" that it makes sense to convert, said Joshua Bernstein, chief executive of Bernstein Management Corp., based in Washington. He added that the high cost of constructing new apartment buildings and the scarcity of land in the Washington area are additional factors driving conversions.

In September, Bernstein acquired a 50% joint venture interest in the Virginian Suites hotel, in Arlington, Virginia. The property is currently being renovated and will open as a luxury apartment building this summer.

One of the busiest cities for potential hotel conversions is Baltimore. Even before the pandemic reduced travel to Maryland's largest city, Baltimore's hotel industry was struggling due to perceptions that the city is unsafe, according to industry analysts.

Those perceptions were partly related to weeks of protests that occurred in the spring of 2015, after a 25-year-old African-American resident named Freddie Gray died while in police custody. The death sparked weeks of unrest that led to hundreds of arrests and more than 300 businesses being damaged.

The protests "helped give Baltimore a black eye and made it difficult to attract group/convention business to the city," said Mike Muldowney, an executive vice president at CBRE. With the pandemic hurting business travel even more, "the conversion of certain properties to multifamily units seemed logical."

CBRE is currently marketing several Baltimore hotels that are expected to be converted to apartment buildings, including an Embassy Suites, a Crown Plaza and a Radisson Complex near downtown. The Crown Plaza and Radisson properties are currently owned by the McSam Hotel Group and the Embassy Suites is currently owned by Starwood Capital Group and the Schulte Hospitality Group.

"Although it will be necessary to combine rooms to make larger units," said Muldowney, "the locations are central to a number of walkable employers in the central business district of Baltimore."

Some public officials in the Washington area see the hotel crisis as an opportunity to increase the supply of affordable housing.

In high-cost housing regions such as Washington, converted hotel rooms—which tend to be smaller than traditional apartments—could provide relief for renters who can't afford higher-end apartments.

In 2019, the Metropolitan Washington Council of Governments found that the metro area needs to add 320,000 housing units by 2030. At least 75% of that housing, the council said, "should be affordable to low- and middle-income households."

Repurposing commercial real estate as housing dates back to the 1950s, although the trend didn't pick up momentum until the 1970s when real estate developers converted shuttered factories to loft apartments and condominiums that attracted artists and young urban professionals.

In the 1990s, when firms started to relocate from outdated office buildings to modern glass towers, some of the older buildings were converted to apartments.

Between 2010 and 2020, more buildings were converted into apartment buildings than during any previous decade, according to a report by RENTCafe, a real estate listing and research service. Hotels have been one of the most popular building types to be converted into residential living, second only to factories.

Hotels would appear to be relatively easy to convert since they already have existing bathrooms and amenities that renters find attractive, including gyms, swimming pools, dog parks and trendy common areas.

However, hotel-to-apartment conversions are much more complicated than they appear, said Varsity's Gross. Varsity has found that it's often necessary to combine multiple hotel units to create a space large enough for an apartment. That requires removing walls, demolishing extra bathrooms while adding kitchens.

Conversion projects also can face roadblocks due to zoning, licensing and other legal requirements.

B.F. Saul Co., a real estate company based in Bethesda, Maryland, had plans to convert a 300-room Holiday Inn hotel in Gaithersburg into affordable housing for senior citizens. To complete the conversion, the property would need to be re-zoned from commercial to residential use. But Saul got into hot water with local officials several months ago when it tried to bypass the rezoning process.

"The Saul team attempted to use a clever legal interpretation to create a shortcut in the process and not go through the rezoning," Gaithersburg Mayor Jud Ashman said. "The city did not allow them to take that shortcut, and so I do not know where the project stands at the moment—or whether they intend to move forward with the rezoning."

Saul didn't return calls seeking comment.

Real estate investment firm MRK Partners had better luck in 2018 when it converted the 140-room Hyatt House Hotel in Gaithersburg into an affordable housing complex for residents aged 62 and older. The complex, now called Hillside Senior Living, is located six minutes from the Shady Grove Metro Station and is managed by Franklin Johnston Group, according to its website.

Even before the pandemic, Varsity was converting hotels to apartments. Although the company is best known for building off-campus student housing near colleges across the United States—including the University of Maryland in College Park—Varsity also develops market-rate and active-adult housing communities.

In 2017, it converted the former Saint James Suites hotel in Washington's Foggy Bottom neighborhood into Varsity on K, a student-oriented apartment building near George Washington University.

Alexander Schwarz, 24, lived at Varsity on K from 2017 to 2018 during his senior year at George Washington University. Schwarz said his primary reason for choosing the building was its location and the Varsity's reputation, but the fact that it used to be a hotel was an interesting piece of history as well.

"It got my attention for sure," he said.

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