One Solution to the Affordable Housing Crisis Might be Right in Front of Us
As housing prices continue to rise to record levels across most markets throughout the United States, buying a home or renting an apartment at an affordable price is becoming more prohibitive for many middle and low income Americans. During 2010 through 2020, housing completions for single-family and multifamily housing were 6.3 million units short of the demand arising from household formation and the need to replace housing that has been lost due to demolition and obsolescence.
Converting underutilized hotels and motels into affordable and workforce housing could be a practical and cost-effective method to help address the affordable housing crisis in the United States. In 2020 the national hotel occupancy rate plunged to 37%. The American Hotel and Lodging Association expects a full recovery of the lodging sector by 2024 based on revenue per available room. Though, as demand for lodging recovers, stiff competition from short-term rental providers like Airbnb and Vrbo, along with a permanent reduction in business travel compared to pre-Covid levels, will continue to plague the long-term viability of many hospitality assets.
Airbnb now has 4 million hosts globally and as of 2020, Airbnb’s gross worldwide booking value of $23.6 Billion exceeded the combined gross revenues of Marriott International, Hilton Worldwide, International Hotels, and Choice Hotels International. While the hospitality sector continues to face headwinds, repurposing these projects into much-needed housing may not only be a social-good, but good business for developers and real estate investors.
According to a survey by the National Association of Realtors, 64% of hotels/motels that were converted into multifamily housing involved limited-service hotels. Based on the same survey, 53% of hotel/motel conversions cost less than $25,000 a room in construction costs and 54% of conversions were acquired at less than $50,000 per room. That brings the all-in project costs for hotel/motel conversions to less than $75,000 a unit on over 50% of these projects, well less than the project costs of ground-up multifamily development on a per unit basis in almost every housing market in the United States. It is estimated that converting hotels into multifamily housing costs about one-half the price of new construction and can be brought online much faster, saving additional interest payments on a project’s construction loan.
There is already some public momentum for these types of projects. In June, the New York State Legislature passed a bill to allow the conversion of some distressed hotels into affordable housing. The state’s latest budget appropriated $100 Million to fund the purchase and conversion of hotels or office properties into housing.
Extended stay hotels are best suited for apartments because they generally have kitchenettes already built in. Prices for extended-stay hotels have dropped about 15%-20% from their pre-pandemic levels. Converted hotels can also be particularly appealing to millennials who would rather live in a converted hotel room than in a traditional apartment where many young professionals end-up paying 40%-50% of their gross income in housing costs. Living in a smaller and more economical unit allows young people to save-up a greater proportion of their income to buy a home later in life.
Zoning regulations have posed the greatest challenge to getting hotel/motel conversions over the finish-line. 55% of hotel/motel conversions nationally have required a zoning variance according to the National Association of Realtors survey. Zoning can also make it more challenging to receive financing. When developers rely on Low Income Housing Tax Credit (LIHTC) equity to fund their projects, zoning will determine whether or not affordable housing can be built at the site.
Yet in spite of having to receive a zoning variance to convert many buildings from a hotel/motel to multifamily housing, conversions allow multifamily operators and investors to buy into assets at a favorable basis. In addition to lower all-in project costs compared to ground-up development, the average cap-rate in the hospitality sector nationally was 7.7% based on transactions of at-least $2.5 Million as of February 2021. This compares well to national multifamily cap rates that were on average 3.8% as of the first quarter of this year.
Converting hospitality assets into multifamily housing could continue to serve as a pragmatic and effective tool to help alleviate the nation’s shortage of affordable and workforce housing. Look for hotel conversions to pick-up steam as there seems to be bipartisan support for dramatically expanding tax-credit allocations to states for affordable housing. The Biden administration has presented a plan that would increase federal spending on housing by $318 Billion, of which $105 Billion would be used to fund the tax-credit program.
These funds could make it easier for developers to get conversions off the ground and ultimately help to provide much-needed housing units around the country.
 NAR estimate based on US Census Bureau net household formation (March supplement), housing completions, and 0.4% of housing lost to demolition or obsolescence.