Creativity reigns as office, hotel conversions rise

Market specialist Malcolm Davies at WAY Capital believes there is a need for more pragmatism and creativity around office conversion projects.

While capital can still be difficult to line up for office-to-multifamily and hotel-to-multifamily conversions, US real estate debt investors are increasingly looking for creative ways to tap into these trends in a bid to navigate broader market uncertainty.

Malcolm Davies, founder and senior managing partner at Los Angeles-based capital advisory firm WAY Capital, believes there needs to be more pragmatism and creativity around these types of conversion projects. Transforming under-occupied Class A office space into niche residential or a mix of hotel and multifamily, and transforming hotel assets into multifamily are some examples of ways to tick that box.

“We have to think about what else we can put on the site and how to think of the capitalization,” Davies told Real Estate Capital USA. “It’s about creating value in places where others may or may not see them.”

“The office to residential and/or hotels is more difficult than the hotel to multifamily conversions,” he added.

Working with borrowers and lenders to convert properties into new uses is part of WAY Capital’s business plan. The firm is working on an office restructuring project in Miami, and last year completed a deal in Arizona where the first few floors were converted to hotel and the top 15 floors remained as office. WAY Capital has also completed deals of this kind in Houston with T2 Investments, Colorado Springs with Parkview Financial and in Salt Lake City with Pacific Western Bank.

The trend goes beyond obsolete offices, Davies said.

“We have executed over 10 of these capitalizations from a Holiday Inn in Sacramento to a Sheraton Four Points in Houston to a Hotel RL in Salt Lake City,” Davies said. “Conversions occur when the functional obsolescence of the property exceeds its future use as a hotel and can be sold for a price that is cheap enough to renovate the property for multifamily purposes.”

The firm, which is active throughout the capital stack, has been highly active in the build-for-rent markets, co-living and finally in the hotel to multifamily conversion space as a limited partner.

“[Our] general thesis is there have been a heck of a lot of hotels built in the US over the past few years and when a new hotel is built in a downtown market in any city, there is a hotel that was likely built 50 or so years ago that simply cannot keep up any longer,” Davies said.

Thus, they become perfect candidates for conversion.

“When you combine that with a housing crisis like we’ve had for many years, these conversions are a great solution,” Davies added. “While the amount of interior unit space may be smaller, the whole rent check is significantly less than traditional apartments which are a far greater cost to build. The phrase we like to use in this space, is this is this is an attainable housing solution, one in which the private sector is helping provide solutions to without any government subsidies.”

Davies described these types of conversion financings as difficult.

“But there has to be significant discount for these types of properties,” Davies said. “Especially for suburban distressed deals, where the developer is converting only a portion of the office building.”

Davies concluded: “But all development issues considered, it can still work.”