Adaptive Reuse: Office Conversion to Hotel
Case Study: Redevelopment of a Partially Constructed Luxury Hotel in a Revitalized Urban District
Opportunity Overview
Background
The project involves the acquisition and finishing of a partially completed hotel redevelopment project located in a revitalized urban district. This area has recently seen a resurgence, thanks to zoning changes and city efforts to combat homelessness and high-vacancy buildings. The asset is a 13-story, 180-room hotel with 20 suites, initially an office building. The previous owner defaulted on their construction loan, and the asset is being acquired free from all liens.
Why This is an Opportunity
Location: Property is located in one of LA's most vibrant neighborhoods, bustling with tourists, residents, and workers.
Adaptive Reuse: The asset is part of an adaptive reuse project, a trend in the submarket that provides higher than average returns to investors.
Financial Leverage: Acquired at a 41.5% discount compared to its 2018 price.
Brand Approval: Pre-approved by a National Brand Hotel for their luxury class flag.
Contractor and Amenities
The General Contractor for this project is known for their extensive experience in adaptive reuse projects in the submarket. The hotel will feature a range of amenities, including a mezzanine-level Piano Lounge, high-end restaurant, and rooftop dining & bar with panoramic views.
Market Analysis
Demographics and Trends
The revitalized district is densely populated and has a mix of art galleries, restaurants, and boutiques. The area is seeing an influx of both tourists and locals due to recent revitalization efforts. Tourism has grown 7% Y-O-Y. to 55 million in 2023.
Competitive Analysis
The hotel's luxury amenities and brand affiliation give it a competitive edge over other hotels in the area, many of which are of lesser brands.
Third-Party Market Study
A market study performed by an independent consultancy in May 2023 serves as the basis for the major revenue assumptions. The report included 5 hotels in the comparables data set, with 1,188 rooms. The average sale price was over 600k per room. The projected hotel occupants are 42% commercial, 33% leisure, and 24% group. Since a January 2022 appraisal, hotel rates in the submarket have increased by 22% and are forecasted to increase by 5% annually over the next several years.
Financials
Investment Structure
Offering Type: Private Placement; 506(c)
Hold Period: 2.3 – 3 years
Class-A Preferred Return: 12% Cashflow
Class B: 26.3% IRR
1st Year Ops Cash on Cash: 16.3%
Cost and Funding
Total Cost to Complete: $62.4 M
Loan/Debt: 75-80% LTC @ 9% Fixed Interest Rate
Total Equity Needed: $16.5 M
Sponsor Equity Contribution: $4+ M
Minimum Investment: $100 k
Refinance/Disposition Fee: None
Valuation and Underwriting Assumptions
As-Is Market Value (Jan 2022): $42.5 M
Appraised Market Value Upon Completion: $82 M
Appraised Market Value Upon Stabilization: $93.5 M
Potential Value Based on Comparable Sale: $109.9 M
Underwriting Assumptions: Based on the May 2023 Independent Consultancy Report
Sale Timeframe: July 2025 – March 2026 just before the 2026 Olympics
Partnership and Management
We have identified a specialized hotel development company as co-general partners for this project. They specialize in redevelopment and value-add of existing hotel properties and new hotel construction. They have a track record of over $1.2 Billion in hotel properties across the U.S. Their vertical integration strategy eliminates the need for third-party services, resulting in predictable and outsized NOI. Their management style and extensive experience in all aspects of hotel development and operations add a layer of confidence in the project's success.
Current Challenges
Financing Hurdles
The project is currently stalled due to difficulties in securing attractive loan terms in the current high-interest-rate environment. One loan has good terms, but the bank must open a division to accommodate the project and that will take several months. There are also uncertainties regarding further interest rate hikes by the Federal Reserve.
Geopolitical Tensions
Geopolitical tensions in Ukraine-Russia and Israel-Palestine are adding to the uncertainties.
Risks and Mitigations
Financial Risks: Risk of interest rate fluctuations can be mitigated by taking a fixed-rate loan or loan with rate cap. The General Contractor's reputation and experience in adaptive reuse projects can minimize the risk of cost overruns.
Market Risks: Economic downturn and market saturation. The asset's prime location and luxury amenities make it more resilient to market downturns.
Conclusion
The project offers a unique opportunity to capitalize on the revitalization of a bustling urban district. With strong financial projections, a prime location, and a reputable contractor, this investment presents a compelling case for high returns.
Next Steps
Alternative financing models such as equity partnerships, mezzanine financing, or international financing options will be investigated.