Walker & Dunlop is finding financial success while helping to provide high-demand, affordable housing in key markets by converting hotel assets into multifamily buildings.
Brian Cornell, managing director at Walker & Dunlop Investment Partners (WDIP), says his firm is identifying hotels that are already built out and can accommodate market-rate multifamily use. Extended-stay hotels have the best layout for this type of conversion because their footprint already includes the floor plans and many of the amenities that multifamily residents expect.
“The units are typically one-bedroom, but with some two-bedroom suites and studios,” he outlines. “This creates a variety of unit types within the existing physical build-out of the property, and these assets can operate as true multifamily without having to combine walls and do extensive capital renovations.”
When it comes to location, Cornell explains, “We prefer infill locations that have strong employment drivers and a dearth of affordable housing.”
Underutilized Properties, Multifamily Strategies
The three investments Walker & Dunlop has done in the past two years are in the heart of commercial corridors, in areas where there are limited multifamily projects within a two-to-three-mile radius offering rents that can support an 80 percent area median income (AMI) threshold.
One is Trellis Hunt Valley, located in an affluent commercial pocket north of Baltimore. Trellis Herndon, in Northern Virginia, near the Dulles Airport corridor, and Trellis North Fayette, located in a commercial hub just west of downtown Pittsburgh, represent two additional success stories.
At Hunt Valley, Walker & Dunlop spent about $35,000 per unit for a property that took 17 months from closing to fully reposition and stabilize. It is above 95-percent occupied and recently received an appraisal of more than double its basis over the course of just those 17 months.
“We’re excited to do similar strategies that make sense,” Cornell said. “This strategy works in a lot of major metros experiencing a sustained undersupply of workforce rental product and rapidly escalating construction costs. The suburbs of Denver and Philadelphia are other markets that we are considering.”
WDIP’s overall investment approach consists of identifying well-located but under-utilized properties within the property sectors that have the strongest long-term demand fundamentals (residential and industrial) to drive opportunistic returns. Extended-stay hotel conversions serve as a great example — in addition to their propensity for infill locations and convertible floorplans, these hotel assets witnessed a decline in demand during the COVID pandemic and have been further affected by the impact of work-from-home trends on business travel.
“We convert them to a higher and better use — multifamily housing — at a price point that’s in short supply and high demand,” he said. “Here, we can provide something that’s missing and is much needed.”
Cornell said another consideration is that Walker & Dunlop won’t take entitlement risk.
“One of the challenges of hotel conversions is that it’s hard to find properties where you can acquire the property as a hotel — before it’s already been converted — without taking some discretionary entitlement risk at the local municipality level.”
To smooth the process, Walker & Dunlop works with local operators and partners like Blue Ocean who can tie up these properties subject to a rezoning process. “Or we do the work upfront to confirm that the existing zoning is such that we can do the conversion by right,” Cornell explains.
“If the market doesn’t already have flexible zoning in place, it can be a difficult process to rezone hotels to multifamily because of factors such as infrastructure for school systems. You can get resistance from neighborhoods to convert hotel use to full-time living if those who live in that immediate area feel like full-time residents are going to be a burden on the local schools and services.”
Often Walker & Dunlop agrees to certain affordability criteria to get approval. For example, the company had to set aside 50 percent of the units at a maximum rent of 80 percent of AMI for the Trellis Herndon property.
“By embracing that long-term affordability component, the community had a positive response because everyone is looking for a way to provide more affordable housing,” Cornell said.
Practical Conversion Considerations
Cornell said from an execution standpoint, it was important to understand how best to underwrite, including keeping extended-stay residents in place while renovations took place unit by unit, slowly converting the buildings to accommodate longer-term tenants.
One benefit of market-rate multifamily product is that owners can use Fannie Mae and Freddie Mac financing, which is an important source of liquidity and favorable debt. “That resource is not available to hotels,” Cornell says.
“We went through a rezoning process solely for the benefit of being able to use agency financing on a permanent takeout loan,” he said.
Walker & Dunlop typically invests $25,000 to $40,000 per unit in capital improvements into these projects. That includes a full interior renovation of each unit, creating more storage for tenants. The conversion requires enhancements to the amenities and the property itself, such as pool renovations. It also converts hotel-centric space into meeting space.
Electrical work is the biggest challenge, according to Cornell. “Ideally, you have individual electrical meters for all multifamily units,” he said. “Most hotels are not designed to have that flexibility.”
“We’re trying to invest in properties where we don’t have to do a really heavy lift, and we’re working with partners who do or that have done this work for many years — people who know the process intimately. They have to be able to wear hotel and apartment construction hats.”
Partnering with Blue Ocean
Walker & Dunlop partnered with Blue Ocean out of Baltimore as its local operating partner. Cornell said “the stars kind of aligned” for this partnership for Hunt Valley, because Walker & Dunlop had done a half-dozen projects with Blue Ocean on the multifamily side in the past.
“We trust them,” he said. “They happen to also own hotels, and they had done a lot of the legwork upfront to create their own brand and platform, Trellis, designed specifically for this conversion strategy.”
Hunt Valley is in the heart of a commercial corridor with a ton of job drivers. “There are only five comparable multifamily projects in the area, and none offer rents anywhere close to the starting $1,500 a month rent that these conversions can offer,” Cornell said.
“By buying from a hotel owner, who hadn’t put a lot of money into the property and was dealing with some stress from COVID, we were able to get the asset at a price that allowed us to really undercut the market in terms of the rental rates we could offer,” Cornell says.
He looks forward to future projects combining Walker & Dunlop’s research expertise with experienced partners to offer communities much-need affordable housing options.
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