What to know before pursuing a change of use
The pandemic has disrupted real estate demand, creating many opportunities for change-of-use redevelopment projects. Today, office spaces are becoming lab spaces to meet life science demand, extended-stay hotels are a jumping-off point for apartment communities, and big box stores can be turned into warehouses and distribution facilities.
While demand has been redistributed, achieving a change of use is not always easy. David Reina, a partner in the hotel practice of Morris, Manning & Martin LLP, which has seen several conversions from hotel to multifamily, says zoning is the primary consideration for investors pursuing such transactions. “When considering a change of use, the first consideration for a buyer is whether they will require rezoning or similar approval from a government agency,” Reina told GlobeSt.com. “In a number of urban jurisdictions, existing zoning may allow for hotel or multi-family use, with switching from one to the other requiring no approval or only an abbreviated or as-of-right application process – this is the ‘ideal.”
There are also instances where rezoning approval is required, according to Reina. “Depending on market dynamics and if the relevant zoning board or city council has indicated support for adding housing units, it could still be a good deal,” Reina says, advising that investors in this situation should hire a land use lawyer. who has experience and a positive history with the zoning board.
Once zoning challenges have been overcome, investors will need to assess whether the configuration of the property will lend itself to the new use. This includes everything from potential building challenges, like adding demountable walls to complying with ADA and other building code requirements. “These considerations should be taken into account even before negotiating a PSA, as the PSA will need to include, for example, an extended period of closure to allow the rights approval process to take place, should such approval be required,” says Reina.” And of course, sellers have to be okay with the deal failing if approval isn’t obtained – sometimes that’s more risk than a seller, even a seller of a active in difficulty, is ready to take.”
On the financing side, Reina advises working with a lender who understands the change-of-use process. “You need to work with a lender who understands what’s happening with the change in use, and that there may be a short period of time between closing the purchase and when the asset is operational as a than apartments,” says Reina. . “Most loans will also include a small building component to fund renovations.”
For hotel-to-multifamily conversions for extended stays in particular, Reina says there will likely be a pending tenant. “The pandemic has seen a marked increase in the number of tenants staying in extended stay products, particularly after the enactment of the federal moratorium on evictions,” says Reina. “However, most conversion renovation plans require the building to be completely vacant for at least some time, for example, if the electricity or water systems need to be upgraded. As a result, buyers are requiring sellers to deliver their fully vacant hotels at closing. To do this, sellers may need to provide cash incentives to remaining tenants. In these conversion projects, acquirers will also need to ensure that hotels are delivered free of charge and out of hotel franchise agreements.
Conversion deals inherently come with extensive due diligence compared to a standard deal or redevelopment project. “Vendors are also much more sensitive to the confidentiality of these transactions,” says Reina.