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From room service to rehab, distressed assets are finding new life

Demand for “convertible” properties has skyrocketed over the past year

April 16, 2021

The skilled nursing and hotel industries, while improving, have faced pandemic-fueled challenges over the past year that resulted in empty rooms.

But real estate owners selling some of the underperforming properties and streamlining their portfolios are finding plenty of buyers, with an increasing number converting distressed assets into new uses that are in high demand, like affordable housing, behavioral health facilities and student accommodation.

For example, a skilled nursing facility outside the greater Boston area is on its way to being converted to affordable housing. Developer CK Asset Holdings Ltd. is converting two Hong Kong hotels into apartments to satisfy housing demand. In London, developer Dominv changed its plans for developing two hotels, making one of them into student accommodation instead. An abandoned former four-star hotel in Melbourne on the market is attracting attention as a re-development site.

“The trend of opening up these distressed properties to a much larger buyer pool is here to stay for the foreseeable future given the demand from a wide array of users,” says Jason Skalko, Director, JLL Capital Markets, Seniors Housing and Healthcare. “We are seeing more interest in behavioral health conversions, including rehabs, and there is unlimited demand for affordable housing.”

Converting skilled nursing facilities

More than 1,600 skilled nursing facilities in the U.S. could close in 2021 — more than 10 times the number that closed last year, according to a February analysis from the American Health Care Association and National Center for Assisted Living.

“Many of the properties identified for potential repositioning were not significant performers prior to COVID-19,” says Zach Rigby, Director, JLL Capital Markets.

“It makes sense to close the doors and focus on the more probable winners within a portfolio. Right now, there are many opportunities.”

Many of these properties are being snapped up by other skilled nursing operators.

“Often a large national owner looking to streamline its portfolio sells to either a regional group with an existing footprint or a group looking to enter a new market,” Rigby says. “We are currently marketing multiple properties within these parameters, all of which are receiving interest from a wide variety of conversion types as well.”

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Location is key for those looking to convert, Rigby says. Then, in order to make their deals pencil, buyers consider the existing layout of a facility in the hopes of keeping conversion costs low.

“There continues to be a deep bench of investors looking for high performing, best-in-class assets with excellent surrounding demographics” Rigby says. “The lower performing assets are ostensibly tougher, but also attractive to many buyers because of their affordability at a time when more affordable seniors housing, student housing, workforce housing, rehabs, behavioral health centers and housing for the homeless are all in high demand.”

Hotel conversions

Investors acquiring hotels for conversion isn’t new, with condominiums, affordable housing, student housing and assisted living long-standing options.

But interest in conversions has grown during the pandemic, sometimes leaving traditional hotel investors outbid. In the U.S., alternate-use investors are pushing pricing between 25 percent and 35 percent above traditional levels. Recent activity suggests the total market value of hotels sold for conversion over the next five years will range between $25 and $30 billion, according to JLL research.

“The types of investors that wish to do conversions have become more active participants in the hotel investment market, beating out other bidders in the hotel sales process not only because they are submitting the highest bids but also because they are able to more easily secure financing for acquisitions relative to traditional hotel buyers,” says Geraldine Guichardo, Global Head of Research, Hotels & Hospitality Group, JLL. “With hotel values coming under pressure as a result of the current challenged operating environment, alternative-use investor return requirements are being met or surpassed, even after taking into account capital expenditures and other conversion related costs.”

In Australia, hotels have been challenged by international border restrictions during the pandemic, while, strong pre-pandemic fundamentals are bringing a lot of new hotel supply to the market, says Annabel McFarlane, Senior Director, Research, Australia, JLL. At the same time, government stimulus measures and low interest rates are driving residential demand, leading to an uptick in conversions.

“An example of this is Queens Boulevard, which is an older hotel asset, which won’t be able to complete with new supply, in a cracking residential location,” McFarlane says. “It will almost certainly be redeveloped as residential, with residential unit sale prices increasing again.”

The bare necessities for conversion

There are many overlaps between the considerations for converting hotels and skilled-nursing facilities to other uses, Skalko says.

These facilities are ideal for multi-housing conversions when they have in-unit bathrooms and kitchenettes, which is more common at extended-stay hotels, he says.

Senior-living conversions benefit from full-service hotels because they have conference spaces that can be turned into general-purpose rooms and industrial kitchens allow for cooking meals for residents.

Low-cost conversions allow for the potential for affordable seniors housing in urban markets with high barriers to entry, which is a significant need, Skalko says. Fairstead, for example, is planning a $60 million adaptive reuse of a historic hotel on Manhattan’s Upper West Side into affordable senior housing.

Conversions into student housing are popular for many hotel layouts because they are similar and sometimes require only light renovation, Guichardo says.

The U.K. has seen a flurry of such conversions. The landmark former Hartlepool Hotel, most recently called the Hillcarter Hotel, for example, is being converted into studios and dorms for students.

“It’s typically not a big gut job and it gets heads in beds, keeping costs down,” she says.

But wait…

There isn’t likely to be mass conversions of hotels or other distressed assets, with the economic recovery and vaccine rollout underway. This is a good thing for owners who can hold out.

“High levels of vaccination have stabilized occupancy within skilled nursing facilities and we are seeing increased occupancy in seniors housing,” Skalko says. “While some took their relatives home during the height of the pandemic, a return to normalcy is giving some serious tailwinds to the asset class.These properties are needs-based, and we have an increasingly aged population.”

There is optimism, too, for hotels, as pent-up demand during the pandemic is released. 

“It’s important to keep in mind that while hotels are the first to see demand drop, they’re also one of the first sectors to see demand come back,” Guichardo says.

Kontaktieren Jason Skalko

Director, JLL Capital Markets, Seniors Housing and Healthcare

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