Mr. Glincher

Hospitality Law

New Hotel Development in Office Space Conversions

By Andrew Glincher, Office Managing Partner, Nixon Peabody LLP

The benefits of developing, building and opening a new hotel from the ground up in an urban, downtown metropolitan area are many. Closeness to attractions, whether they are major retail centers or sporting venues, and proximity to hubs of business and tourism are just a few examples of the benefits. However, metropolitan markets present significant barriers to entry for ground up development and construction of a new hotel. These barriers can prohibit and delay a project, which in turn can present significant added cost and unbudgeted expense for new hotel development projects.

The reasons for time delays and added costs are many, and include, among others, the following:

• Extensive permitting and zoning process:
  When considering new hotel development, it can take anywhere from two-to-seven years (including appeals) to get the go-ahead from the City just to begin building. It can and does take years to receive the appropriate approvals from permitting, zoning and other real estate licensing agencies for the construction and development of a new site and use such as a free-standing hotel. Factoring in a two-to-seven year pipeline merely to get the approvals to begin construction on a new hotel development is standard.

• Longer lead times lead to higher costs:
  Longer lead times make it much more difficult to predict and anticipate costs for construction, beyond planning for a reasonable rate of inflation and other straight-forward factors. For developers who began working on permitting and zoning for a new development two-to-seven years ago, how many would have anticipated that the cost of gasoline, for example, would have risen to the level it has today? Recently, we've seen the costs of construction increase 20-50% on some development projects. It's very difficult to forecast the costs of construction when you're working with a two-to-seven year advance timeline to secure appropriate permits and zoning approvals. The longer it takes to receive permitting on a project, the higher and more expensive the costs are bound to become to build the project.

• Uncertain demand:
  Longer lead times also make it more difficult to predict demand. It's difficult to predict demand for a new hotel development, two-to-seven years into the future. Neighborhoods may change and new developments, including other hotels, may open in the same area. While you're waiting for approvals, the area around your site may not only change considerably, but also the customer you are hoping to serve may change as well.

So rather than build a new hotel from the ground up, what are the advantages of converting existing office space into a new hotel? The advantages are many, of which just a few we will focus on now for the purposes of this article.

Existing Class B or Class C office buildings, if in an area where hotel or residential use is allowed, are ripe for conversion. When a market weakens for Class B or Class C office space, the space may be bought up by new owners and easily converted to other uses, so long as the zoning allows for it. For example, in the early-to-mid 1990s, Class B and Class C office buildings were hard to occupy in Boston. Universities were quick and smart to act, buying up these empty buildings and converting them to student dormitories. Now, boutique hotel chains and independent hotel owners are taking similar action and driving a new trend in hotel development across the country.

It is important to distinguish that conversion of office space into a hotel is most advantageous when the space is Class B or Class C. Class A office buildings tend to have longer-term leases and more space, making them less ideal for boutique hotel conversions.

By converting Class B or Class C space into a boutique hotel, developers have many factors on their side, provided hotel or residential use is already in place. These are just a few of the benefits:

• Building permitting is the main approval sought:
  Rather than needing both the zoning and permitting approvals required for brand new construction and development, conversions of existing office space may require only a building permit to officially start the project. This drastically reduces the amount of time needed to plan for approvals. In Boston, for example, obtaining a building permit to convert offices into housing takes a substantially shorter lead time - often less than a year. Developers can start renovations often times within a year of when they begin to seek a building permit, a drastic shift from what could be a two-to-seven year lead time required of new construction in Boston.

• Less extensive construction:
  From a construction standpoint, the focus shifts to renovations of an existing interior space, rather than actual construction of a new property. Class B or Class C office space lends itself favorably for becoming renovated into a boutique hotel, because the sizes of individual offices are well-aligned to the general space of individual boutique-style hotel rooms. In addition, the overall size of a smaller office building lends itself quite well to the character of a boutique hotel. That is why many of the conversions of Class B or Class C office space tend to turn into boutique hotels with between 100 and 200 rooms. Lastly, when the project calls for an interior upgrade only (rather than an extensive exterior overhaul as well), the timeline to complete the project is much faster. In addition to being faster, the costs associated with the project are much less expensive because less work is being done when compared to the build-out of an entirely new construction.

In hotel development, a great location, high occupancy and high RevPAR are keys to success. The conversion of existing office space into new hotel development is just another trend to consider and evaluate as a way to achieve optimal success.

Kevin P. Joyce, a real estate partner at Nixon Peabody LLP, assisted with this article. Mr. Joyce specializes in the acquisition, development, leasing, permitting and financing of commercial real estate, both locally and nationally. He is particularly skilled with zoning and permitting of property in the City of Boston.

Andrew Glincher specializes in the negotiation and resolution of business and real estate disputes. Mr. Glincher has represented developers and owners of retail centers, hotels, movie theatres, office and industrial buildings and parks, utilities, restaurants, subdivisions, apartment complexes, assisted living housing complexes, long-term care facilities and condominium projects. Mr. Glincher is admitted to practice in Massachusetts, the U.S. Court of Appeals, Third Circuit, the U.S. District Court, District of Massachusetts and the U.S. Tax Court. Mr. Glincher can be contacted at 617-345-1222 or aglincher@nixonpeabody.com Extended Bio...

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