Anyone has experience leasing commercial space and turn into hotel?

Question

Hi all,

I am considering leasing an industrial space in Toronto and turning it into a boutique hotel. However, I have not seen many people leasing space for hotels, even though residential/Airbnb arbitrage is very popular these days.

I have a lot of experience running short-term rental/Airbnb, but not so much when it comes to renovation.

I am really interested to find out:

What is the industrial standard term to lease space for hotel, 20 years?

What type of due diligence I should complete on the property.

What other pitfalls I might encounter that I should be aware of?

Thank you all for your time!

Michael K Gallagher · Answer

I'm with @Evan Polaski on this one, I think I have the wrong picture in my head of going from essentially a manufacturing facility to a hotel?

But perhaps I'm not up on the Northern lingo!!??  If I make the assumption you mean leasing commercial space in general and turning it into a hotel I'd have the following questions and concerns:

- location, many industrial (commercial) buildings are close to highways, generally outside major metros, and in what we'd consider industrial parks. who wants to stay in a hotel in an area like this?

- Zoning - going from a non residential use to a residential use I can only imagine is going to be a nightmare.

- build out - while many commercial leases can come with TIA to help the tenant build out the space, many LL's will want the space returned to the state it was leased in at the end of the lease.  So even if you solve the first two on my points, and get the project approved I have to assume retrofitting a building to be a hotel (the plumbing solution alone!!!) would be astronomically expensive and prohibitive to the deal, and then you'd have to find an LL who is going to be ok with completely changing the use and layout/function of their building, effectively pigeonholing their building into only a hotel use for future operators to lease.

- I've heard of people doing this with office, but again the build out and retrofit is going to be absurd and most of these deals I've seen are a purchase/BRRRR situation.  AKA they buy the distressed or failing office asset, put in the money to retrofit and change it, operate it and then turn around and refinance or sell the building to pull the capital back out.  Essentially a sale leaseback.

- The most streamline way to do what I think you are talking about would be to lease out an entire apartment building, and then do the retrofit, which at that point is less intensive as all the infrastructure for residential is already in the building, but again, you'd need to find an asset that was distressed enough to be empty, or close to empty all at once for you to lease out and build out, and the question I have there is if its empty for you to lease, why would anyone want to stay there in a hotel?

I like the creativity and the idea, and certainly there is an opportunity there, but I think regardless its going to be crazy capitol intensive and likely the only way to do it would be to do a huge BRRRR or sale leaseback type deal.

Evan Polaski · Answer

@Patrick K., I am not sure if there is a misunderstanding in the terms you are using.

When I think Industrial space, I am thinking warehouses.  When I think boutique hotel, I am thinking something nicer, but ultimately synonymous with a Marriot or Hilton.

Am I misunderstanding what you mean by industrial?  Am I misunderstanding what you mean by boutique hotel?

Residential/Airbnb arbitrage, while risky, is effectively the same use.  Sign a lease on an apartment at $2,000/mo, furnish it, then airbnb is for $200/night.  Kitchen is in place, bathroom is in place, bedrooms, etc all exist.

Ultimately, I do not believe this is typically viable.  Look at the typical hotel footprint: long and shallow.  In many jurisdictions (likely all) every room will need a window as a secondary ingress/egress.  The typical warehouse is often a cube, meaning trying to subdivide it into individual hotel rooms means most would be fully interior.  Along these lines, the amount of work you would need to do to the existing exterior to add windows for those rooms would cost more than just building something new from scratch.

If you are intent on developing a hotel, you can find ground lease options, but even then, while that saves you the upfront cost of buying land, you will still be spending millions and millions of dollars on vertical construction.