Podcast Summary: Real Estate Investing School Podcast – Episode 204. REAL DEAL: Converting Hotels to Multifamily with Mitchell Rice
Introduction
In Episode 204 of the Real Estate Investing School Podcast, host Brody Fawcett welcomes guest Mitchell Rice to discuss an innovative real estate strategy: converting hotels into multifamily apartment buildings. This episode delves deep into the intricacies of identifying, financing, and executing such conversions, providing listeners with actionable insights and valuable lessons from Mitchell's real-world experience.
Finding the Deal
Mitchell Rice and his team targeted Houston for its unique advantage of having no zoning laws, described by Rice as "a little bit Wild west" [00:00]. They identified an extended stay hotel in the Channel View area, a region with high demand for workforce housing. The property, known as RelaxInn, was being operated as a no-brand hotel by an owner who planned to franchise it under Red Roofs. However, financial strains during the renovation process made the seller motivated to sell [00:17].
Quote:
"The first hurdle with converting a hotel to an apartment is zoning. You've got to get the city on board, and a lot of them shut it down immediately because cities get more taxes from a hotel than from an apartment." – Mitchell Rice [00:00]
Financing the Deal
The deal was secured off-market through networking with a local hotel broker who recognized Rice's sophisticated investment approach [07:46]. Mitchell negotiated a seller financing arrangement where the seller agreed to finance half of the purchase price, becoming "the bank" with a $2.5 million note at a 2.5% interest-only rate over 24 months [09:12].
Quote:
"He became the bank, which is awesome. To do that with a big commercial deal like this is a little more rare than with single family." – Mitchell Rice [09:17]
Appraisal and Valuation
Rice explained the significance of the income approach in commercial real estate appraisals, particularly using cap rates. The property was initially purchased at a 12.8% cap rate based on an in-place NOI of $611,000, leading to a purchase price of $4.75 million [24:44]. Upon converting the hotel to multifamily, the property's valuation increased significantly as multifamily properties typically enjoy lower cap rates (e.g., 7%), resulting in a potential new value of approximately $9 million [30:08].
Quote:
"Commercial is figure out how to increase the income and you just create value just like that." – Mitchell Rice [28:34]
Renovation Process
The renovation focused on essential upgrades to meet residential codes and enhance the property's appeal:
- Installation of fire sprinklers across the building: $200,000
- Conversion of the lobby into a leasing office and adding storage and laundry facilities
- Expanding the unit count from 100 to 108
- Enhancing security with cameras and gated parking
- Addressing balcony railings to comply with safety standards
Overall, the capital expenditures (CapEx) totaled approximately $500,000, which was considered relatively low for hotel conversions, thanks to the property's pre-renovated state by the seller [31:42].
Capital Raising
The total capital raise amounted to $3.1 million, covering the purchase price, CapEx, acquisition fees, and reserves. Rice detailed a tiered share class structure to attract larger investors, offering preferred returns and profit splits based on investment size:
- $100,000 Share Class: 8% preferred return, 70/30 split after a 20% IRR hurdle
- $250,000 Share Class: 9% preferred return, 80/20 split after a 20% IRR hurdle
This structure ensured that all investors received their capital back with preferred returns before any profit sharing [39:15].
Quote:
"Everybody knows somebody with money. Everybody. And if you have a good deal, money will find you." – Brody Fawcett [41:44]
Refinancing Strategy
Post-renovation and leasing-up, Rice plans to refinance the property through government loans (Hud or Fannie Mae), leveraging the increased appraisal value. For instance, with a new valuation of $9.5 million and a 70% loan-to-value (LTV) ratio, the team could secure $6.6 million, allowing them to cash out over $4 million. This process ensures investors receive their initial capital plus additional returns, all tax-efficient [34:37].
Operational Insights
Rice emphasized the importance of maintaining strong relationships with brokers, consistent communication, and due diligence in underwriting deals. He also highlighted the benefits of sharing investment activities on platforms like LinkedIn to attract and engage potential investors, growing his network organically [13:17].
Quote:
"The deal doesn't follow money. Money follows a deal." – Brody Fawcett [41:44]
Challenges and Solutions
Mitchell discussed potential challenges, such as dealing with government-paid FEMA vouchers, which provided a temporary income stream but lacked permanence. By securing stable, local workforce housing demands and implementing security measures, the team mitigates risks associated with fluctuating rental income [21:37].
Conclusion
Episode 204 of the Real Estate Investing School Podcast offers a comprehensive look into the process of converting hotels into multifamily properties, showcasing the strategic planning, financial acumen, and operational execution required for success. Mitchell Rice's experience underscores the value of innovative thinking, robust networking, and meticulous due diligence in real estate investing. Listeners are encouraged to apply these insights to their own ventures, emphasizing that knowledge coupled with action leads to substantial rewards.
Key Takeaways:
- Innovative Strategies: Converting hotels to multifamily can unlock significant value through lower cap rates and stable income streams.
- Financing Flexibility: Seller financing can provide advantageous terms and foster long-term partnerships.
- Due Diligence: Understanding local market cap rates and conducting thorough appraisals are crucial for accurate property valuation.
- Networking: Building and maintaining strong relationships with brokers and leveraging social media can uncover exclusive deals.
- Capital Structure: Structured share classes with preferred returns can attract diverse investor pools while ensuring fair profit distribution.
Notable Quotes with Timestamps:
- Mitchell Rice: "The first hurdle with converting a hotel to an apartment is zoning..." [00:00]
- Mitchell Rice: "He became the bank, which is awesome..." [09:17]
- Mitchell Rice: "Commercial is figure out how to increase the income and you just create value just like that." [28:34]
- Brody Fawcett: "Everybody knows somebody with money. Everybody. And if you have a good deal, money will find you." [41:44]
This episode serves as an invaluable resource for real estate investors seeking to explore alternative investment strategies and expand their expertise in multifamily property development.