Office use vs. hotel use

Historic buildings dedicated to office use have seen a decline in yields in selected European markets since 2008. A good example of this has been the Spanish office market, hit particularly hard as office yields have suffered as a result of the flow into the market of historic buildings and residential space that has not been met by residential buyers with the expected prices.

As a consequence, landlords of these less-optimized spaces gradually have been considering turning these assets into hotels, hence exiting the office market completely in destinations such as Barcelona and Madrid. Office assets owned by insurance companies such as Generali or MC Mutual, multinationals such as Henkel or Deutsche Bank or businesses less concerned about location, such as water supply company Agbar, are exiting the office market and entering the hotel market after going through a conversion process. 

Italian insurance company Generali will convert an office building on Madrid’s Gran Via Street into a 4-star hotel operated by Spanish hotel group Vincci Hotels.
Italian insurance company Generali will convert an office building on Madrid’s Gran Via Street into a 4-star hotel operated by Spanish hotel group Vincci Hotels.

For office landlords, the benefits of joining the hotel market are many, and in most city-center locations, a bank-guaranteed fixed lease is usually achievable. In our experience, when asset managers analyze the potential of converting such office buildings into hotels, they should carefully consider the following key parameters that hotel usage can add to the equation of the landlord:

Higher leaseable square footage

Hotel chains always lease the total square footage of the properties, hence taking into account common areas, technical areas, roofs, corridors and lobbies. On the contrary, with an office-building lease contract, roughly 10% of the property square footage has to stay out of the negotiation.

It is also our experience that in hotel-conversion projects, the building landlords benefit from a higher involvement in the space redesign concept by hotel tenants. This is not so much the case with office tenants, who consider their space more of a commodity.

No ‘structural’ vacant space

Before the financial crisis, when leasing an office building, typically between 5% and 6% of the net leasable square footage, on average, was never leased due to structural rotation (between 5.5% and 6.6% of the total gross square footage of the building). With hotels, in the case of fixed lease contracts, occupancy is always at 100% from the landlord’s viewpoint.

Moreover, the landlord benefits from roughly one-year advance notice before the tenant exits, which is not usually the case with office tenants.

Finally, the barrier to exit for the hotel tenant is higher than with offices. Meanwhile, switching hotel tenants only takes an average of four months.

Higher lease stability

With hotel lease contracts it is common to agree 10- to 20-year contracts. In city-center locations it is common for tenants to provide bank guarantees for a full year (contrary to office tenants that by law only provide roughly two monthly installments, depending on the market). Therefore, another advantage vis-à-vis office tenants is that with hotel leases the occupancy or operational risk is fully transferred from the landlord to the tenant.

Lower parking requirements

In most of Europe, operating licenses are much more flexible regarding parking requirements with hotels than with offices. In some European markets, hotel regulations allow the shared use of nearby public parking or the use of a limited number of parking spaces fully dedicated to the hotel.

Higher building appreciation

For little-optimized historical buildings, the value appreciation of the asset is usually higher when a hotel is in place, with the exception of office buildings with a single-client operation and a triple-A tenant. Also, the book value of the building increases as a result of adding up the furnishing of the hotel equipment.

Elimination of building expenses

Finally, the usual general expenses incurred by offices — that is, cleaning, maintenance, security, electricity, heating, water, reception, etc. — will be completely eliminated if the property owner converts an office building into hotel use.