The beginning of 2024 saw an iconic London landmark, the BT Tower, snapped up by MCR Hotels, one of the largest hotel owner and operators in the U.S., as BT Group moves to lower costs and reduce the number of offices. It’s part of a growing trend, indicative of a wider pattern in property development, as post-pandemic shifts toward hybrid working has seen reduced demand for traditional office settings. Consequently, local authorities, such as the City of London, are looking to diversify building usage to transition the City into a bustling 24/7 destination. With culture at the forefront of City planners’ minds, an increasing number of office spaces are exploring being transformed into hotels, which function as creative centers and business hubs for residents and visitors, alike.
Office Obsolescence?
The surge in hotel interest is underpinned by changing behavior, with the proliferation of hybrid working arrangements signaling a shift in the types of offices desired by tenants. In addition to changing demand from commercial tenants, the modern office must now contend with tightening energy efficiency requirements, which means that many sites are no longer fit for purpose without significant investment. As it stands, by 2030, in the UK, non-domestic landlords must obtain an EPC rating of ‘B’, meaning many buildings may need substantial structural work to surpass Minimum Energy Efficiency Standards.
At a time when costly permanent office space is low down on the list of businesses’ priorities, aside from prime West End or City space, many owners and operators may find it difficult to raise rents sufficiently to cover the cost of updating buildings without impacting demand, or the ability to attract new commercial tenants. Although many pockets within the West End and Mayfair have been resilient to this trend, some other boroughs are seeing the start of a slow steady stream of liquidations of office buildings, the result of lowered demand, higher interest rates, debt covenant breaches and looming debt maturities.
This is not to say that the office is superannuated—far from it. The City of London Corporation’s City Plan 2040 allocates for more than 1.2 million square meters of additional office floorspace, as many companies are now mandating employees to return to the office at least a few days a week. Accordingly, a two-tier model appears to have emerged for office buildings, with sustained demand for grade A office buildings which are energy efficient, provide flexibility on leases and are built for modern, flexible working. This also leaves plenty of 1970s and 1980s ex-office building stock, ripe for repurposing with alternative uses in mind.
Planning committees are slowly becoming increasingly sympathetic to new uses for stranded assets, including plans to convert older office buildings into hotels. Consequently, there has been an uptick in the number of office-to-hotel conversions, with this trend only set to continue throughout 2024 and beyond until the policy is inevitably tightened.
Transitioning to Hotels
According to data from Cushman & Wakefield, office-to-hotel redevelopments accounted for a fifth of the £2.4 billion invested into the hospitality sector in 2023. Though employee behavior has changed as a result of a post-pandemic shift, international tourism is on its way to recovery. Thanks to the relative weakness of the pound, overnight stays in hotels this year are projected to surpass 2019 levels. As such, many investors and developers looking for new uses for office space are finding hotels an attractive alternative as demand grows, particularly due to the prime, central locations of many office buildings.
From a planning perspective, this aligns with the City of London Corporation’s vision for a more vibrant borough. As workers increasingly opt to stay home, particularly on Fridays, it’s not gone unnoticed that retail, leisure and hospitality are suffering from a lack of foot traffic. To combat this, the City of London have unveiled their vision for the Square Mile in its City Plan 2040 to breathe new life into underutilized spaces, beyond residential and traditional hotel conversions. As part of this transformation, the Square Mile is seeking to transition into a seven-days-a-week cultural and leisure destination, providing encouragement for hotels who make best-use of their multipurpose functionalities, ideally encompassing fitness and wellness facilities, restaurants, bars and nightlife hubs under one roof.
Though traditionally larger hotel chains have not maximized their ground-floor experiences, instead focusing purely on bed capacity, modern hoteliers are reimagining spaces as business hubs, which appeal to many planners through adding life to the micro-locality. For example, Southwark Borough is elated with the Hoxton Southwark hotel, as it not only delivers a vibrant social ground floor, but adapts to modern business needs by delivering flexible working capabilities and private meeting rooms. This ensures that hotel developments not only serve the needs of tourists, but also of local businesses and residents.
Jeremy Randall, a partner in the Planning and Development team at Gerald Eve, recently mentioned in conversation that, “The City of London’s Destination City strategy proposes a package of measures to transform the Square Mile as a world-class arts and culture venue to ensure that the City is attractive seven days of the week for workers, residents and tourists. Hotels are one cog in the wheel to this shift—not only will increased footfall require more bedrooms, but hoteliers are reimagining hotels beyond accommodation for tourists. Instead, many are developing with the purpose of becoming a creative hub, not only for fleeting visitors, but a ‘third space’ for the residents of cities, providing a space to work, drink, eat and play.”
As a result, investors and developers who are concurrent with this vision are likely to find City planners more amenable to their proposals to convert vacant office space into hotels. While this trend of office-to-hotel conversions is underway in the Square Mile, the reimagining of the modern hotel will not be confined to the City. Starting with adjacent areas, such as Southwark, hotels as creative and cultural hubs are likely to emerge throughout other European gateway cities as well, particularly in areas where digitization has particularly taken root such as Dublin.
The Future of Deal Financing
In 2023, private buyers, such as high-net-worth individuals (HNWIs) and family offices, appeared to be the driving force behind these conversion deals. Despite the retreat of the equity markets and reluctant bank lending, debt has been available to high-quality borrowers with high-quality assets, which has sustained activity throughout 2023 and 2024.
With rates looking to soften, and the gap between valuations and asking prices beginning to narrow, the pipeline of office-to-hotel conversions is likely to increase, particularly as a number of consensual restructurings and loan maturities will provide a greater number of assets for investors to play with.
Ultimately, the office-to-hotel conversion trend is more than just a passing fancy; it’s a strategic response to changing market dynamics, shifting work patterns and evolving urban-planning priorities. As property owners and investors adapt to these changes, those with a strong brand, innovative management and a keen eye for transforming cities into creative hubs will stand out as robust and resilient investments in an ever-changing landscape.
Story contributed by Stephen Nicolas, a partner in the corporate real estate practice at Paul Hastings, and Eric Jafari, managing director and founder of AENDRE.
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