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Transforming California's Hospitality Landscape: Office Conversions and Economic Trends

Writer's picture: Erik RansdellErik Ransdell

By Erik Ransdell and Mike Annunziata

Strands Realty Group

January 14, 2025


As California's hospitality market evolves, two significant trends are reshaping the industry: the conversion of underutilized office spaces into hotels and the impact of economic factors on hotel valuations and transactions. These trends highlight the resilience and adaptability of the state's hospitality market, offering opportunities for investors and developers willing to innovate and take calculated risks.


Office-to-Hotel Conversions: A Strategic Response to Market Dynamics


The pandemic reshaped the work landscape, leaving many office buildings in limbo. Remote work has become the norm for many industries, pushing office vacancy rates to record highs. San Francisco, for instance, saw its office vacancy rate reach 31.8% in Q4 2024, according to CoStar. This shift has presented a unique opportunity for developers to repurpose vacant office spaces into hotels, tapping into the rising demand for accommodations and reducing environmental impact.


“Conversions can be a smart move as demand for hotel rooms rises, while office supply remains abundant,” said Zach Demuth, Global Head of Hotels Research at JLL. The strategy is not only financially pragmatic but also aligns with the growing emphasis on sustainability in the real estate sector.


Key Examples of Success


California has emerged as a leader in successful office-to-hotel conversions. One standout is the Freehand Los Angeles, a boutique hotel crafted from the historic Commercial Exchange Building. This property preserved the character of the original structure while introducing a vibrant, modern hospitality experience.


Another compelling example is Hotel Per La, formerly the Bank of Italy Building in Los Angeles. This transformation retained the building’s iconic architecture and infused it with luxurious touches that appeal to both leisure and business travelers.


Jane Smith, VP at CBRE Hotels, explained, “Repurposing existing buildings allows us to preserve the essence of a city while meeting the growing demand for distinctive accommodations.”


Challenges in Conversions


However, conversions are far from simple. California's stringent building codes and zoning laws present hurdles that can significantly inflate project costs. The Real Deal reported that these regulatory requirements often necessitate substantial retrofitting, which can eat into potential profits.


Moreover, adapting office layouts for hospitality use involves structural and logistical challenges. For example, converting a high-rise office tower into a hotel may require extensive modifications to plumbing, electrical systems, and floor plans to accommodate guest rooms and amenities.


While these obstacles are formidable, developers who navigate them successfully often find that the rewards justify the risks. The demand for boutique and lifestyle hotels in California's urban centers remains robust, driven by both domestic and international travelers seeking unique experiences.


Economic Factors Influencing Hotel Valuations and Transactions


Beyond conversions, economic pressures are shaping the state's hospitality market in profound ways. Rising interest rates, inflation, and supply chain disruptions are influencing investment strategies and property valuations.


Interest Rates and Capital Costs


The Federal Reserve’s rate hikes have significantly increased borrowing costs, directly impacting hotel developments and acquisitions. According to the Wall Street Journal, a $50 million hotel project now incurs an additional $2–3 million in annual interest expenses compared to pre-pandemic conditions.


This environment has shifted investor focus toward cash-flowing assets and away from speculative developments. As one CBRE Hotels analyst observed, “High interest rates make value-add acquisitions more challenging, but well-performing hotels in strong markets still attract buyers.”


Inflation and Operational Costs


Inflation has added further complexity, driving up the cost of labor, utilities, and supplies. Hotel operators are increasingly turning to technology to maintain profitability. Innovations like AI-powered management systems, smart energy solutions, and contactless check-ins are helping reduce operational costs while enhancing guest satisfaction.


Hotel News Now highlighted the importance of these technological advancements, noting that properties that invest in efficiency-focused technologies often see faster recoveries in profitability, even amid inflationary pressures.


Supply Chain Challenges


Supply chain disruptions remain a thorn in the side of developers. According to CoStar, delays in securing construction materials and equipment have prolonged project timelines across the state. For investors and developers, strategic planning and cost management have become critical to mitigating these challenges.


California’s Transaction Trends


Despite these economic pressures, California continues to lead the nation in hotel transactions. Crexi reported a median price per key of $250,000 in 2024, reflecting a 15% year-over-year increase.


One of the most notable transactions was the acquisition of the Fashion Island Hotel in Newport Beach by Eagle Four Partners for $145 million. The property has been repositioned as a Pendry Hotel, a move that underscores the demand for high-end accommodations in affluent markets. This rebranding aligns with Pendry's reputation for luxury and lifestyle-focused hospitality, making it a standout in Newport Beach's upscale market.


Another headline-grabbing deal was the sale of the Montage Healdsburg in Sonoma County, which fetched $2.038 million per key. These deals highlight the resilience of California’s luxury hotel market, even in the face of economic uncertainty.


“California’s unique market dynamics continue to draw investors, even in a high-rate environment,” noted a representative from JLL.


Strategies for Investors and Developers


The current market demands a blend of creativity, adaptability, and calculated risk-taking. Here are three strategies gaining traction among successful developers and investors:


  • Focus on Secondary Markets: Areas like Riverside, Fresno, and Bakersfield offer lower costs and growing demand, making them attractive alternatives to high-cost urban centers like Los Angeles and San Francisco. These markets are ripe for midscale and economy hotels that cater to business and leisure travelers.


  • Embrace Sustainability: Eco-conscious travelers increasingly prioritize accommodations with visible environmental practices. Properties that adopt green building materials, renewable energy sources, and waste reduction initiatives not only appeal to this demographic but also enjoy operational cost savings over time.


  • Leverage Technology: From AI-driven pricing strategies to energy-efficient infrastructure, technology is becoming a critical tool for improving profitability and guest satisfaction. Smart investments in technology can yield significant returns, especially in a high-cost environment.


Looking Forward


California’s hospitality market is navigating a period of significant transformation. Office-to-hotel conversions and strategic responses to economic challenges offer pathways for continued growth and resilience. Developers and investors who embrace innovation and focus on emerging opportunities are well-positioned to thrive.


As Zach Demuth aptly stated, “Success in California’s hospitality market requires innovation, adaptability, and a keen eye on emerging opportunities.”


If you or your family have been impacted by the devastating fires in California, please know that our thoughts and prayers are with you during this difficult time.


For more insights or to discuss investment opportunities, feel free to contact us. We're here to help you navigate this dynamic market.

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