If you are in a desirable area where tourists come, seems like there is more upside potential for short term, if you can set up processes that work.  

They can afford more than graduate/medical students that have limited, often debt-funded, incomes.Whereas I like graduate students, I once was one, they are on the low end of corporate housing.Gainfully-employed business travelers (not tourists) are willing to pay for nicer housing options and they don't want to interact with you.

As @David Krulac said, you need to check with the local Building Department and check the local Code to make sure you know what it would be allowed in that area.They have a lot of code requirements on hurricane areas like the Caribbean (at least on tourist areas).

CC has about 5,000 residents in town, and it's basically a blue collar tourist town. 

As you rightly pointed out, it doesn't work with local mortgages so you'd have to pay pretty much 100% in cash, which doesn't give you a very profitable investment.What works in Mexico is short-term rentals, especially in the places popular with tourists.

Is the property in a tourist area?

If there's not a tourist or business demand for hotel, it would not perform well.It's not as simple  as property, you have to bring market demand into the picture.

Here are the limitations and requirements, ( narrow lot, but the location is awesome and brings a lot of tourist because of downtown):Lots are 55ft x 203ft and the setbacks are, 25ft from the street (55ft side)10ft from side (203ft side) 10ft from the back Garage can be 5ft from sides and back Vertical lifted doors can not face the street 2 story, 2000-2500 sqft, 18" min crawlspace, detached garage with a living space above, 2 cars min, 25% of lot size coverage max. 

Not living in the US, I have the perspective of an overseas tourist so my apologies if this is a stupid question (I'm pretty sure I heard @Brandon Turner say that there's no such thing as a stupid question on the BP forums but I do sometimes wonder if I'm putting this words to the test ;) ).So, what I'm seeing is some places get overcrowded with tourists in season and there's simply not enough room for everyone to stay at reasonable prices.

I understand that I could use AirBnb, but it's in a big tourist town...