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Serviced Units/Apartments - Finance
One of the many forms of property investment products in the market is investment in units or apartments attached to, or forming part of, hotels or other forms of tourist accommodation. This type of investment requires a different understanding of how they work. They are often referred to as serviced and/or managed units or apartments (units) and from a lending risk perspective it brings a new set of risks into play.
Often investors or prospective investors are from the residential property investment sectors who are entranced by either the romance of owning an apartment or unit in an upmarket hotel or accommodation complex and/or the guaranteed returns they offer. They often enter into purchase arrangements without having a fundamental understanding of the different risks involved to both themselves and their lenders.
There are very few lenders who will provide “stand alone” finance for such purchases. That is when the security is solely against the unit and/or its income streams. Those that do generally charge commercial interest rates that can often make the venture uneconomic. In other words, investors will generally need to provide security over other property in addition to the tourist apartment or unit being purchased and have other income that can support the repayments.
So what are some of the basic things to be researched as part of the due diligence process?
The key areas any lender considers in such projects are:
- The location of the complex
- The relativity of the tourist complex to proven tourism sectors or areas
- The ability and substance of the complex owners
- The experience and ability of the contracted operators of the complex
- The terms and conditions of the Management Agreement that attaches to the units being sold
- The available options at the end of the management agreement
- GST and other taxation issues.
The subject of location and the designed use of tourist apartments is a complex one but suffice to say if tourist demand is not proven then the risks are higher. It is not dissimilar to buying other property – location and demand are the keys to a successful investment. It is not that demand cannot be created with some innovative ideas and marketing, but sustainability is paramount, otherwise what can the property be used for in the event of it not being successful?
The substance behind the owners of any tourist complex is also very important. While the investor owns the unit, the complex owners own the common areas such as reception areas, restaurants, bars and pools. The owner’s ability to maintain and improve and refurbish these areas has a direct bearing on the investors return from the units.
The next important area is who is operating the complex. Is it a Sheraton, Hyatt or Carlton operated complex or someone unknown? The important point to note here is, it is the operator that markets, promotes and manages the complex.
Then there is the management agreement itself.
Management Agreement
The terms and conditions in the agreement and what happens to the unit once the agreed operating term has expired are critical to how a lender will view the risk. The management agreement sets out the income return, how it is calculated and method of payment of the rental that the investor will receive.
Firstly, lenders will look to see if a guaranteed return is offered and for how long. Many operators/developers offer a guaranteed return on new developments during the first few years. These guaranteed rentals can be inflated and are often funded out of the purchase price. Therefore, it is important to understand what the achievable (not published) market daily room rate for the unit is, both at the outset and what it is expected to be when the unit comes off ‘management’ and further, that an independent assessment is carried out.
In these types of investment, the value of the unit is a direct reflection of the income it can generate and this is why lenders are reluctant to lender solely against them, as their value is so dependent on the operator’s ability and all the other points mentioned above.
Once a complex has earned a poor reputation through a sub standard operator, it is very difficult to pull back from and correct.
Other points in the management agreement a lender will consider are:
- What happens if there is no guaranteed return or when it ceases?
- How does the operator allocate its guests to the available units?
- Does one investor's unit get a better return than another?
- What is the formula?
- Can the unit be extracted from management to be used as the investor’s own holiday unit?
If a tourist complex has a high occupancy level then it is not so much of a problem, but there are off peak and low peak times and the room allocation has to be seen to be equitable.
As the unit is being used for commercial purposes, investors will be subject to GST implications on the unit at both the time of purchase and on the rentals received. Whilst an investor will gain a GST refund when the unit is purchased they will pay GST if at a later date the unit is taken off management or sold at the then value.
The real key to obtaining finance for these types of investment is the investor’s ability to generate and manage their cash flow expectations as tourist accommodation is seasonal and subject to the many influences discussed here.
Essentially, the reason tourist accommodation units can be purchased by individual investors is that it is a means for developers/ owners to sell down their risk as opposed to trying to find one buyer for the total complex.
There are good ones and bad ones and as an investor or lender, the trick is to pick the good ones.
