Investing in Hotels, Resort or Serviced Apartments?

For many property investors, including both private investors or self-managed superannuation funds, one option that many investors like to consider is whether to invest in a hotel, serviced apartment or resort.

Investment Options

There are several ways purchasers can participate in hotel ownership, and these include:

1. Managed Investment Scheme (which ASIC notes are also known as “managed funds”, pooled investments” or “collective investments”) 
2. Individual Lease to the tenant/operator
3. Management letting rights agreement

1. Managed investment schemes

According to ASIC (Australian Securities and Investments Commission), in a managed investment scheme:

• People are brought together to contribute money to get an interest in the scheme ('interests' in a scheme are a type of 'financial product' and are regulated by the Corporations Act 2001 (Corporations Act))
• Money is pooled together with other investors (often many hundreds or thousands of investors) or used in a common enterprise
• a 'responsible entity' operates the scheme. Investors do not have day to day control over the operation of the scheme.  The Responsible Entity has the dual role of trustee and manager of an investment scheme and must be appointed if an investment scheme needs to be registered.

If the Scheme invests in a Hotel, it will generally enter into either a Lease Agreement with an operator (where the tenant/operator pays a monthly rent to the Scheme, thus providing consistent income), or it appoints a manager under a Hotel Management Agreement, whereby a professional management company is paid a fee to manage the hotel on behalf of the Scheme, which provides a more variable return. 

• With a Lease Agreement:

1. The Tenant will pay an agreed monthly rent and a share of outgoings (building expenses) to the Scheme, but the Tenant wears all risk and upside of the business. 
2. Rent may be fixed, variable, or a combination of the two.
3. The Scheme is still responsible for all major structural repairs.
4. Leases can run from 15 to 25 years with further options.

• With a Hotel Management Agreement:

1. the management company is paid a fee to oversee the day-to-day operations of the hotel (including sales and marketing, finance, staff supervision etc) however all expenses are paid by the Scheme and most of the risk rests with the Scheme. 
2. Any profits are shared amongst the investors in the Scheme according to their entitlements.

No matter which of the above applies, the Responsible entity manages all legal/compliance aspects of the Scheme on behalf of the investors.

2. Individual Leases are a much simpler structure, and generally apply to a Hotel that operates within a strata-titled building such as a multi-storey apartment building. In these instances:

• The tenant enters into individual leases with each owner. 
• Typically, these leases may have been established by the original developer who has standardised all terms and sets the initial rental amount.
• Rental is a set amount with annual increases set by reference to CPI or a fixed percentage amount. The first owners may have a guarantee of a minimum gross return on their investment (for example, 5% or 6%).
• Some rental agreements may also be variable, where they are based on a percentage of revenue generated OR they could have a fixed base rent plus a percentage of revenue.
• Most strata-titled buildings have an Owners’ Corporation, Body Corporate, Community Corporation (or similar) who will manage the common property on behalf of all owners and will arrange insurance or maintenance to structure within a building, however they have no control over the Hotel other than where agreements have been entered into for use or management of common property.
• These types of investments generally have low capital growth due to the fixed nature of the rent.

3. Management Letting Rights are another common management solution for strata-titled Hotels. In this instance, typically:

• The Manager will enter into an exclusive arrangement to manage letting rights within the building 
• They will operate the Hotel or letting business and undertake caretaking of the building as well as operating the Hotel. 
• The Manager may enter into a lease (as noted above) or agree to share the revenue generated for each room/apartment with the individual owner.
• Occasionally, these agreements will see revenue pooled with other owners and the revenue split.
• If the Manager does not have exclusivity in the building then there may be competing rooms/apartments that may compete and/or detract from yours.

Questions to consider

No matter which of the above options you may be considering, there are a number of questions that will help understand both the risks and opportunities inherent in each. Some of these include:

1. Who is the operator?

• Is it an internationally recognised operator in this space or a small mum-and-dad operation?
• Do they have a strong balance sheet able to support any lease or rental guarantees?
• What other properties do they manage, and can you seek testimonials from other owners?

2. How does the rental return compare to leasing out an apartment or room by yourself?

• Remember to factor in all the other costs involved in self-management ie agent leasing fees, general maintenance, refurbishment costs, etc.

3. What are the refurbishment obligations?

• Is the tenant/Manager responsible for undertaking this? If so, how often and to what extent (for example, who is responsible for repainting and replacing carpets? What about renovating bathrooms, kitchens, and common property?)

Seeking advice

No matter the purpose of your investment, it is vital that you seek expert advice. 

On that basis, it is vitally important to find a good lawyer, accountant, and financial adviser who are specialists in the hotel sector to advise you.

Conclusion

As you can see from the above, hotels are an interesting means of investment however there are numerous ways in which this can occur, each of them with their own challenges. No investment is fireproof, however taking the time to understand how each model works will hopefully contribute to much better decisions.

Disclaimer
The information provided on this website is general in nature only and does not constitute personal financial advice.

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