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Tenanted Motel Investments

Written by Andrew Morgan, Specialist Motel & Accommodation Broker

The high return and low risk offered by motels as a tenanted investment was targeted by many savvy investors over  twenty-five years ago.  In its infancy in the early 1990’s, some leases were put into place that were not suitable for both parties involved.  These teething issues were largely ironed out by the mid 90’s.  Since then demand for motel investments has been strong ever since.  Today we find they are rarely available on the market and are a tightly held commodity.  With the high volume of motels that operate under a lease today, it is surprising just how few tenanted investment motels are ever on the open market for sale at any one time.  When they do come onto the market they do not remain available for long, generally selling quite quickly.

In the early stages of leases being put in place over motels it was largely only former or existing motel owners/operators who were interested in investing in motels as passive investments.  They knew the industry well, they understood how a motel was operated and they knew travellers always require accommodation, no matter what the reason for their travel was, business, work, pleasure, etc.  The wider investor market had not considered investing in motels, and not having any history or dealings within the motel industry, were not that interested.

However, overtime as the high return and low risk benefits of motels were more recognised, interest started building in the motel industry as a tenanted investment opportunity from other investor markets.  Investors who had previously focused on Residential, Commercial or Industrial Properties, were now looking at the benefits a motel investment offered.  Corporate investors as opposed to the traditional “Mum and Dad” investor entered the industry in a big way.  Many of these larger entities own numerous motel properties and even the smaller individual investors have continued to add more motels to their investment portfolios.  Self-Managed Superfunds have become a popular investment vehicle for investors to purchase their own motel, with a secure long term lease in place.

Bank interest rates over recent years have assisted to increase the demand for passive investment motels where cash in the bank at its current interest rate levels is not an attractive investment option.

Benefits that have attracted the interest of the investor market to motels as tenanted investment options are:-

  • High Investment Returns – Investors have achieved excellent returns on passive investment motels over the years.  Market net returns on passive investment motels are currently at approximately 9%+ on capital invested.  The return to an investor compared with other investment options such as cash or residential property make them very attractive to a number of investor types.
  • Low Risk – Motels have proven themselves over the years to be very low risk investments.  Solid and consistent businesses in general operating from an investors building is what anyone is looking for.  Good locations in busy positions often means the investment is underpinned by a strong land component.
  • Fully Tenanted – One way or another, a motel property that is leased almost always has a lessee, as opposed to other investment options.  If a lessee/operator was to close the doors of the business the mortgagee would almost always appoint an operator to reopen until the business was on sold.  The alternative is that the property owner operates the business themselves or under management until the business is on sold.
  • Freehold Tenure/Increasing Land Values – Freehold tenure and the ownership of a tangible product, being a commercial property.  Motels are generally located on busy main roads or other desirable locations which are larger blocks of freehold land that increase in value over the longer term.
  • Solid Building Structure – Motels are typically of brick/block construction and this type of structure requires minimal ongoing works.  Any move away from this type of structure to more cost saving types of building materials/construction means an adjustment in the maintenance requirement to be budgeted for over time.
  • Outgoings – Generally within motel leases the Lessee pays all outgoings.  Outgoings paid by the Lessee include, but are not limited to Property Rates, Insurances, Repairs and Maintenance, and Electricity.  Leases were originally set up this way so that the Lessee had control of his/her own business and did not have to go to the property owner every time they needed a light bulb changed.  The Lessor may be responsible for a few items such as Land Tax (unless included as an outgoing) and Structural Repairs/Replacements.
  • Building Allowance/Tax Benefits – Relatively young buildings or those that have undergone major refurbishments (capital works) will have some level of building depreciation or write off allowable.  This will vary for each property however the tax benefits in many cases can provide good taxation relief to the property owner.

Know the Cost

Written by Andrew Morgan, Specialist Motel & Accommodation Broker

Hopefully we all love or enjoy what we do for a living, however we do not do it for the sport.  A business must produce a profit to survive.  Knowing how or what is needed to achieve a profit is a starting point.  In its simplest form, product cost plus mark-up equals selling price.

When a product or service is offered to a market, what it costs a business to purchase then get that product or service to the market in a position to sell is the breakeven point.

By understanding where the breakeven point is and what the product or service can be sold for in the market, one is able to know the following:-

  1. The profit level of the product or service
  2. The amount or volume of sales required to make a profit
  3. The impact on profit of declining tariffs/prices or volumes of sales
  4. The level sales can reduce to before a loss is incurred

The addition of a mark-up to make a profit and still be competitive then determines the price the product/service will be offered at.  The product of the motel room and associated services cost the operator to rent the room in wages, cleaning products, laundry/linen, electricity, insurance, wear and tear, etc.  A combination of fixed and variable costs.  If the total cost including these expenses and others are unknown, then how can the price be set to ensure the business is not losing money on the sale.  If a motel is selling a strong number of rooms at a solid occupancy rate however at the end of the month there is no money in the bank account, then alarm bells should be going off.

Accurate costs to rent a motel room offer very useful tools of measurement or key performance indicators (KPI’s), so a motel operator can know how much they can afford to rent a motel unit for to breakeven and then to make a profit.

Each different accommodation business/property will have different cost bases.  The reasons why can be due to several factors that affect this figure – property features, operation and utilities.

Property Features

  • Unit Size – the square metre area that the unit occupies.  A standard studio unit costs less to occupy than a 2 bedroom unit.
  • Self-Contained – the cleaning costs alone to rent a self-contained unit can be substantially higher
  • Age of Property – how old the property is may determine how much upkeep is required to the buildings
  • Standard of Property – if a motel is in disrepair it will require more expense to maintain
  • Location – sea air may increase corrosion of buildings such as metal staircase hand rails, roofing, etc.  Building movement in some areas may create brickwork cracking and other issues.
  • Unit Fit Out – what condition is the furniture and fittings in?  Does the high level of humidity require tiles rather than carpet?  Are blinds or block out curtains required?
  • Restaurant – a restaurant will substantially increase many costs, however this is a separate income department where the same considerations on what it costs to produce that product are relevant
  • General Services/Facilities – a lift on site, trees and gardens, swimming pool, spa or sauna are all services/facilities that contribute to the cost base
Operation
  • Lease/Freehold – Is the tenure leasehold with a rental to be paid each month, or is it freehold where mortgage repayments are due?  Interest rates will rise and fall changing repayment amounts.  Interest payments will be applicable with leasing as well however the level of borrowing will be generally lower than a freehold purchase.
  • Type of Clientele – the motel’s business could be corporate customers, tourists, families, contractors, etc
  • Laundry – is the linen cleaned onsite or offsite at a commercial laundry?
  • Staff Levels – are staffing levels correct or is the business over or under staffed?
  • Owner/Operator or Under Management – the cost of management wages will increase the cost to rent a motel unit.  This can be a moot point as the owner should expect to pay themselves a wage for their time anyway
  • Consumables – what type of soaps, tissues, shampoos, etc are included within the unit?
  • Cleaning – are the cleaning products the most cost effective?  How long are the cleaners allocated to clean each room, e.g. 20 minutes, 30 minutes, or unlimited?
  • Eftpos/Credit Card Fees – the fees charged by some credit card operators are higher than others
  • Marketing – is the motel a member of a chain?  The fees paid to a motel chain form part of the cost to rent a motel room, as does the commissions for booking sites and any other marketing initiatives.
Utilities
  • Property Rates - coastal motels may include much higher property rates than an inland motel where the land value is not as high as a beachfront property
  • Electricity/Gas – the costs of electricity have risen substantially in the past 3 years
  • Telephone – What type of phone system does the motel have?  Is it reliable in its charging of customers?
  • Land Tax – Is land tax paid by the property owner, Lessee or not applicable?
  • Insurance – the cost to insure properties has more than doubled in some areas over recent years
Costs easily add up and can “blow out” if not contained.  Knowing what the costs are is the first step in containment and an operator can then be confident in their sale price position.