Motel Leases: The Long and The Short
- Posted By Andrew Morgan
Whether we a talking about a Lessee or Lessor, having a long term lease in place is generally beneficial for all involved. Long term leases provide security and surety of occupation for one, and well, the same for the other.
What is a long term lease, and why in addition to the above, is it beneficial to both parties? In a commercial, retail or industrial property a standard lease term may be a 3 year plus 3 year lease or considered long term if it’s a 5 year plus 5 year lease. The motel, hotel and caravan park industries however view a 5 year plus 5 year lease as a short term lease. One argument for this differing perception is that a motel business cannot be easily moved to another building/locality, or more accurately, is never moved from its original position. This is also the case for many retail, commercial or industrial businesses, for example a service station or convenience store cannot be picked up and moved to another locality, well not without any degree of difficulty or other issues. This being said, a 3 year plus 3 year lease for these and other businesses is considered normal practice. Many industrial businesses require heavy tonnage cranes in their buildings. This is not easily replaced without hundreds of thousands of dollars to install a new crane or cranes elsewhere as per the requirements.
Another argument is that one is buying a business (inclusive of the lease document) and has a capital outlay to buy the assets of the business. These assets diminish in value rather than appreciate once the lease reduces below a certain level of time remaining. It is often the case when a motel lease is being sold, a potential buyer will say for example “there is only 15 years left on the lease”. If run for 5 years there will only be 10 years remaining. This may be the case but the return on investment of a lease is high, and will increase the lower the term of the lease. Reduced tenure/security will reduce the value of the business but increase the return to the buyer.
Ten or fifteen years is a long time and is also a long time in terms of a lease. No one knows what they will be doing in ten or fifteen years, or where they will be. People have goals in life and directions they would like to head in, and places they would like to be, but no one can guarantee where life will take them such a long time into the future. The tenure spoken about revolves around maintaining the value of the business and property for both Lessee and Lessor. Not having a short term lease where a Lessee pulls everything they can from the business without investing back into it. Thereby affecting the value of the Lessor’s property.
It is generally in the Lessor’s interest to extend a lease for their security of tenure and to provide them with more options when refinancing, etc. It is reasonable to believe that the longer the term remaining on the lease, the stronger the position/security of both the Lessee and Lessor. This may not be the case when the land is situated in highly desired positions. The site may be ripe for redevelopment with a higher or better use or the motel may be in need in major refurbishment and be deemed that it is more cost effective to be demolished rather than renovate. This sounds good in theory but what happens when the lease is close to expiration and the development market is poor. Timing is all important in any case.
Due to most Lessor’s owning a motel property that is leased as a passive investment, it is often the case that the Lessor will not want the Lease to come to an end. The majority of the time the purpose of ownership is a passive investment, not the day to day operating of a business. Many motel investors have had a background in the industry. Many may be retired business owners who simply want an asset they trust in and will receive a regular rental income from. The day to day business operations are no longer for them, and asset security is of the utmost importance. A long term lease offers this investor piece of mind.
Lease extensions are a saleable commodity in the market place and are a direct investment back into the business. Most Lessors whose lease term has run below 15 years, will have been asked at some stage by a Lessee to extend the lease. The result should be a mutually beneficial transaction for both parties. The differing needs of both Lessee and Lessor can be satisfied with one gaining funds and security and the other gaining an increased value or saleability of their business, and again security.
It does not happen often but sometimes a Lessor when asked will not extend a lease. Often they ask “why extend the lease when there is still 14 years to run, which is still a long term lease?” Fair point, however a Lessee will argue if either party wants to sell their interest at some stage a longer lease of say 20+ years will be more attractive to a potential buyer on both sides. This also has merit.