Investing in Service Apartments

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From: Anonymous


Can someone help with this. I am looking at investing in a Service Apartment but unsure of the potential growth (if any) that it may have over the future years.

Is anyone out there who has invested in Service apartment be able to give some ideas.

Thanks,

MM
 
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Reply: 1
From: Gail H


Be afraid.....be very afraid. They are in oversupply in many cities, so question agents carefully about price history, rental history etc. Better still, post the city you're thinking of, and someone here will tell you. Brisbane is one of the worst cases I believe,

Gail
 
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Reply: 1.1
From: Frank Shead


Extremely hard to get good finance

Frank Shead
 
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Reply: 2
From: GoAnna !


Hi MM

When you are considering serviced apartments you need to be aware that there are roughly two types.

One. Those with long term commercial lease where returns are set and all outgoings are usually paid by the leasee as per usual commercial leases. The main risk here is the viability of the specific management company. Growth will tend to be less than similar properties in the area as the resell group is smaller as it excludes owner occupiers. This should however be offset with a cash flow positive rent.

I own such a property in an inner Melbourne suburb and have received 40% capital growth since purchase in early 1998. The current rent is 7.5% nett compared to the original purchase price.

The second type has higher risk and a less predictable income. In this case you are effectively running the business yourself and you run the risk of high vacancy and high running cots. My personal view is that these types of serviced apartments are high risk as you are carrying the risk of both the business and the property. If the business does not perform well the property will also decline in value.

Please note that I have not had personal experience of the second type and perhaps others who have would like to add their views?


GoAnna !
"Obstacles are those frightful things you see when you take your eyes off your goal."
-Henry Ford
 
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Reply: 3
From: Kristine .


Hi, MM

I posted the following in reply to C Xu's post of 26 January.

Regards finance, banks usually view serviced apartments as commercial deals, and thus the strength of the tenant is first consideration.

A capital based tenant will usually mean you can finance higher, an operations based tenant, lower. This means from 60% taking the apartment as first security, to 100%. Of course, if your funding is based on a line of credit secured against other property, then the 'stand alone' question is hypothetical. The Melbourne broker with whom I have been mainly involved is a very conservative chap, works well within safety margins, and has organised quite a few 100% and 105% that I know of for serviced apartments.

'We' - the Agency I work with - are just finishing an excellent project in CBD Melbourne, and I have had a number of customers come back for seconds. These have all been experienced investors who are concerned more about security and yield, than they are about reselling or short term capital gain. Some people like to be actively involved in their investments - managing, new bathrooms etc, while others take the view that they are in for the long haul and the less involvement from them, the better.

Different strokes for different folks.

""
Hi C Xu

Here is a summary of 'What Is A Serviced Apartment'. I wrote this as an introduction for sales people. It's a bit rambling in parts, and probably needs a good editing, but bear with me.

My personal opinion is that serviced apartments are a great property investment if you don't really want to be a landlord, and have no intention of spending any more money eg renovating bathrooms, updating fire services etc.

Remember, your lease will provide for regular revaluation to market, so rents will reflect market rates - no more, but no less.

And assuming you have chosen well ie that there would be an alternative use for your particular apartment or apartment complex, then as your original lease is amortised, the property will be worth market rates either to continue with the commercial tenant, or to be used as its alternative purpose eg residential, student, office etc.

Anyway, make a cup of tea and have a quick read of this. Your feedback welcomed.


Serviced Apartments

Introduction

The term ‘Serviced Apartments’ usually applies to individual freehold apartments, often but not always within a single building, which are leased to a corporate tenant for the business purposes of the tenant.

The tenant is committed to the lease and frequently enjoys naming rights over the building.

The tenant occupies the property under a commercial grade lease. A commercial lease differs from a residential lease primarily in the length of the term and the areas of responsibility for the property accepted by either the tenant or the landlord.

A residential tenant may, at the end of a lease, decide to move and live somewhere else for any number of reasons, or simply for variety. A corporate tenant is committed to the business enterprise which relies on the location of the apartment. As such, the corporate tenant usually holds extended options to the first lease, in many cases for as long as twenty five years.

The investment yield associated with traditional residential rental property can vary considerably depending on competition within the market, the level of outgoing expenses, how long a property is vacant between tenants, letting and management fees, rates and insurance, repairs and maintenance, and replacement of capital items over time.

The ability to financially plan and to forecast return and result is quite definite with a serviced apartment. Many projects can demonstrate a secure and tangible return far in excess of conventional residential rental properties.





Corporate tenants usually prefer to lease rather than own the premises, as this arrangement allows more flexible use of working capital and offers direct taxation benefit to the business. Frequently, the building was purpose built or modified for or by the tenant in anticipation of their long term business requirements.

The tenants are companies and the performance of the lease is guaranteed by the Company Directors. In the case of Public Companies listed on the Stock Exchange, leases are guaranteed by the parent or group corporation. However, in the unlikely event that the lease fails, the investor continues to own the title to the apartment and could then occupy it, rent it privately or sell it as would be possible with any other apartment or property. In fact, even during the life of the lease, the investor could sell the apartment at any time as each apartment has a separate tile and is individually leased to the tenant.

Serviced apartments offer short or long term accommodation to the visitor, tourist, student, to people between permanent accommodation, and increasingly, for the accommodation of business personnel or the work-relocated family. In fact, the share of the short term accommodation market is growing as anyone requiring a high standard of lodging on as required basis increasingly uses serviced apartments instead of traditional motel or hotel accommodation.

Serviced apartments usually offer extra facilities other than simply the accommodation itself. The apartments may be cleaned daily with all linen supplied, there may be internet or laundry facilities, a full kitchen, and a mini-bar or shopping service. In addition, there may be on-site or discount rate car parking, room service from an in-house or nearby restaurant or food hall, dry cleaning service, office equipment or meeting rooms, interpreter, tour guide or secretarial services. There may also be significant recreational facilities such as swimming pools, gymnasiums or residents lounges.



Serviced apartments are assessed on a ‘star’ rating, with the maximum being four stars for the physical accommodation, with extra stars being for associated services.

The position and situation of the apartments will have been carefully chosen by the developer or tenant, to meet the business needs of the tenant. Often, the location will be prime real estate chosen to establish and maintain market focus for the tenant. If the market focus is the business traveler for example, the property may be central to the CBD, but if the market is for students, teachers or student’s visitors, the property would be positioned near the appropriate campus.

Serviced Apartments have gained increasing popularity within the hospitality industry and with investors over the last ten years. They are a cost effective way to run a business, and a cost effective and secure investment for the individual owners. Investors appreciate the security of the lease and the ability to financially plan for the life of the lease. Investors also appreciate that the tenant is usually responsible for all ongoing costs associated with the safe operation of the building.

These costs may include all insurance premiums, body corporate levies, regular maintenance, and items of a capital nature such as painting, floor coverings, replacement of lost, damaged or obsolete items eg crockery, kitchen utensils or even the beds, and some leases may require that the tenant pays for any works of a capital nature during the life of the lease.

Some leases provide bonus to the investors such as free or discounted accommodation during each year, but as benefits of this kind can not be financially estimated they cannot be factored into the projected financial returns.




The prime lease may be of five or ten years, with the tenant holding options for further terms of five years each. The longevity of these arrangements allows the tenant to plan and operate financially viable businesses, and the investor to confidently plan the life of the investment.

Returns to the investor come from five main areas within the investment.

Yield: The cash yield or passing rent will be determined by the percentage rental payable on the initial contract price. This may vary from 6% to 7.5%, and leases usually include a growth clause of eg 3% per annum or CPI indexation, the application of which is at the tenant’s option.

Pre-paid expense: The assumption of building expense by the tenant which is paid separately to the rental, must be taken into account when determining the return to the investor. In many cases, this will amount to between $2,000 and $4,000 per annum.

Financial: In Australia, our tax structure allows the combination of all income earned and all expense assumed in the earning of that income. This is commonly referred to as ‘negative gearing’ and provides significant tax benefit to the investor in that all expense, both of a cash and non-cash nature, may be taken into account when determining the investors taxable income for the year. Thus, interest expense on loans or any other direct cost of the investment may be fully claimed against the rental and other income of the investor.

Depreciation: As a non-cash expense, depreciation may significantly increase the real return on the investment by lowering the tax burden of the investor. This effectively converts the appropriate tax rate to actual cash income earned from the investment. This will apply even if the investment is fully paid and/or the investor has no other income.



Capital Growth: The rate of capital growth can only be fully determined with hindsight, but various indicators may be used to project anticipated growth rates:

Land Value
Site value changes and grows over time, and may be influenced by a number of factors. The general state of the market, the use to which the land may be put, the presentation of the immediate neighbourhood, the investment of new capital into the area, transport, employment, local amenities etc will all affect the market or assessed value of the site.

Comparable new projects and comparable re-sales
The cost of building, outfitting and establishment continues to rise and re-sales of property will be influenced by the cost of new projects. A busy, well maintained and continually updated building will hold or even improve value against the cost of new construction, particularly if the property is well positioned.

Yield: The yield of the investment will indicate the capitalization rate of the property. We are now experiencing the lowest interest rates for thirty years. This is having a direct impact on the private, non-secured residential rental market, with many investors calculating a 3.5% or 4% gross (ie, before outgoing expenses are paid) return against market value of their property. For owners of serviced apartments however, with long indexed leases, the yield against the value of the property remains constant or grows.

Market Appeal: Security: A freehold title provides security of ownership, and serviced apartments provide constant income secured by lease. This allows current and future investors to accurately calculate the rate of return on the investment. Comprehensive insurance for both building and income within the responsibility of the tenant and body corporate, provides security for the physical and financial structure of the investment.


Significance of Construction: Serviced apartments frequently become local landmark buildings due to position or architectural significance. There is often considerable prestige attached to the building and also to the tenant. Throughout history, major hotels have become attractions in their own right, adding to the cultural threads of a neighbourhood or city.

Negotiability: The freehold nature of the apartments mean the individual properties can be bought, sold, mortgaged, inherited or gifted as can any other freehold property. At the expiration of the lease and options, the owners may choose to occupy the property, decorating it to suit themselves.

There are four main criteria against which any investment should be measured. These are Security, Negotiability, Yield and Capital Gain. Serviced Apartments leased to reputable and experienced tenants fulfill these criteria and further provide the intangible benefit of pride of ownership while contributing to the significant long term financial benefit of the individual owners and investors.





A handy statistics reference page is www.prd.com.au as their research shows lots of interesting facts regarding numbers of rooms, occupancy, length of stay etc.
 
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Reply: 3.1
From: Anonymous



Thanks for all the responses. It was good reading. The Service Apartment (SP) I am looking at is in the Sydney suburb of North Ryde "Silicon Valley of Sydney" - 20 mins from the CBD.

At first glance of the glossy, it looks like a very good investment with a positive cashflow for 10 years having the following:

# 6.2% yield guaranteed by the Ascott group for 10 years with a CPI increase of 2% p.a. from years 2-6 and 3.25% p.a. from years 6-10;

# No running costs and statutory out goings (only $250 p.a. sinking fund); and

# Fully furnished - great depreciation having 17,700 for the year etc.

Being my first SP, I guess my concern is the potential capital growth in a SP vs a residential property.

Thanks again.

MM.
 
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Reply: 3.1.1
From: Francoise B


Hello - very interesting postings. Can some please explain the difference between a "capital based tenant" and an "operations based tenant"??
 
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Reply: 3.1.1.1
From: Kristine .


Hi Francoise

You've raised an interesting point.

In my reference to a 'capital based tenant' I mean a tenant (company) which has considerable capital eg a public company with real assets, whether property, cash or other assets. The operator in the building may be a franchise owner, or a staff appointment, but either way, you are guaranteed that the operations will continue, and the rent to you be paid, even if the individual operator fails, is sick, is a poor manager etc

An 'operations based tenant', on the other hand, may have no capital invested in the business eg a 'Mom & Pop', who simply trade as building and/or operations manager at that site. Where is the back up if they fail? The building may be without active management while the legal situation is resolved, and it may be difficult to recover the rent.

Both these models exist in the market place, and both models operate successfully. However, the 'capital based tenant' is likely to be stronger in the long term and lenders will usually look at the track record of the tenant when considering the risk.

Cheers

Kristine
 
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Reply: 4
From: Kristine .


More recycling of relevant threads.

Phew! stepping back through zillions of posts, I've quite worn my button clicking finger out!

However, these pro & con points of view are still relevant to today's discussion

Kristine
 
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Reply: 2.1
From: Joanna K


On 2/12/02 9:13:00 AM, GoAnna ! wrote:
>
>The second type has higher
>risk and a less predictable
>income. In this case you are
>effectively running the
>business yourself and you run
>the risk of high vacancy and
>high running cots. My
>personal view is that these
>types of serviced apartments
>are high risk as you are
>carrying the risk of both the
>business and the property. If
>the business does not perform
>well the property will also
>decline in value.
>
>Please note that I have not
>had personal experience of the
>second type and perhaps others
>who have would like to add
>their views?
>
>
>

Hi GoAnna,

I have experience with the 2nd type of serviced apartment you mention.

I had a landlord who bought on OTP at an extremely over inflated price. The agent he purchased it from had it vacant for 12 MONTHS!!! and not one single prospective tenant at $500 per week.

I met this guy by chance as I was also managing property in this particular building and when he advised me of his problem I convinced him to give "servicing" a go.

Although reluctant at first, he spent about $15k for furnishings and equipment. He had it so that anyone just needed to walk in and hang up their clothes. I went and purchased bulk toilet paper, mini shampoo's and coffee & tea satchels for the guests who stayed there, and hooked up foxtel.

In 12 months since the setup the property was leased at $1,200 per week and was vacant only 3 weeks in that whole time.

The extra weekly running costs of the "servicing" were the higher management fees, cleaning, laundering and foxtel.

The apartment was such a huge success that I am in the process now of setting up more to meet the huge demand that I discovered existed in the area of operation.


Kind regards

JOANNA

The Rental Specialists
 
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Reply: 2.1.1
From: Joanna K




I forgot to mention, we did the calc's and it figured that even if the property was vacant for 4 months in that year, we still generated more rent than if it were to be leased on a stardard residential lease for 12 months paying normal market rent.

The only other thing I did was establish credit card facilities so occupants gave me their card number and when the rent was due, it was taken directly from their credit card. At the end of their stay, I downloaded the phone bill off the telstra site and charged them phone usage. EASY.

I recommend this way of leasing property any day, but that's my personal opinion.

Kind regards

JOANNA

The Rental Specialists
 
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