property with guaranteed lease

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From: C Xu


Hi, IP experts
I'm getting serious about the idea of purchasing a property with a guaranteed long-term lease (8-10 years), honestly, under a effective promotion by a sales representative. He presented two options: (1) a 1-b unit in a serviced apartment in Sydney CBD, and (2) a residential property under the management of the government housing corporation.
I received a good education about the advantages e.g. no fear of vacant, negative gearing. I'm really new to the IP let alone guaranteed lease. It sounds good but is there any pitfalls? Can anyone enlighten me?
Thanks
 
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Reply: 1
From: Frank Shead


You may find it harder to obtain finance for serviced apartments as banks are not keen to give your mortgage.

Frank Shead
 
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Reply: 2
From: Michael Yardney


Hi C Xu
I can understand that as a new investor you may see the comfort of a long lease as an advantage.
There are some downsides and personally would not buy that type of residential property.
On the other hand... a long lease to a good tenant for a commercial property is a big bonus.
When buying serviced apartments or other residential properties with long leases, you are usually buying an income stream, not really a property investment.
You have little or no control over the rate of increase in the rent, which is one factors in the capital growth of your property and the increase in your wealth.
Also, you have no opportunity to add value to your property by doing renovations etc. You may find it more difficult to sell the property down the track as fewer investors will be interested in this type of property
particularly as the length of the remaining lease gets shorter.

Michael Yardney
Metropole Properties
 
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Reply: 2.1
From: C Xu


Michael & Frank,
Really appreciate your advice.
C
 
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Reply: 2.1.1
From: Kristine .


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 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
From: Geoff Whitfield


Is option 2 DHA?

There's lots of responses in the forum- a search on DHA (Defense Housing Authority) will tell you a lot.
 
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