Risks in purchasing hotel apmnts on 10-year lease

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From: John Shadow


I am currently looking at buying an apartment in Melbourne city from a large hotel chain. They give you a 10-year lease with 3 x 5-year extensions starting with 6.5% return on the purchase price. Rent increases at 3%pa and is reviewed every 5 years. They also pay all out goings except council and water rates.

With all the depreciation of the new property and furniture, it is cashflow positive for at least 10-years and it seems like a good deal. The prices are factored up quite high to give the 6.5% rental return.

I am wondering what the down side is? Where can I get stung? The things I can think of are:

* what if the company goes bankrupt and dumps the lease?

* what do I do in 10-years if the lease is not renewed?

* the price is higher than normal because of the long term lease.

However, these are not deal breakers. are there any other risks I should be aware of?

All comments and suggestions are warmly welcomed. Thanks.
 
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Reply: 1
From: Nigel W


getting finance may be difficult.

capital growth may be limited and you're already paying a higher price than you think it's worth.
 
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Reply: 1.1
From: Gail H


Hi,

The cash in your pocket may be quite modest once it is taxed. If capital growth is non existent or if price falls, you may find yourself standing still or going backwards. It will also be hard to sell. Probably not worth tying up too much cash in a deal that may show no or negative growth.

And yes, banks don't like 'em, so you'll have to chip in a higher amount yourself, thus tying up funds that could have gone into a more growth oriented investment.

Gail
 
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Reply: 2
From: Duncan M




Don't forget that there's also a very limited market should you want to cash
out at any point..

Duncan.
 
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Reply: 2.1
From: Mark Pardi


Very hard to finance on high LVRs

Lenders like a lot of "hurt money" on these deals...so that tells you something

A lot of the benefits are already added into the cost.

Just about nil growth

usually comparatively high depreciation claims which can be of benefit for pure tax minimization........but usually not enough incentive to purchase property for that reason only.

over all these kind of investments are only suited to a limited market.

also they are very difficult to sell down the track.

Mark Pardi

Property Buyers Network
 
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Reply: 2.1.1
From: Michael Ho


Hi,

I bought something that sounds like this in Sydney CBD about 3 years ago.

I agree with the above comments that it was quite difficult to get finance. We finally got finance through NAB of all places.

Initially the the tennant was always quite bad with payments (even though it was managed by a large hotel chain). After the fist 6 months or so, it was more regularly being paid on time.

HOWEVER, about 3 months ago, even though we have the 10 year rental guarantee, the tennants are no longer paying us. They claim the reason is beyond their control due to doom and gloom in the hotel industry and September 11 blah blah blah.

We are now left 2 options: i) taking a rent reduction and call on the tennants guarrantor - but they only will garantee rent for 18 months; or,
ii) trying to sue them (costly and we've got buckleys of getting anything out of the directors from what we've been told)

Neither of these options are terribly good and we are still waiting to hear again from the tennants.

So after experience (my first IP), I'm steering well clear of hotel/serviced appartment properties.

Cheers,
Michael
 
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RE: Risks in purchasing hotel apmnts on 10-year le

Reply: 2.1.1.1
From: John Shadow


Hi Michael,

That sounds like a horrible situation! That is exactly the type of thing that I am worried about with these investments. Can I ask you some more about your experiences?

Who is the hotel chain that has defaulted on you? Do you have any capital growth over the previous 3 years? Does your lease agreement allow you to kick out the hotel on default, and (for example) rent your apartment as a residential property? Or, can you now sell your property to an owner/occupier as a residence?

Thanks for sharing your experiences and saving other people the pain that you have been through.
 
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RE: Risks in purchasing hotel apmnts on 10-year le

Reply: 2.1.1.1.1
From: Michael Ho


Hi John,

To answer your questions:

The tennant is Darmic Pty Ltd & Stevanne Apartment Pty Ltd, and the hotel operator is Pacific International. They explained the relationship a bit like Darmic & Stevanne being the owners, and Pac Int. being the property managers. Pac Int run the hotel and collect money from guests, then they pay Darmic & Stevanne who in turn pay us, the owners. Pac Int make their money from collecting mangement fees from Darmin & Stevanne.

Not sure if Pacific International are big in Melbourne, but they are all over the place in Sydney. They were operating another block of serviced aparmentents in Bankstown where something similar also happend. (This is a Sydney suburb that has been getting plenty of bad press about crime etc so hotel occupancy there was way down) We've been told they managed to resolve this one fairly quickly (3 months altogether), whereby they negitioated with the owners to lower the rents by 20-30%, and half was sub-let as normal residential property. In the case of the CBD building we've been missing rent for more than 3 months already and negotiations are progressing much more slowly.

As for cap gains, way too many inner Sydney apparments popped up since we bought this one off the plan. So no cap gains there. Therefore selling had not been a real option, esp now.

Not sure of the exact details of the lease - we are trying to form an owners corporation and use the solicitor who looked after Bankstown to get things done consistently. I expect residential rentals is one of the avenues to be explored. This building was targetted at business travellers, so my property is a small one bedroom appartment. It's not an idea place to for someone to rent long term and get consistent case flow from.

Hope this helps you decide. Also check the size - under 50sqm makes it alot more difficult to get finance for. My one was only 43sqm.

Live and learn.

Michael
 
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RE: Risks in purchasing hotel apmnts on 10-year le

Reply: 2.1.1.1.1.1
From: Kevin Rogers


We have purchased an apartment in a Hobart estate where the tenant is a sub-letting company, ie Quest. We have a contract with Quest that increases the rent by 4% per annum with independently arbitrated market rent reviews at years 5, 10 and 15.

It is positively geared from the start. We have been going for only 6 months so far and everything has been going well. Is there anything to fear?
 
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Reply: 3
From: A C


John,

Check your contract closely to see if the Hotel Chain reserves the right to on sell the license.
 
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Reply: 3.1
From: Bruce Graham


G'day
I have a serviced apartment in Chatswood,Sydney.
Gross return is 6.5%, no other costs after
the sinking fund($20.71 mth).They pay all
other overheads.
Multiplex built it,managed by Stockland Property Trust,trades under the Saville Suite Apartments.
Never had a days trouble.
Ten year plus two five year options lease.
Rented out at $430 per week.Rent paid into
my bank on the first of every month.
I checked out the Pacific international Hotel
at Central, on George Street.
Didn't like the size of the suites etc.
Gave it a big miss.
Bruce G(Sydney).
 
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Reply: 3.1.1
From: Francoise B


Hi Bruce,
How long have you had your serviced apartment?

Great to hear both the +ve and -ve views.

I am also considering such a deal in Perth - by the River, 5 mins from (but not IN) the CBD. Hurdles I am trying to come to terms with are: 1) not very liquid 2) lease (5 yr + 2 x 5 yrs) ties you up and any early exit will be penalised.

I can see it from the leasors point of view, having owners dip in and out would be a big problem, and so they want continuity, but nonetheless, I am uneasy about being tied up in this way!

Can anyone suggest (here or directly to me) how to research these (serviced apartments?)- I am after cap. growth figures and any other stats. PS: The lease company is Assured Hospitality.

Best
Francoise
Perth Freestylers co-ordinator
 
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Reply: 3.1.1.1
From: Michael Ho


Hi,

Just giving my 2 bobs worth again.

Good luck to you Bruce - sounds like you picked a good one. Guess the lesson is to make sure the mob running the place has realistic projections for their market and a good financials with deep enough pockets to ride out any rough times.

A former colleague of mine who was originally from Perth bought a serviced apartment over there. She also got most of her family to buy some too. The tenant running that building went belly up also. Last I hear they were trying to see if it could be rezoned as a retirement complex. Unfortunately I know the exact details and she's no longer working here.

Yet another former colleague bought a serviced apartment some time back in, I think in Artarmon. I didn't hear of any problems other than it being harder than normal to get finance.

Latest on my situation is that the tenant of our building in Kent Street has gone into voluntary administration :(

So I'm sure there must be some good ones around, but you really have to weigh up the risks. A rental guarantee sounds good but is worthless the company giving that guarantee goes bust.

I'd be interested to know if it's just me who has come across more negative stories than positive ones. Does anyone know of any official stats on hotel run properties?

Cheers,
Michael
 
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Reply: 3.1.1.1.1
From: Bruce Graham


G'day Francoise,
The reason I'm involved with
a serviced apartment is because of the
companies associated with the building and
the location.
Chatswood is on the north side of the city,
plus being a city in it's own right.
Stockland Property Trust is in the top three
trusts in Australia, if they go belly up GOD
help the rest of us.
Multiplex is a family company, West Aussies,
very big they talk in hundreds of millions of
dollars.Too big to rip off people like us.
The bad news is the fact that Meriton apts
are building blocks of units at Chatswood.
The place is swamped with units which is
keeping unit prices down.
Bought off the plan January 1999,(half built when I bought in) took control December 1999.
Cost $344,000 with parking.
These places are hard to borrow against, that's another problem.
Bruce G(Sydney)
 
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