How to invest in serviced apartments

Nick Lenaghan

They are apartments with a difference: owning one of them is akin to having your own hotel room in your investment portfolio.

The asset class is called serviced apartments. It has been building capacity for more than two decades but is still new territory for many investors.

Uncharted waters

It is also an unfamiliar investment for many financial advisers, so investors must take their own counsel in weighing up the risks and returns.

Serviced apartments are a hybrid class, sharing characteristics of residential and commercial property, as well as exposure to the hospitality and accommodation industries.

The sector is big, growing to 55,000 rooms last year from 21,000 rooms in 1997.

Around 82 per cent of those are investment-grade, according to a recent Jones Lang LaSalle report. That’s a $10 billion asset class – one-quarter of Australia’s total accommodation investment stock.

A combination of market forces drove the surge over the last decade: demand for residential investment, credit constraints on hotel construction and the squeeze on accommodation supply.

Fading popularity

The mainstay of support has been retail investors, who have given up the hard work but potentially large gains in traditional residential property for what they hope are steadier returns.

Nevertheless, that demand has slackened recently, the JLL report notes.

“Investor appetite also remains muted in an era of deleveraging and in light of the suboptimal returns which have been evident over the past few years,” it says.

“That said, the growth in apartment-styled product has highlighted consumer eagerness to trade location for space – if offered at a similar price point – and this represents an important trend for the industry, particularly given Australia’s ageing hotel stock,” the report says.

There are more than 1200 operators in the industry, running more than 1300 locations and generating $2.3 billion in revenue.

Typically a serviced apartment complex involves studio, one-bedroom and two-bedroom apartments. Complexes range from 10-unit properties to those with 100 or more units.

Big and small

While there are some big players in the sector – Mantra, Quest, Oaks, Accor and Toga – much still lies in the hands of smaller players.

Often a serviced apartment complex will be operated under franchise, supported by the business procedures and marketing power of a big brand.

Investors must negotiate their way through a variety of ownership and operating structures used in the sector.

Dean Dransfield of Dransfield Hotels and Resorts has consulted on some of the biggest corporate deals in the sector, as well as advising retail investors on shared ownership holiday homes.

Long leases ...

The welter of investment models can be separated into four basic categories, Dransfield says.

Investors can take up long leases with the operator, as long as their apartment has the capacity to revert to traditional residential use.

In this scenario, the operator takes on the vacancy risk and other potential downsides, while offering a set income return to the owner.

... or short ones

Alternatively, short leases are taken on apartments that cannot revert to residential use, with 90-day opt-out clauses. This short-term arrangement is sometimes called a letting appointment.

Such short-term leases are struck with the holder of the management rights, sometimes the original developer or the operator.

The arrangements can then vary, each differently spreading the revenue and volume risk between the owner and the operator.

In some cases, the owner will take a percentage of room revenue and share the vacancy risk with the owner of the management rights.

The Queensland model

Under another model commonly used in Queensland, the owner pays a letting fee, typically 12 per cent, as well as cleaning and other costs, and collects the remainder.

Under the fourth format, apartment owners pool their operating costs and revenue, taking a percentage of the result.

The big question

Cutting through all of this is the single question any potential investor must ask: why do they want the apartment?

“Get a very clear lock on whether you are buying it as an investment or as something you want to use,” Dransfield says.

“If you are trying to get it to do both jobs, then you need to recognise where on the scale it sits.

“The more you like it as a lifestyle property, the worse it will be as an investment.”

At Quest Serviced Apartments, founder and chairman Paul Constantinou uses a long lease model aimed squarely at investors, not lifestylers.

The 6.5 per cent return his assets offer plus any capital growth have so far pulled in 3500 investors, who hold around 6200 apartments in Australia, New Zealand and Fiji.

One-bedroom apartments range between $250,000 and $330,00, two-bedders from $360,000 to $495,000 and three-bedders from $465,000 to $535,000.

The income angle

While mid-career investors have been the staple at Quest, Constantinou hopes new investment will flow from self-managed super funds.

“If you’re going to buy this asset just for capital growth, you are probably better off just buying a residential asset and hoping the market goes up,” he says.

“This is more income-driven, where people want certainty of income.”

Atchison Consultants’ Ken Atchison says the long-term lease structure, with protection against vacancy, is less common.

But it is a model that can provide the secure income component of an investment portfolio, he says.

Monique Wakelin, of Wakelin Property Advisory, is sceptical about the sector, pointing out the limited market for resale and high maintenance costs.

“Buying one of these robs you of the control that property investors usually laud,” she says.

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