Splitting up a Lease and Freehold
When a prospective buyer is considering acquiring a freehold motel they often have an immediate or future agenda or interest in selling off a lease over the property and retaining the freehold property as a passive investment.
The business is leased to an operator and the property owner receives a high return on their investment with the security of a long term lease.
The situation can arise where a motel may not have been trading as well as it could have over recent years and the intention is to operate the business for 12 to 18 months endeavouring to build the business to a higher level. Whilst doing this gain a full knowledge of the property, how it runs, its little quirks, complete any refurbishment matters required, determine what the business is capable of trading at and how much rent can be reasonably demanded for the property.
During this period the owner can gain a great knowledge of the business and property and therefore be comfortable with the decisions they make when the time comes to lease the property.
Having operated the property the owner will have a better understanding of the property and its requirements for maintenance and costs to operate the business whilst it is leased and being operated by a lessee. Communication with the lessee will then more likely be on a basis where both parties understand any issues or problems with the land, buildings and services etc if and when they arise. This will in turn assist in the lessee and lessor hopefully maintaining a better working relationship that is mutually beneficial to both parties.
This method of operating the business for this initial period is also on the basis of trying to achieve the highest possible maintainable rental that can be achieved from the property at that time. If the business has a net profit of $200,000 at the time of purchase and due to refurbishments and better method of operation the business can be improved to a net profit of $300,000 after 18 months for example, then this makes a major difference to the level of rent that can be charged by the lessor.
* All rates quoted are ex GST
The maximum achievable annual rental generally accepted within the motel industry on a new lease being put into place is approximately 45% of the total net profit. Opinions differ on this however it is widely accepted that this is the most fair and equitable method for calculating motel rentals as it takes into account not only the different sources of achieving the income of the business but also the outgoing expenses incurred in achieving the income figure.
This method allows the motel industry to compare apples with apples rather than apples and oranges that other methods of determining rents can create. Both lessee and lessor can then be satisfied that the rental they have put in place is fair and reasonable for both parties and all things being equal should not be detrimental to either party.
Andrew Morgan
QLD Tourism & Hospitality Brokers
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