Motel Leases – Market Rental Determination
Two years ago I wrote an article on this topic and received a number of calls from motel operators regarding their leases in relation to past or upcoming rental increases.
A number of motel lessee’s have contacted me over recent months again about this issue and it is imperative for both lessee and lessor that the correct market rent is in place. Lessees of a motel property will pay a rental to the lessor each month as consideration for leasing the property to operate the motel business from. The annual rent plus GST will be paid monthly in advance by the lessee.
The amount of the annual rental is of most importance to both lessee and lessor. The success of an investment in such a property/business is based on having the correct market rent in place. If the rent is too low, the lessor is at a disadvantage. If the rent is too high the lessee is at a disadvantage. In situations where a lessee believes their rent is too high, they may try to conserve cashflow by not keeping up repairs to the buildings and equipment like they normally would. This detracts from the presentation and ultimately affects the business trading and the value of the business and property. In the situation where the rent is too low, the lessor will not be earning the return on investment required on the capital funds that have been invested.
The happy medium for both parties should in theory be the “market rent”. In other words what rental a lessee in the market is prepared to pay and what rental a lessor in the market is prepared to accept, for such a property on a particular given day.
There are a few different methods of determining a market rent for a leasehold motel. These methods are detailed in no particular order as follows.
Rent/unit basis – This is a simple method of determining what the market level of rent is per unit for a particular type of motel. For example, if the market for a 20 unit four-star motel in a particular locality is a rental of $10,000 per unit per annum, then the market rental for such a property is $10,000 x 20 units equalling $200,000 plus GST per annum.
The industry does show a very wide range of rentals throughout the state, however rentals per unit will generally range anywhere from $5000 per unit through to $12,000 per unit. It depends on the type of accommodation property and each property needs to be looked at individually but a generally accepted maximum viable rental for even the best motel business is approximately $12,000 plus GST per unit per annum. Most motels will fall somewhere into the bracket of approximately $6000 – $9000 plus GST per unit per annum. There is however a large variance on this within the market, due to differing standards of property, business trading and location.
Rent by net profit basis – This method is entirely based on the net operating profit that the motel business is producing. It does not distinguish between and is not distorted by the different income streams of the business. Other factors of rent determination such as the number of motel units, sales revenue, etc, are not directly involved in this calculation. The percentages utilised are generally between 40% – 45% of the total operating net profit. For example, a motel property shows a net profit after all operating expenses of $200,000. The commencing annual rental would be between $80,000 – $90,000 plus GST per annum.
Rent by sales revenue basis – The third method being looked at is the percentage of rent against the sales revenue of the business. This is a common method of determining rents, however it does have its faults, being that two motels with the same income but very different profit levels could potentially pay the same rental. This is due to the different income streams that each has, such as accommodation, food and beverage, tour income, etc. The profit margin on each of these income streams is vastly different, and could cause an incorrect rental assessment to be determined if the differing profit margins are not considered.
Considering the above methods of rent determination and using each as check methods against respective market levels, will result in a more accurate annual rental figure being put in place.
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