And now for something completely different

AccomNews Sunday, May 26, 2013

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As many of you have no doubt worked out by now I long ago ran out of anything new to say about banking and finance.

So, to ensure my readers don’t either avoid my monthly missive altogether or lapse into a coma during the reading thereof I tend to wander into other areas of comment and opinion. This month, much to your surprise I’m sure, I’m going to actually talk about banking and in particular the evolving nature of credit policy and perceptions of risk. I’m also going to try and cover both management rights and other forms of accommodation finance such as motels and caravans parks.

As you have probably gathered by now most of the main stream banks continue to like the idea of lending for management rights. In South East Queensland that means maximum lending ratios around 70% for the combined unit and rights. Different lenders cut and dice these ratios in different ways but the end result is 70% loan to valuation ratios or thereabouts.

Move out of South East Queensland and perceptions of risk among the banks tend to increase. This manifests itself as lower lending margins the further you get from major centres or where there is a perception of travel and tourism demand risk. Typically the banks will look at a lower lending margin for a holiday based management rights in Port Douglas than they will in Noosa or Surfers Paradise.

Once we move interstate the combination of a smaller management rights industry and different legislation will impact lending margins and also general lender confidence. As a result some banks will simply not lend for management rights outside of Queensland. Those that do are generally looking at 65% total gearing ratio maximums.

There has been no real change in lender credit guidelines over the past couple of years. Newcomers to the industry have little difficulty in achieving finance approvals (provided they engage an industry expert finance broker of course) with general credit terms being reasonably favourable. Some banks are starting to show a bit a caution with lending to smaller buildings with very low net profits, limited letting pool numbers or, indeed, for buildings with short agreements.

Contrary to popular belief the lenders do not set maximum multiple levels over which they will not lend. Obviously if someone is clearly paying over the odds the bank will have the business valued and lend on valuation or purchase price, whichever is the lower. For many contracts provided the multiple is within reasonable market standards only the unit will be valued.

A word of warning. Don’t be tempted to load up your unit value and discount the management rights value to save CGT. The bank will only value the unit and then lend on the combined unit valuation and rights contract. A low unit valuation will result in a lower all up loan for your purchaser and can be a deal killer.

The areas in which the banks are currently still finding their way are at the cutting edge of the market where leasebacks, performance undertakings and NRAS based management rights continue to both challenge and provide
interesting opportunities. These business models arguable carry risk factors not generally associated with the more traditional management rights model and, as such, will be assessed by bank appointed valuers in a different light.
Indeed, the assessment of future business, economic and legislative risk within the credit assessment and valuation process continues to be one of the key drivers in respect of finance outcomes. Happily, the management rights model is considered low risk by most lenders, which has had a very positive impact in terms of buyer access to credit.

If you want to see what happens when lenders start to see growing industry risk in a sector look no further than property development, pubs and child care centres. Trying to get finance approved at 70% gearing for a first timer in any of these industries (and many more) would be an exercise in futility!

Motels and caravan parks are an entirely different kettle of fish. Gearing levels range from “no thanks” to 50% of the value of a leasehold. For highly experienced operators gearing above 50% is sometimes available but the choice of main stream lenders is limited.

For freeholds gearing ranges from 60% to 65% with higher levels again available for the right deal. Leases would generally be funded on 10 to 15 years P and I repayments. Credit policies and appetites tend to be consistent across all states and territories with future risk including demand and management being the two big issues for the banks. As you can imagine a motel in a regional centre with great trading figures driven by recent resource sector demand would need to demonstrate the sustainability of that demand in order to value up and attract a suitable finance approval.

So here’s the rub. Give or take a point, management rights (including the unit) tend to change hands on or about a 14% return on investment. That just happens to be pretty close to the return you would expect as the operator of a freehold motel. For a leasehold motel the average return will be in the 27% to 32% range or even higher for shorter term leases. When I say shorter term I’m talking less than 15 years. The average lease term I see for motels is above 20 years to run with many being 30 year leases.

Don’t get me wrong, I love management rights. The industry has been very good to me and I’m sure will continue to be so. However, something here does not make sense to me. I can get a 70% lend on a management rights with the usual multiple ownership risks, committee management challenges and 15 years to go on the agreements with a return of 14%. I go to buy a motel lease with one owner (the landlord), 30 years to go on the lease and a return of 28% and I can only get a 50% lend.

We all know the reason. The bank gets to take a mortgage over a unit in most management rights transactions while a motel lease lend is essentially a goodwill lend. Still if you look at debt servicing capacity and risk I would argue that funding motels and caravan parks carries no more risk than management rights.

Bankers… consider the pin out of the hand grenade… over to you!