Adapting to change

In areas of regional Queensland where economies have slowed over the past 18 months or so, many within the motel industry are now changing the way they look at motel leases and freehold passive investments.

A downturn in various industries and regions, increasing operating costs combined with increased competition coming into the market (a lag from more buoyant times), has challenged how many are approaching the leasing side of the motel industry. It has not only affected leases though, as freehold owners with leases in place have also been forced to consider their positions. Sometimes change is forced upon us and the motel industry is no exception. When there is a shift in the overall balance, adapting is better than burying one’s head in the sand.

Ultimately in any building, when a lessee/tenant is paying their rent without question then all is wonderful. Whether we are talking about a lessee or lessor, when a business’ trading declines to a large extent, the level of pressure increases and questions start to be asked. Both parties have loan repayments to make and both want the value of their asset to remain, at the very least, what it previously was, or preferably increase in value.

If a reduction in income is significant enough, the flow on effect is that the lessee struggles to meet their commitments, which in turn means the lessor will most likely struggle to meet theirs. The value of both assets declines. This is no different to a commercial building that is being sold fully tenanted with all tenants meeting their rental commitments as opposed to the value of that building when it is half empty with the existing tenants struggling to pay their rent. The value of the building “at that time” diminishes.

Over recent years many rents that had been put into place were based on solid and strong trading performances, which has been consistent within the motel industry for a long time. However the combination of the three issues already mentioned would cause tremors in any industry. Some existing leases have seen their current rent levels seem excessive, with a reduction in trading and in the case of a number of motels, rents had been increasing to levels that were too high for quite some time.

Rents are generally set up to increase annually by CPI. The fluctuations in room rates over time has seen that in the overall scheme of things they were not increasing annually in line with CPI. They then received a shot in the arm in many areas of the state on the back of increased demand for accommodation.

A lot of that growth in room rates that had not previously occurred was all of a sudden clawed back. Then when demand declined quite rapidly all of that growth was then extinguished very quickly. Rent levels then in many cases could not be supported when occupancy rates dropped below a certain level and room rates were then dragged back down via supply and demand forces. All the while operating costs continue to increase.

In many cases owners of freehold motels with leases in place have had to pay more attention to the status of the lessee and how the business is trading so they can make informed decisions for the betterment of maintaining the value of their asset. For the time being the attitude of setting and forgetting has required a more active participation in monitoring the status of the asset. Adapting has been required via rent relief or reductions being requested by lessee’s, or offered by proactive lessor’s, amendments to leases, and even termination of leases in some rare cases.

Retaining the existing lease in place rather than having the lessee exit is vitally important to most investors. Many lessors recently have been offering their lessee’s rental relief and/or the option of capital improvements being made to the complexes such as renovations including new bathrooms, kitchenettes, etc to keep the asset competitive in the market going forward. In many cases these capital improvements were well over due anyway and in many ways would have been contributing to general declines in room rates, occupancy and income levels.

A bump in the road tends to shake things up, and has many within the motel industry considering and acting on improved practices to maintain the value of an asset in the future, whether that be freehold, leasehold or both.

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