The following article appeared in New Zealand Resort Broker's "Tourism Informer" publication and has been reproduced in the August/September 2008 Southern Hospitality Magazine. It would be fair to say that the article caused a stir and was a hot topic of conversation within the motel industry.
The article is straight shooting and outlines some of the challenges facing the motel industry. Realistic words written within the "Tourism Industry" are very rare, so it is refreshing for Resort Brokers to have the courage to put their name to this article...
For further information: www.resortbrokers.co.nz
Ageing stock and obsolescence
The bulk of motels in New Zealand are more than 10
years old and are generally well located on main arterial
routes, easily accessible to the traveling public. It is fair
to say that in high profile areas the motel use of the site
is the lowest and worst use of the land and that if the
motel did not exist it would be replaced with enterprises
which can generate better returns for the freehold owner
i.e. apartments, retail, commercial service, fast food, and
service stations all generally provide a better return in
high traffic volume areas.
Freehold owners expecting better returns
So we all need to watch out as any owner will be expecting
to receive a fair return on their investment and rightly
so. Many motels only exist today because of the long
term leases found in the industry. Many freehold owners
cannot wait until the current leases expire so that they
can redevelop and in the interim they will often tend to
push for higher rents thus squeezing the profitability of
the business.
Increasing costs
The costs of operating a motel have increased often
well above general inflation so the business operator’s
margins are suffering another form of squeeze. The old
days of the 1/3 1/3 1/3 rule (1/3rd revenue to rent,
1/3rd revenue to costs, and 1/3rd revenue to operators
profit before drawing, tax, depreciation etc) have gone as
freehold owners have often pushed hard at rent reviews
to get a higher percentage – sometimes up to 40%.
With costs rising we have seen examples of where they
represent a proportion well above 33%. In an example of
a 20 room motel which has a turnover of say $500,000
the traditional split would have been as follows:
- $166,700 rent to the freehold owner
- $166,700 operational costs
- $166,700 operators pre tax and drawings profit
then the operator income will drop from $166,700 per
annum to just $135,000 - $31,700 straight off the bottom line.
Loss in capital value
Investment in a motel lease is in fact a depreciating asset
in any event although many owners have become used
to seeing their values increase over the years for three
major reasons, namely:
- Increased rooms rates and occupancies pushing up real returns
- Ability to buy additional years on their leases at reasonable prices, and
- Little distinction in the market between any lease with more than 20 years to run
incomes through higher rental and costs detailed in the
previous section – that reduction of $35,000 p/a alone
would result in a loss in the lease value of between
$100,000 and $150,000 depending on the location and
nature of the motel.
Many areas of New Zealand have seen a drop off in
custom over the last 12 months with the increases in fuel
costs, higher food prices, interest rate increases, reducing
corporate profits and the like, impacting on people’s
desire and ability to travel for both leisure and business
purposes. Our recent study of what was considered to
be a very profitable modern motel indicated that the 18
room motel was very susceptible to only minor changes
i.e. we demonstrated that just a 10% drop in occupancy,
only a 5% drop in room rate, and a minimal 2% increase
in interest rates turned this successful motel into a
disaster.
Current profit before tax, depn, interest and owner drawings $177,800
Current profit after mortgage
payments 30% P and I loan $ 81,800
After changes outlined above:
Future profit before tax, depn,
interest and owner drawings $ 78,500
Future profit after mortgage
payments 30% P and I loan -$ 21,800
With just these minor changes in the market, the owners
of this business would be losing $21,800 per annum and
their business would have at least halved in value.
Increased competition
The bulk of the industry has been attacked on a number
of fronts with varying degrees of success, namely:
- Increased supply of serviced apartments and the advent of management rights
- Hotels taking customers based on increased service and little differential in price
- More modern motels being built which offer better accommodation than existing stock
- To some degree the establishment of the bed and breakfast industry, and
- Those motels who have seen the light and undertaken extensive refurbishment
low occupancies and were forced to market the attributes
of a quiet location. Now the public have become aware
that many of the more modern motels are not necessarily
on the major arterial routes and the newer motels have
been pretty successful in securing the established
customers from older, better positioned properties.
Customer needs
Let’s face it – when people travel they expect to stay
in accommodation either equivalent to what they have
at home or better. The advent of large screen TV’s,
microwaves, air-conditioning, quality lighting, heated
towel rails, mixing faucets, large mirrors, fast internet
service, quality furniture, comfortable beds, and
quality soft furnishings have meant that these are not
considered luxuries by most people who travel but have
become a part of their every day life.
Most people do not want to stay in a motel with floral carpets, floral curtains,
patterned wallpaper, sagging beds, dated bathrooms and
kitchenettes, and dated soft furnishings - not even if it is
inexpensive.
A brief review of the industry would indicate that most
operators of motels are on average in the 50’s and it is
clear that the limited refurbishment that takes place is
orientated towards the tastes of that age group rather
than the wider travelling public. Clearly there is a need
for motel operator/owners to seek external advice on
refurbishment.
Make your customers happy and comfortable and they
will come back and also tell their friends – the cheapest
advertising you can get. Let them think that it is like
staying with the mother in law and you risk a final goodbye
as they begrudgingly hand you $120 and wonder what
for.
Legal structures standing in the way
20-30 years ago it became popular for freehold going
concern owners to split their assets into a freehold
investment portion and a business lease. This generally
yielded a greater value as it satisfied two investor
demands.
The freehold investments became very popular
with long term investors due to the length of the leases
offered and the quality locations of most of the properties.
Freehold owners felt very safe with their investments and
were prepared to pay premiums over and above normal
commercial investments.
The process also opened up the ability for people with less capital to get into the
business through the acquisition of a lease/business.
So splitting up of the entities was a profitable exercise
and before long most motels of any size throughout the
country had such structures in place and almost all new
properties were and are formed on this basis.
The problem with this structure is mainly that the leases
are for such a long term and the lessor will generally
demand a ratchet clause meaning that the rental can
never go down below that set at the last review. This
is perfectly fine if the market continues to improve over
the 25 or 30 year term but sure as eggs the market will
decline at some point in time and the rental will become
unaffordable.
The second major issue with leases is that generally
the freehold owner does not take any responsibility for
expenses other than structural repairs and maintenance
plus water tightness. Well it does not take an accountant
to understand that the share of profits the operator
receives makes it difficult to afford and undertake the
refurbishment required over time to ensure that the
motel has a lasting place in the transient industry.
It is the writer’s belief that the leases need to be reformatted
over time to reflect these inherent difficulties otherwise
many freehold owners may find themselves standing
behind the reception desk rather than simply awaiting
their next monthly automatic bank payment.
The third issue is that most leases have a provision for
a maintenance fund for future R and M but generally this
represents only a fraction of what is required. In hotels
it is usual practice to set aside a fund equivalent to 5%
of gross revenue and this is never enough to keep the
property up to standard and requires periodic capital
injection. In motels the usual fund is only 3%-5% of the
annual rental – not gross revenue. Therefore maintenance
provisions in motel leases are usually less than a third of
what is provided for in hotels – yet as already stated the
provision in hotels is not enough. The motel industry is
not generally aware of this huge shortfall and the lessee
feels that there is inadequate revenue to set aside – a
problem to be dealt with in the future.
The trouble is that lessees all around the country have
continued to ignore the issue and the deterioration of
motel stock has begun to accelerate.
value of leases/tax depreciation
One wonders if the effects of obsolescence and physical
deterioration have been properly factored into the
assessment of worth for motel leases. I suspect not,
other than in extreme cases where the motel has reached
the stage where it is simply not habitable.
If buyers looking at motel leases were more discerning and fully
reflected deferred maintenance into their thinking then
it might force current owners to be more responsible in
the protection of their major asset. A motel business is
no different than most other businesses – if you continue
to take out and not put back then you will suffer an
eventual loss in income and capital worth.
Most owners are more than happy to accept tax reductions in terms of
depreciation and spend the savings elsewhere without
regard to the fact that depreciation is real and needs to
be dealt with. Depreciation is not just a tax break – it is
real.
Why don’t moteliers refurbish?
Well the major reasons are usually fiscal. Normally
owner operators feel that they cannot afford to expend
the capital. The reality is however that they simply
cannot afford not to refurbish in most circumstances.
Others simply choose to ignore the reality and hope to
sell before it becomes too apparent. Over time buyers
will be made aware of the problem facing the industry
of a deteriorating stock as it will become public news
and these same buyers will look for low maintenance
properties that have demonstrated a willingness to set
additional funds aside and undertake progressive well
planned improvements.
The industry is walking a dangerous path but it will all
come home to roost and someone will have to pay. Unless
addressed, our industry will suffer with less guest nights
sold to domestic and foreign visitors, less revenue, and
loss in business values.
The good news
Whilst we are aware of the problem and little is being
done to remedy it we can at least get comfort that the
industry does have a good backbone. Our motels are
generally very spacious and include features such as
kitchenettes which is fairly extraordinary by international
standards. We have a strong base to work off and the
distribution of our stock is pretty much in proportion with
the demand.
Resort Brokers has produced a very simple model to
help moteliers understand the potential benefits of
refurbishment which can be downloaded as follows:
http://www.resortbrokers.co.nz/research-andreports/117/
There is no pain involved in at least having a look at
this model and then talking with a refurbishment expert
– in association with your accountant, valuer, and bank.
These people can help you make the right decision and
grow your business.
The future will be bright if we wake up to our responsibilities either individually or collectively.
Please don’t undertake piecemeal or sporadic
improvements because a new bedspread does not help
a room that needs new carpet, new paintwork and is
shabby in other areas. A decent refurbishment plan
is a continuous operation which does not stop and will
mean that the motel will never be run down. Sure you will
undertake most of your more major tasks in the off-peak
season but the process will be continual. Leave it for 10-
15 years and the cost will be prohibitive – leave it for 2 or
3 years and it will stretch your finances.
Treat your motel business like a family member - make sure
it is well fed and you will prosper along with you golden nest
egg. Please set about helping yourselves which will in turn
help us when it comes time for you to sell. Establishing
and implementing a refurbishment programme should
be one of your highest priorities and if done right you
will benefit from stronger income streams and retention
of value. There are plenty of people that can help you
– unless you are well skilled in this area, you are well
advised to bring in the experts.
For more information, or if you would like to
discuss any of the elements of this article,
please contact Gordon McGregor:
Mobile: 021 99 88 10
DDI: 09 369 9700
Email:gordon@resortbrokers.co.nz
