Monday, August 13, 2012

The Motel Ratchet Clause

I see that the Motel Association of NZ (MANZ) have recently taken a swipe at unsympathetic motel landlords and the pesky (and appropriately named) “ratchet clause" that determines lease rentals can rise, but not fall.

A motel lease is an agreement that is unique in the business world. Splitting up a freehold going concern can satisfy two distinct parties - the long-term freehold investor and the leasehold owner of the motel business. Most motels in New Zealand are set up this way.

Generally a motel lease starts off at a 25-30 + year term. This long term agreement can be problematic as set terms and conditions apply over a longer period of time than most other types of business lease agreements and the parties can endure vast changes in economic conditions.

This arrangement generally works well assuming that the market steadily improves over the term of the lease, however economic road bumps along the way can cause heartache - and there is a perception that any angst will tend to fall upon the leaseholder.

Motel landlords that have the largest stake in the deal expect to receive a fair return on their investment and rightly so. Many motels only exist today because of the long term leases prevalent in the industry that have allowed a lower entry point into buying and running a motel business.

It is accepted that the costs of operating a motel have increased often well above general inflation. 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) is under threat as freehold owners have often pushed hard at rent reviews to get a higher percentage. This has caused operating pressures for some motel lease holders.

The squeeze on the operating costs has been to the detriment of maintenance. Generally the landlord is only responsible for maintaining the buildings in watertight condition - although sometimes this isn't clear-cut if it can be determined that the leaseholder didn't undertake required maintenance that may have prevented moisture entering the building! 

While the ratchet clause may pose a barrier for some motel properties wishing to catch a break over hard economic times, probably the bigger problem with motel leases is how maintenance and refurbishment is prescribed over the term of the lease, well before a crisis point is reached.

Older leases generally don't have a maintenance fund for future R and M and those leases that do may only require 3%-5% of the annual rental. Over the course of a lease (in particular the later years), this reinvestment in buildings is often scarcely adequate to keep up-to-date.

Ongoing investment is also required in motel chattels that form part of the tangible assets of the lease. Most lease agreements generally leave the management of these over to the leaseholder and inactivity/mismanagement in required refurbishment can quickly leave a motel behind-the-times in offering the travelling public what they expect.

The motel stock in New Zealand is aging and some older leasehold motels have become past the best economic use of the land well before their time. This is frustrating for both the landlord and the leaseholder and can be predominately due to an inadequate schedule of repairs and maintenance and refurbishment undertaken by a revolving door of past leaseholders that have stripped value.

While the motel industry looks warily at the scrum of alternative accommodation sectors such as bed and breakfasts, apartments and private accommodation, the real competition has come from the hotel sector. In spite of hard economic times, the hotel sector have retained up-to-date skilled management, reinvested in their product, operate well in the online environment and have managed to effectively deliver and communicate to the public stratas of consistent quality brands. 

All is not doom and gloom as the motel industry is still a valid product that offers value to the travelling public. Large pockets of motels that are run by switched-on moteliers have managed to keep ahead of the game and operate profitably. They have been able to maintain or increase the value of their leasehold investment by keeping up maintenance, increasing tariff, growing occupancy and buying additional lease years at reasonable prices.

Rent rises strangling small business says Motel Association of NZ

The relentless rise of rents is acting as a handbrake on many small businesses and in turn restricting the country’s economic recovery, says the Motel Association of New Zealand (MANZ).

The prevalence of “ratchet clauses” within rental agreements does not reflect the economy or the sector in which the business operates, and assumes the tenant is able to absorb rising costs year in and year out, says MANZ Chief Executive Michael Baines.

“Rents are one of the many costs of doing business which are caught in an upward spiral. This is at a time when the country’s economic recovery is still tentative and global uncertainty threatens,” Mr Baines says.

“Obviously it is to no-one’s benefit to see businesses go to the wall under the pressure of rent rises. So we’d like to see landlords take more of a partnering approach and realise that a tenant paying a manageable rent is better than no tenant at all,” Mr Baines says.

More than 75 per cent of MANZ member motels are in premises that are not owned by the operator. Like many businesses at the smaller end of the scale, the pickup in the nationwide economy does not see the benefits flow evenly to everybody.

Some moteliers are still feeling the pinch after slow years in the tourism sector, while some parts of the country, such as the South Island outside of Christchurch, are continuing to struggle.

New Zealand is in danger of forgetting the boom and bust days of the 1980’s when tenants had to pay ever-increasing rents even as buildings stood empty.

“We’d like to see these ‘ratchet clauses’ phased out of rental agreements and replaced with something that more accurately reflects the businesses’ sector and it’s ability to cope with price increases.”

“By working together, we will build a better and healthier economy in the long run,” Mr Baines says.

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