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The darker side of serviced apartments

Imagine an affordable, hassle-free investment in one of our major cities that offered a guaranteed rental return of over 6% and a long term lease with fixed annual rent increases.

In cash-strapped times, this would seem an opportunity too good to miss.

But, as always, there is a darker side.Welcome to the world of serviced apartments

Welcome to the world of serviced apartments.

Serviced apartments are basically strata-titled units within a hotel development.

Traditionally, a hotel would be owned by a single investor or a small group of investors.

As the hotel business is generally high-risk in nature, it can be difficult for a hotel operator to raise funds to construct a hotel project at a reasonable rate of interest.

Hotel developers came up with a strategy to reduce their funding cost and free up equity by strata-titling the apartments and selling them individually to mum and dad investors.

Some hotel operators offer fixed leases to the purchasers of the properties, while some offer a share of the income generated by that unit (or pool of income) from the operation as a hotel / serviced apartment.

So why do some investors buy serviced apartments?

Well, for anyone who is used to investing in houses, a 6% or 7% guaranteed rental return with no vacancies would appear very attractive indeed.

Serviced apartments promise security as they usually involve a leaseback agreement with the hotel operator, who may have a five or ten year lease to manage the property as a serviced apartment hotel.

Sometimes, the operator may even pay the body corporate fees.

But let’s examine why investors should be wary.

What happened to my rental returns?

Given that serviced apartments are sold on the promise of their strong rental returns and short-term rental guarantees, it’s worrying that many of the claims simply do not stand up to scrutiny.

In reality, many rental guarantees simply do not deliver or even if they do the returns following the guarantee period are often far less. 

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The occupants of serviced apartments are typically tourists and business travellers.

As we know, the accommodation industry is typically a very cyclical business and impacted by a number of external events ranging from terrorist attacks to airline strikes.

That is why rental returns are often lower than expected.

Plus, in the case of rental guarantees, it’s important to know who exactly is underpinning the guarantee.

If the company or person guaranteeing the rent goes out of business, then the guarantee could be worthless.

Generally speaking, rental guarantees should be a warning sign to investors.

They offer comfort but it’s what they hide that is a real danger.

A good question to ask yourself is ‘how good an investment can this really be if the seller needs to offer a rental guarantee?’

Another question to ask is “how long is the guarantee for?” – if it is only for 1-2 years, then really the market rent is more important.

Why isn’t my bank excited about my investment?

Another major problem with serviced apartments is getting finance for them.

Many lenders have a negative attitude towards them and will lend a lower percentage of the purchase price than a traditional residential investment and in some cases they won’t lend at all.

It’s not uncommon for lenders to have strict criteria regarding the size or location of serviced apartments.

It’s worth how much?

For an investor, there’s nothing worse than finding out that your property has lost value. There's nothing worse than finding out that your property has lost value

But this is a reality for many owners of serviced apartments.

Because of the long leases, serviced apartments can only be sold to investors – the owner-occupier market is effectively shut out.

This severely affects the level of demand for the product and restricts capital growth.

While there are always exceptions to the rule, generally speaking serviced apartments have poor capital growth.

If they didn’t, why would they need to offer a rental guarantee?

Conclusion

With more and more serviced apartments available, the problem of oversupply will hinder the capital growth of the category.The problem of oversupply

Also the high rental returns become less appealing the more you investigate the high risks involved.

There are also many other traps to avoid if you are thinking of investing in a serviced apartment.

For instance, what obligations do you have to renovate the property at the end of the lease?

While there have been some successful service apartment projects where all parties in the transaction have profited, in many cases investors who purchased the units have suffered poor returns.

All in all, it seems that serviced apartments are great for hotel operators, tourists and business travellers, but not necessarily for investors.



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About

Damian is managing director of Momentum Wealth, a Perth based property investment consultancy firm. A successful property investor in his own right, Damian formed Momentum Wealth to assist time poor investors in building their portfolios and applies his many years of experience to help clients accelerate their wealth creation. Visit www.momentumwealth.com.au


'The darker side of serviced apartments' have 17 comments

  1. Avatar for Property Update

    January 4, 2014 @ 5:36 pm accombrisban

    Thanks for sharing this informative post!

    Reply

  2. Avatar for Property Update

    April 13, 2014 @ 10:31 am mason

    As we know, the accommodation industry is typically a very cyclical business and impacted by a number of external events ranging from terrorist attacks to airline strikes.

    LOL, Bacause this happens on am onthly basis.

    Very poor article. i own many serviced apartments as they fit my investment strategy. Each to there own.

    Reply

    • Avatar for Property Update

      April 13, 2014 @ 8:27 pm Michael Yardney

      I’m glad serviced apartments have worked well for you. I agree with Damian that in general they make very poor investments.
      The internet is littered with stories of investors who regret buying into this type of property

      Reply

    • Avatar for Property Update

      September 27, 2016 @ 2:15 pm M Kat

      I concur with Mason, my experience is the exact opposite of this poorly researched article. I have capital growth over 10 years of ownership (in line with property 7 yr cycles) and have had trouble free, incrementally increasing rental returns averaging
      over $100,000 every 5 years.
      You have not listened carefully to serviced apartment investors, or if you have you have listened to those who chose poorly.

      Reply

      • Avatar for Property Update

        September 27, 2016 @ 2:28 pm Michael Yardney

        M Kat, I’m pleased you’ve had a great result with your investments, because like Damian I have seen many investors who have lost out substantially by buying serviced apartments.
        Having said that, clearly not all investors in homes or apartments have done well either, so correct asset selection and sensible timing in the market goes a long way to purchasing a good investment.
        however, in my mind, serviced apartments are not investment-grade properties. This article explains what I mean.

        Reply

  3. Avatar for Property Update

    April 3, 2015 @ 11:27 am Gino

    The article is totally negative.
    I have had a serviced apartment in the Paris end of Collins St Melbourne for the last 15 years.
    We started off with a 7% rental With the operator paying ALL outgoings (body corporate fees, council rates, water rates and no rental fees). Factoring in these expenses the return is more like 13-14 percent and increases with CPI each year. My only expense has been 2 lots of “updates” at a total cost which equates to less than $1000 per year. The valuation has gone up 150% in that time. All with NO headaches.
    Please show me a better, easier investment.

    Reply

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      April 3, 2015 @ 12:21 pm Michael Yardney

      Gino

      I’m glad you’ve done well. It sounds like you’re an unusually lucky. The internet is littered with stories of investors who’ve lost out investing in this type of property – I’ve spoken to many potential clients who’ve been held back owning secondary properties like this.
      Here’s Shannon Davis’s view on why not to invest in Serviced Apartments

      Reply

  4. Avatar for Property Update

    April 3, 2015 @ 6:53 pm Chris

    Mr. Yardney, I am renting out my first investment unit. Could you recommend some good landlord insurance policies or companies? Thank you

    Chris

    Reply

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      April 4, 2015 @ 9:17 am Michael Yardney

      Chris
      Congratulations on becoming a property investor. Ask your property manager -they should be able to recommend someone. Terry Sheer is a company that specialises in Landlord’s Insurance

      Reply

  5. Avatar for Property Update

    December 23, 2016 @ 11:31 pm Alex

    I agree with many of the investors of serviced apartments . I myself own many serviced apartments ,some for 15 years and I find them to be a wonderful investments. This is over a long period of time , locations and operators. This article made assumptions that are not accurately true. As actual owners of serviced apartments have lend their voices in support of them, I being one of them , these misconceptions serve as positives for the true serviced apartment investors as we would have better bargains due to less competition.
    Thanks a lot.

    Reply

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      December 24, 2016 @ 9:15 am Michael Yardney

      Alex – it’s great that you’ve done well out of your serviced apartments. However, in my opinion, in general they make secondary investments

      Reply

  6. Avatar for Property Update

    February 11, 2017 @ 1:56 pm Heather

    Hi there I have heard a lot about serviced apartments. The one I am looking at is been refurbished and more towards a sea side resort held by Mantra, with 35 year lease. I don’t know much but reading the article and some of the comments have left me confused. What questions should I ask, to make sure it is the right thing for me, and how much money would a bank lend. Your insight will be appreciated. .
    Cheers

    Reply

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      February 11, 2017 @ 8:08 pm Michael Yardney

      Heather – it’s really simple in my opinion. I’d steer clear of them.
      Of course I don’t know your personal circumstances, but if you’re keen to develop financial freedom through property you should only buy investment grade propertiesclick here to find out what they are

      Reply

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        April 5, 2017 @ 7:57 am Richard

        I have owned serviced apartments in one of Melbourne’s best suburbs since 2013 and the returns have been fantastic, I bought these as a substitute for term deposits in a low interest rate environment, the only people who these investments aren’t suitable for are ones who don’t have cash as banks require larger deposits. Beware of people like the author who personally hasn’t experienced these investments, there’s nothing worse than someone who says you cant do this or that when they haven’t achieved it or experienced it them selves… Buying in blue chip areas also applies to serviced apartments and the majority of people who probably didn’t do well with serviced apartments probably bought in mining areas which suffered down turns after the gfc….

        Reply

        • Avatar for Property Update

          April 5, 2017 @ 7:09 pm Michael Yardney

          Richard
          Thanks for your thoughts – there are clearly many ways to make money from property and you’re right I have never personally owned serviced apartments.
          Having said that I seen many, many clients and potential clients loose either money or opportunity by owning this type of property.
          You’re clearly investing for yield – and that’s fine – I don’t know your circumstances, but the strategic investors I deal with investor for capital growth – you don’t get that from serviced apartments

          Reply

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            May 9, 2017 @ 8:39 am Ange

            “You’re clearly investing for yield – and that’s fine – I don’t know your circumstances, but the strategic investors I deal with investor for capital growth – you don’t get that from serviced apartments.”

            Dear Michael.

            You sound a little like a RE property seminar guru. Let me guess, the ‘strategic plan’ you’ve taught your ‘investors’ is to load up on, say, $5 million worth of debt on LVRS of 95%, dreaming all the while of sweet, sweet, infinite capital growth. Money will be ‘free’ forever right? What could possibly go wrong, right?? Ever hear of the reflation trade? Look it up. Fed’s gonna raise up to 5 times over the next couple years. We will follow soon after. Your money won’t be ‘free’ any more.

            I sincerely hope you’ve spoken to your ‘investors’ about the massive dangers of $4.75 million worth of debt on a $5 million RE portfolio. Attitudes like yours gave us the GFC. You and other ‘investors’ have gifted us the second biggest bubble on the planet. Economic downturns never happen, right? Good luck with that.

          • Avatar for Property Update

            May 9, 2017 @ 8:52 am Michael Yardney

            Ange you’re way off the mark!
            Have you been reading my blogs?
            I agree with you that ongoing capital growth is not a given, and that having cash flow buffers is critical.
            Plus I’ve never suggested that 95% LVr or even 90% or 85% are a good thing.
            But my strategy has the proven track record – both personally for over 40 years and with the clients we’ve helped for over 17 years.
            Results not talk is what counts


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