13 May 2024
Words David Faiers Informer

Stay on Top of Top-Ups

Not topping up your motel lease risks missing out on big bucks when it’s time to sell — or not being able to sell at all.

What do you have to sell? How long does your lease have to run?

These are the first two questions I ask motel lease operators looking to sell their business. Essentially, that’s what they’re taking to market: goodwill and tenure.

Many motel operators focus on goodwill and overlook tenure.

When it’s time to sell, the bottom line is you need both to be working for you not against you. The best goodwill in the world simply won’t compensate for a lease with a suboptimal term remaining.

In the trade, we call this a ‘short lease.’ Unfortunately, we see it all too frequently in the marketplace — operators who’ve purchased a 20- to 25-year motel lease and have been effectively running their businesses for, say, seven to 10 years leaving them with the balance of 18 years remaining at best. I’ve even seen leases that were sub 15 years, at which point these businesses become much harder to sell.

There are formulas we use to assist in applying a value to short leases and can assist in giving you an appraisal of your motel business on a short lease versus a lease at full term or a 20-year plus term. Vendors are always amazed at the differential when I show these comparisons to them, which often well exceed the cost of acquiring additional years from a landlord prior to going to market.

SET YOURSELF UP FOR SUCCESS NOT FAILURE

You’re doing yourself no favours by letting your lease term run down. Look, I get it, operators are busy running their motels. I’ve run an accommodation business, so I know how little time and headspace it gives you for anything else.

But operating your business with little to no thought as to an exit strategy or retirement is setting yourself up for failure. It’s actually heartbreaking to see operators put hard work and effort into building a great motel business only to let themselves down by letting their lease term run down.

As an example, a couple of years ago there was a listing for a quality four-star, 40-room motel, with a high net profit, but with a lease term balance of just 15 years. It was a terrific business — except for the short lease. Unfortunately, I was unable to secure a buyer despite my best efforts as broker. Now, two years on, the vendor is in an even worse position. With only 13 years left on the lease, the motel business has gone from being difficult to sell to being near impossible to sell. The business has retained its healthy net profit; however, incoming buyers are only focused on the remaining tenure and will struggle to obtain a competitive finance package for the short lease terms on offer. Don’t let this be you.

HOW MANY YEARS?

Keeping your lease topped up is clearly the clever thing to do. So, how many years should you top-up for?

Buyers are generally looking for 20 years plus. They want the same security of long tenure that you wanted when you were initially looking for a motel lease.

Banks generally want no less than 18 years. From their perspective, a minimum term of 18 years allows enough time for any loans to be paid in full. Obviously, anything above 18 years is preferrable — longer terms mean more time to service the loan.

This is the rule of thumb for management rights too. But management rights operators have a couple of advantages over their motel counterparts. First, there’s a lot more awareness among management rights operators regarding top-ups. Operators know that when their caretaking and letting agreements dip below 18 to 20 years it’s time to apply to the body corporate for a top-up. Second, there’s a built-in alarm clock by way of the annual general meeting to give management rights operators a prompt to top up. When AGM papers are issued, it jogs their memory to submit a motion for a top-up, if they haven’t thought of it already. 

TOP-UP COST

Obviously, topping up comes at a price. You’ll need to negotiate with your landlord over how and what you’ll pay for the top-up, as well as foot the legal costs (refer to your lease for specific terms).

There are a number of ways landlords negotiate additional years / lease top-ups. They can charge a nominal value per year, there may be a rent increase option, or you may discuss a refurbishment and/or maintenance option as a trade-off with your landlord for the increase. This is something you’ll need to negotiate with your landlord, which is why it always pays to have a healthy ongoing relationship with them.

Should your landlord want a nominal value per year, there’s no hard and fast rule as to the amount. I’ve seen everything from $4,000 to $15,000 per year, depending on the quality and size of the motel.

Whatever money you spend topping up your motel lease will be money well spent when the time comes to sell. If you don’t spend the money and wind down the clock on the lease, you risk ending up with a motel business you can’t sell.

Think of your motel lease term as petrol in your car. Keep an eye on your fuel gauge. If you’ve got a 10-bar gauge, keep it at eight bars at the very least.

That way you’ll never run out of fuel, and you’ll have nearly a full tank if you decide it’s time to hit the road. END