If you have travelled, whether for business or pleasure, it’s likely you’ve stayed in a serviced apartment. It is similar to a hotel room, but it offers a more spacious and featured experience, having more amenities for guests, such as a kitchenette.
Growing domestic inbound and business tourism was one of the factors behind the serviced apartment industry’s annual revenue increase of 5.9% from 2012 to 2017, according to a report by IBISWorld.
But is this a good investment option for an everyday investor?
What is a serviced apartment?
A serviced apartment is generally furnished and available for long or short-term stays. Most of these apartments have kitchen facilities and often have separate bedrooms for the clients. The apartment is typically located in resort or hotel-style complexes with added amenities such as a pool and gym. It is also sold strata-titled.
Investors could buy this type of property with built-in rental guarantees that set a minimum rate for rental returns, vacancies, maintenance costs and damages. The management company does much of the legwork in maintaining and managing your serviced apartment, although, you generally pay a higher amount in management fees than you would pay with a standard residential property investment.
However, this type of property could pose some risks, which we’ll explore throughout this article.
Serviced apartments offer two general different types of leases, depending on the agreement with the property’s operator:
- Long-term lease. In this type of lease, the apartment is offered for long-term accommodation, operating like a hotel room. It is used exclusively as a rental property and as the owner; you don’t have plans to use the property yourself.
- Short-term lease. With a short-term lease model, you have the chance to use your serviced apartment occasionally. The operator can rent it out when not in use by the owner. This is typical for resort properties where investors may wish to use their property as holiday accommodation.
There are many reasons a serviced apartment could work for you as an investment, as it offers a few enticing benefits, some of which are:
- Guaranteed rental income. When you purchase a serviced apartment, you enter into a lease agreement with a management company, as opposed to a tenant. The company will then pay you the agreed rental rate for the term of the lease, which could include pre-negotiated rental reviews to ensure you get a fair market rate.
- Lower fees and charges. With this type of property, some landlord outgoings are paid for by the tenant, which could result in higher rental returns.
- Maintenance is taken care of. The day to day maintenance of this type of property is usually handled by the on-site management company. Cleaning, minor repairs and accidental damage may be covered under the lease. While major repairs or appliance replacement are your responsibility, they are handled by the management company and charged back to you as the owner.
Risks to consider
The promised guaranteed rental income when investing in a serviced apartment is enough to lure all kinds of investors. However, there are risks you have to consider before purchasing this type of property for your portfolio. Some of these are:
- Financial risk. Investing in a serviced apartment can be costly. While its benefits are attractive offering rental guarantees, you still have to ensure that it will stand up if things don’t go as expected. Like any property, location, price and demand are things you have to look for. You also need to know exactly how long the lease runs for, and the terms of the lease are also very important, according to Paul Bieg, director of Duplex Invest.
- Lower capital growth. The 2019 Property Investment Sentiment Survey found that 49% of investors who responded said long term capital growth is their preferred strategy. If you are investing for capital growth prospects, investing in a serviced apartment may not be for you. These properties typically have weaker capital growth because they are exclusively offered to investors, which minimises demand, so they are more suitable for cash flow investors.
- It could be difficult to find financing. Lenders may be hesitant to finance your investment. Should you find a lender to fund it, you may need to shell out a higher deposit amount to mitigate the sector’s riskier features. Some lenders may even have stricter criteria you have to fulfil before you get financing.
- It’s not for every investor. If you are just starting out in your investment career, a serviced apartment may not be for you as it suits a very specific investing strategy, and "may only suit about 10% of investors”, says Bieg.
“Lenders will only ever go to a maximum LVR of 80% but in most cases, it is 70%, so this will rule out most investors who are trying to build a portfolio and maximise their cash or equity. Serviced apartments are usually best suited to an experienced investor using an SMSF,” he explains.
Financing a serviced apartment investment
Finding a lender to finance this type of investment could be tricky. Lenders may consider a serviced apartment as a unit, which is an owner-occupied home, says Bieg. The type of agreement the property has in place could determine whether you get financing or not.
Lenders may only provide 70% of the purchase price, or even less, if the property has a “restrictive agreement” in place, according to Jessica Darnbrough, Mortgage Choice’s company spokesperson.
“If the serviced apartment does not allow for permanent occupancy under the terms of the management agreement, this would be considered a ‘restrictive agreement’,” she explains.
Lenders consider serviced apartments with “restrictive agreements” to be high-risk because they can be difficult to resell should the borrower defaults on their mortgage.
After balancing the pros and cons of investing in a serviced apartment, it is best to consult a professional who could assist you in making a sound decision about whether this investment is right for you.
Shelling out money, especially for a complex investment such as this type of property, could be quite risky. Do your due diligence and thoroughly study the serviced apartment industry before you give it the green light.
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