As a solicitor practising in the sale and purchase of motel properties, this is a question which I am regularly asked by people in the industry and people considering joining the industry.

The commercial answer to the question is that the net return on a leasehold property is much higher than that on a "freehold going concern" and the entry cost is comparatively low.

Suited to a lifestyle

Purchase of a leasehold property is becoming popular with people (usually husband and wife teams) entering the industry for the first time.  Before the decision is taken, intending moteliers need to think very carefully whether they are suited to a life in a particularly demanding service industry.

If consideration of those lifestyle questions is favourably resolved then many new entrants into the motel industry choose to buy a leasehold property.

As a purchaser of a lease you are purchasing the goodwill and chattels of the operation, not the real estate and buildings attached thereto.  The cost of purchase of a leasehold business is approximately one third of a freehold going concern yet the returns are considerably higher.

Consult with experienced adviser

It is very important when considering the purchase of a leasehold property, that an intending purchaser consult with a real estate broker and accountant, who is experienced in understanding the industry formulas which apply in the purchase of leasehold properties.

Rent

Rent under the lease is paid calendar monthly in advance and usually there is provision in most new lease documents for an increase in rent pursuant to the Consumer Price Index on an annual basis.  Rents are calculated on different methods.

One method to calculate rent is to take 25‑ 27½% of annual accommodation and sundries turnover, plus no more than 8% of annual turnover for food and beverage.  Another method of calculation involves estimating rental as approximately 45% of net profit of the business.

It can be dangerous to calculate rent on turnover because there may be other sources of income which may not result in additional net profit, eg sales of theme park and tourist attraction tickets.

These percentage formulas are approximate and will vary from property to property.

Term of lease

Leases generally run for an initial 10 year term with two or three options of five years each, capable of being exercised by the Lessee of the property.  The Lease should provide for the purchase of the chattels of the business by the landlord on expiry of the Lease term.

There is potential for capital growth with respect to leasehold properties, particularly where a new owner is able to increase turnover and therefore net profit of an operation.  Rents generally speaking are not related to turnover and therefore an increase in net profit is enjoyed by the proprietor of the motel rather than the landlord.

An increase in net profit means that on disposal of the property (note the industry average for turnover is about 2 ‑ 3 years for each owner of a motel) will result in the vendor of a business enjoying an increase in the value of the goodwill for which he is able to sell the property.

This is particularly so where there are still a good number of years left to run on the lease.  Because of the higher return in respect of these properties as compared to freehold going concerns, one must consider the time honoured investment slogan "Risk equals return".

Understand lease document

It is important that potential Lessees understand that their occupation of the motel is controlled ultimately by the landlord through the Lease document.  It is essential prior to purchase of the business that the purchaser understands as much as possible about the Lease document and how it works.

Not only does this document affect his own activities in the motel business, but is also is an important part of the asset which is sold when the motelier decides to move on to another property.

Remember the Lease document on the sale of the motel will be carefully scrutinised by an incoming purchaser and his solicitor to ensure that the new buyer is adequately propertied.

It is essential that the document be analysed by the purchaser and his consultants so that the motelier understands what costs he will be responsible for in relation to the property.

It is a feature of most well drawn modern Leases that responsibility for maintenance and upkeep of the motel is very much left to the tenant.

The rationale behind this is that the motelier does not want his business suffering whilst he waits for a tardy landlord to effect repairs to the property.  It is far more desirable that the motelier be in control of the maintenance of his own building so that his business is not adversely effected.

The results of the analysis of the Lease in terms of cost to the tenant could be conveyed to the purchaser’s accountant prior to any Contract for the purchase of a property becoming unconditional.