While serviced apartments might seem like the secure option in the short term, they may present a whole range of potential problems in the long term.
I’ve recently met a few investors who are lured by the 'security' of serviced apartments.
Usually they’ve attended a seminar or received a glossy brochure, spruiking the benefits of their secure rental returns.
But are serviced apartments really as secure as they seem?
Or are you just sacrificing a sound, long-term wealth generating investment strategy for perceived short-term security?
Tenants on tap and not a care in the world
Sure, most serviced apartments come with rental guarantees, where the management company looks after the day-to-day operation and pays you rent.
Just to be clear, different operators work with different rental structures – with some paying a fixed rental return, while others pay a share of all rents received.
Now I can understand why for risk adverse investors who fret about things like extended vacancy periods rental guarantees could tempt them into considering a serviced apartment.
However, they may not realise the sacrifices they are making for that so called security.
You see, I have heard many horror stories of rents being reduced rather than increased at the expiration of a lease term, meaning that initial lucrative looking guarantee suddenly becomes a lot less appealing.
Just do a quick Google search on the topic of serviced apartment investments and you will find no shortage of forums littered with the bodies of unsuspecting investors who thought it was too good to pass up.
In my mind, serviced apartments mean sacrificing what really matters when building a successful, long-term property portfolio and therefore, I find it difficult to take them seriously as long-term wealth creation candidates.
Real wealth comes from building a strong asset base
To me residential real estate is a high growth and lower yield type of investment which means the goal of property investors should be to build a substantial asset base of properties that offer above average long-term capital growth.
However, serviced apartments generally offer a higher yields, which is why they can be popular with novice investors, but this tends to come at the expense of solid capital growth.
The banks say 'no'
Let’s be blunt – the banks consider serviced apartments to be a niche type of property and, since they don’t see them as great investments, they usually require investors to fork out a deposit of around 40 per cent.
This means investors need to contribute a larger deposit.
The specialized nature of this type of property and the larger cash injection investors need to contribute if they want to by a serviced apartment means you will always have a smaller secondary market to sell to if ever you want to exit your investment.
This makes for the banks a little nervous and maybe you should also feel the same.
Losing your leverage
The fact that the banks will generally only lend up to 60 per cent of the serviced apartment’s value means you are already on the back foot when it comes to using the power of leverage to grow your wealth.
Add to this the generally lower growth and you’re really on the backfoot when it comes to your property’s performance.
You get what you pay for
While a rental guarantee might seem a good selling point, along with the fact that all of the furniture is often thrown in for good measure, the truth is you get what you pay for with serviced apartments; and by that I mean you will pay top dollar for those little extras!
This type of property normally comes with a premium price tag, but the problem is that banks and valuers won’t count the furniture package when determining the apartment’s final value and amount they will lend against.
Therefore while you are paying more, you can’t necessarily borrow more to cover this additional cost.
Out of control
Perhaps the biggest problem I have with serviced apartments is the fact that when you buy into them, you sacrifice any control over your investment.
With these properties managed by some overarching organisation like a hotel chain, student accommodation provider, retirement village and so forth, decisions about refurbishments or improvements to the building or maintenance of the property ultimately will fall to them.
Off-loading these responsibilities may initially sound attractive, until you are suddenly hit for costs to undertake improvements that you had no control or say over.
Conversely, if the building is in disrepair you may have no recourse to address the issue, which could affect on the value of your property or your ability to generate income.
And let’s not forget the management fees that will be deducted. You can guarantee the company looking after your building will want their cut before they pay your share of the profits!
As I’ve explained, as an investor your goal should be to build a substantial asset base and that’s only achieved by capital growth. It’s just too hard to save the deposit for your next property through a little bit of positive cash flow.
Furthermore, you should only own the type of property that will be in strong demand by a wide range of owner-occupiers, because they’re the ones who will push up the value of your property.
Of course, these are also the types of properties banks love to lend to.
On the other hand while serviced apartments might seem like the secure option in the short term, they present a whole range of potential problems in the long term.