A freehold accommodation business is made up of two main components. One is the land and buildings (the real estate), the other is the business. The business is comprised of the plant and chattels (tangible assets), and goodwill. (The goodwill is sometimes referred to as the benefit of the lease or the intangible asset.) Even if the complex is owned and operated as one entity, known as the freehold going concern, the distinction still applies. This is relevant because the returns from these two main components are quite different.
The land and buildings, if owned and leased out as a separate commercial investment, would often show a return of between 6% and 7% at this time. (This is a full 1% higher range than would have been allowed for as recently as 2021, so could come down if interest rates do.) The business (lease) will usually achieve a return of around 20% to 25%. This business return is based on earnings before interest, depreciation & amortisation, taxation and salaries or drawings for the operators, this is often referred to as EBIDTA.
Because around 75% to 80% of the total value may be in the land and buildings, which are showing the lower return of the two components, the overall return for a freehold going concern could be around 10%. (Some recent sales have evidenced lower yields.) This conclusion is based on a 6.5% return for the land and buildings and a 22.5% return for the business/lease component. Naturally the more desirable the property and its location, the lower a yield is more likely to be acceptable.
We believe that most freehold operations in this industry are currently being sold at well below replacement cost, which could suggest that now is a good time to be entering the market. In the last decade we have seen a huge increase in building, consenting and compliance costs and also land costs. During the same period in many locations, there has been significantly less increase in accommodation tariffs, which is now probably overdue.
Any questions or comments on this subject would be very welcome.
