Horror tale of Quest a warning for serviced apartments investors

Serviced apartment investment may be suitable for some property investors, but the severe limitations need to be considered. Photo Contributed

Imagine owning an investment property paying an 8 per cent rental return with no ongoing tenant hassles. Sounds great doesn’t it, and it is the reason why many retail investors have bought serviced apartments around the country offered by Singapore-owned Quest Apartment Hotels.

So what is the catch? Well, everything is great until it’s not. COVID-19 has thrown the accommodation industry into disarray. The investors in Quest Hotels were actually involved with a franchise company, CEM Limited, which has now closed a string of the hotel ventures leaving the investors in a difficult position.

With CEM receiving virtually no income from hotels in Sydney, Melbourne, Adelaide and Gladstone, the group has now closed (or plans to close) five hotels. The outcome for investors is no income and a cloudy future where legal costs are mounting and some may not even be allowed to live in their properties due to zoning ­restrictions.

In terms of how serviced apartments work, Quest explains on its website: “When you buy a serviced apartment, you lease it on a long-term basis to a third-party operator, who then lets the room for short stays, like a hotel room.

“Your tenant therefore is the accommodation company, rather than the individual guests who will stay in your room. This means that you will earn your rent, regardless of whether your apartment is occupied or not.”

The complex lease that is in place is for up to 10 years and usually has five-year rolling options, which means that if the hotel operator is happy to continue trading from your building, you will never get access to your property. Not a problem as long as the agreed rental income keeps coming in.

Tania Waterhouse, a former ATO director and partner at tax law firm Waterhouse Lawyers, bought into a Quest serviced apartment in 2015 at Potts Point in Sydney. All was good until March, when Quest stopped paying the rent, blaming COVID-19 for a drop-off in occupancy.

She challenged Quest and forced it to pay a reduced rent, but the rent stopped again two months ago and last week she and the other landlords were served with a proposed deed of termination and surrender. In addition to nullifying the lease, it contained a confidentiality agreement and removed the owners’ right to sue.

Waterhouse says Quest should honour the terms of the lease agreement: “I knew it was an oppressive lease from the outset but accepted it due to the high guaranteed rental returns. Quest took on the risk of operating the business in good and bad times and I want them to pay the rent they owe.”

Going through legal channels to retrieve the outstanding amount and other costs may not be an easy path for the owners. Waterhouse says: “Our lease is not with Quest itself, but a shell company they control with no significant assets. Every Quest property has a different shell company ­operator. Ours was Potts Point Tenancy Pty Ltd.”

Adding further difficulty, the properties are usually commercially zoned, which restricts the usage such that you cannot live in the property yourself for more than two weeks and cannot rent it on a normal 12-month lease.

Waterhouse and the other 72 owners in the Potts Point block are now reviewing their options. They are considering whether to sell the property as a whole block, put in another management company or sublet it themselves. Waterhouse is also preparing a class action.

In terms of the make-up of the owners, Waterhouse says: “Only three out of the 72 owners are professionals, the rest are unsophisticated mums and dads, many of whom purchased through their self-managed super fund and are relying on this investment to help get them by in retirement.

“Instead, the owners face an uncertain six to 12-month period of financial hardship before everything gets moving again. Even though the income has stopped, the body corporate fees and other outgoings will not.” Waterhouse says future investors should “make sure their lawyer advises them of the issues with the lease and that a financial adviser does the number crunching for them to say what happens if it falls apart. I am a superannuation lawyer, but even I got taken in.”

Serviced apartment investment may be suitable for some property investors, but the severe limitations need to be considered. You are likely to have no voting rights on ongoing building decisions and be locked into an indefinite lease with the property operator. Sales prices are also ­affected due to the restricted zoning and long-term lease in place.

Banks may also impose stronger loan restrictions over serviced apartment investments. And if a problem comes up, the property operator is likely to rely on the complex contracts and financial structuring to mitigate their financial obligations to the owners.

James Gerrard is principal and director of Sydney financial planning firm www.financialadvisor.com.au