As readers of previous articles I have written will be aware, I have never been a great fan of leasebacks. For those readers unfamiliar with the term “leaseback”, it is the name given to the leases or tenancy agreements between an owner as landlord and the manager (or sometimes a company related to the manager) as tenant under which the tenant can sublet the apartment for short term letting.
As it is a lease, the owner receives an agreed rent as set out in the lease irrespective of the return achieved from the short term letting of the apartment by the manager. It is often used by managers as a way of attracting to the short term letting pool owners who are concerned about inconsistent or potentially lower returns (from which the manager can make significantly greater income).
The reservations I hold about such arrangements include potential breach of a manager’s duty to a client where there is not full disclosure, a similar breach of duty (and code of conduct) if disclosure of such an arrangement is not made to other owners in the letting pool, the need for the tariffs paid by guests to be deposited to the manager’s general account and not the trust account, the potential for the tariff to attract GST as the accommodation for the guest is being supplied by the manager in the manager’s own right not as agent for an owner, how the income from the arrangement is treated for income verification purposes and the manager being locked into a significant financial liability should there be a downturn in the market.
The COVID-19 crisis highlighted this last point with many managers finding themselves locked into significant lease commitments at a time when occupancies fell dramatically. In Victoria particularly, the fall in occupancy levels lasted for many months. Whilst the Government’s COVID-19 initiatives around both commercial and residential tenancies presented opportunities for the manager to seek a rent reduction, waiver or deferral, there was always some uncertainty how that would play out.
For example was a leaseback where the parties have used a residential tenancy agreement in reality a commercial lease arrangement where the manager as tenant can seek relief under the commercial lease relief provisions? Or was it what it states – a residential tenancy agreement in which case the manager had to seek relief under the residential tenancy relief provisions? Fortunately most if not all managers were able to come to sensible commercial arrangements with their owners to pay a reduced rent for the duration of the period during extremely low occupancies. We saw very few disputes around this.
Despite that it seems clear that in the future managers will be less keen to enter into such leaseback arrangements. I expect that managers will opt for some form of guaranteed return in letting appointments but with the ability to avoid or suspend the guarantee in circumstances like the pandemic. Well drafted provisions suspend the guarantee for any period in which the occupancy levels for the property are adversely affected due to events or circumstances beyond the control of the manager – such as COVID-19.
Apart from the adverse impacts many managers faced and some continue to face during COVID-19, there are for the reasons expressed above, many other reasons why managers should be looking at a different model in the future.