LORD HOWE ISLAND BOARD
Business Paper
ITEM
Commercial Rentals and Service Level Agreements
BACKGROUND
At the March 2013 Board meeting is was agreed that, over the following 12 months, the feasibility of:
· Calculating commercial rentals on the basis of return on investment, turnover, ability to generate income or some other basis be investigated, and
· Investigate introducing service level agreements for commercial rentals and permissive occupancies.
CURRENT POSITION
Valuation Methodology
The following excerpt is from valuation documents provided by Valustate Pty Ltd, Property Valuer's and Consultants, a property consultancy business used by the Board for many years.
Although the following valuation methodologies refer to Permissive Occupancies, it may apply as well to commercial rentals.
“There are various valuation methodologies that may be used in the assessment of rental value on Crown land occupied by permissive occupancies. The methodology is dependent upon the use of the land.
In regard to the subject permissive occupancies (PO's), I have utilised three valuation techniques in the assessment of the land rental value. A general overview of each of the valuation methodologies are;
1. Residual Valuation - the market rental value of the subject Crown land has been undertaken by utilising the "Residual Valuation" technique. This style of valuation comprises capitalising an assessed net rental by an appropriate yield thus providing an improved value.
From the improved value is the deduction of the initial set-up components such as construction costs, professional fees and holding costs. The resultant value is the site value, i.e. the value of the Crown land.
The land rental is then determined from what would be considered an appropriate percentage return on the vacant land value to the Lord Howe Island Board.
2. Ground Rental - a current market rental value from the land is driven by what is considered an appropriate capital value of the land, taking into account the use of the occupancy, allowing for a return on this type of investment on the land.
An investment of this specialised nature would be considered to return in the vicinity of eight percent per annum.
3. Current Market Rental Value - is the estimated amount for which premises would rent, as at the relevant date, between a willing lessor and a willing lessee in an arm's length transaction, wherein the parties had each acted knowledgeable, prudently and without compulsion and having regard to the usual market terms conditions for leases of similar premises".
The Australian Property Institute, the national professional association, recommends and approves the above accepted valuation methodologies.
Although the current market rental value is most commonly used for commercial rentals where there is evidence of market value, the results of the valuations from the other accepted methodologies may also be taken into account. Where there is insufficient evidence to establish market value then one or a mix of the other methodologies may be used.
The rental value must reflect market value, that is, what a willing lessor and lessee would agree upon having regard to market conditions.
In view of the above, there is no scope to determine rentals outside the lessor/lessee relationship.
Current Commercial Buildings Situation
The Financial Sustainability review recently completed by PWC identified commercial buildings owned by the Board as a non-core responsibility.
Commercial buildings owned by the Board (and leased commercially) include the post office, shops and boatsheds. Revenue from commercial rents in FY 2012/13 totalled $75,531.While costs incurred by the Board associated with the operation and maintenance of commercial buildings may vary, these costs are covered (on average) by current rents.
Rents levied on commercial buildings, however, are not expected to be sufficient to cover any capital maintenance or significant refurbishment costs that may be required in the future. Hence, while the activity does not significantly add to the Board’s current operating expenditure, future requirements to upgrade buildings may drive greater expenditure over the medium to long term.
Options
Options to minimise future costs associated with the Board’s commercial buildings are as follows:
1. Sell the premises. This approach would result in the Board receiving an initial injection of revenue associated with the sale, and remove any future costs associated with maintaining these premises. The sale of premises on a commercial lease would entail the creation of a Permissive Occupancy over the land. However, selling the Board’s commercial properties would be subject to the existence of a willing buyer. This could be problematic given that a Permissive Occupancy is terminable at will by the Minister on the recommendation of the Board. Furthermore, any sale would need to ensure that important services, such as those provided by the Post Office, continued to be provided.
2. Enter into Ground Rental Arrangements. This option involves entering into an agreement to rent the land only, while the lessee is required to maintain the building or improve the building to certain standards. Again, this assumes the existence of willing renters. Given the condition of many buildings, any significant expenditure on improvements could result in over-capitalisation.
3. Replace Some of the Existing Buildings. Those buildings likely to incur significant capital maintenance or refurbishment costs in the short to medium term could be replaced. In the case of Boatshed No. 3, for example, the cost of replacing the building is estimated to be much cheaper than the estimated $125,000 needed for refurbishment. Furthermore, the rental return would, very likely, be sufficient to cover all costs and provide the Board with a reasonable return on investment. However, many of the buildings are Heritage listed; obtaining all the necessary approvals for demolition and replacement may not be a simple process.
There are several factors to be considered in considering a future course of action:
· As a first step the current status of each asset must be determined. It is necessary to understand such things as the useful life, structural capacity, short, medium and long term costs associated with maintenance and refurbishment, and rental potential,
· Tender processes for commercial rentals could be used to establish market value levels; that is, what willing lessees will pay,
· The sale of properties would impact on potential future capacity. For example, the sale of the Signal building could affect future redevelopment of that area. The sale of the Airport Kiosk could hamper the redevelopment of a major infrastructure asset,
· The Board needs to keep control of the tenant mix. For example, the Board does not want all buildings in the CBD area operating as food service outlets at the expense of other enterprises, and
· The costs of undertaking tenure separation for sale purposes may be revenue neutral or cost more than the actual asset value as survey, legal, valuation professional fees, etc, must be taken into account.
Service Level Agreements
When entering into commercial rental agreements the Board may choose to impose any terms and conditions that it sees fit. The terms and conditions could include such things as:
· The purpose or purposes for which the premises may be used,
· The hours during which the premises may be used,
· If a business, the required service levels, such as:
o The minimum hours of operation,
o The minimum range of goods and services to be provided,
o The minimum acceptable performance standards, such as those pertaining to responsiveness to customer requests, waiting times and quality of services provided.
All commercial rental agreements expire as of 30 June 2014. Therefore, should the Board wish to consider the introduction of terms and conditions such as those shown above for certain commercial rental agreements, now would be the time to consider the additional terms and conditions it wishes to impose – before new agreements are prepared.
In order to provide lessees with adequate notice, a grace period of between six and twelve months may be necessary before any new terms and conditions come into effect.
RECOMMENDATIONS
It is recommended that:
1. The current status of each commercial lease asset be determined in order to understand such things as the useful life, structural capacity, short, medium and long term projected costs associated with maintenance and refurbishment, and rental potential, and
2. The Board provide guidance as to the service level terms and conditions it would like the Administration to explore in relation to commercial rentals (listed below).
a) Commonwealth Bank,
b) Airport Kiosk,
c) LHI Post Office,
d) LHI Boatshed No. 3 - front, mid and rear tenancies,
e) LHI Boatshed No. 4,
f) “Not Just a Salon”,
g) Bulk Food Co-Operative,
h) Signal Building,
i) Jetty Storage Facilities, and
j) LHI Boatshed No. 2.
Prepared Bill Monks Manager Business & Corporate Services
Endorsed Penny Holloway Chief Executive Officer