In the second part of our series on how to grow your property management business, we take an in-depth look at buying rent rolls and, as Residential Property Manager’s Simon Parker finds out, there’s plenty to consider before you can commit to a purchase
If you’ve decided that buying rent rolls is the best way forward for your agency, your next step is finding one available for purchase.
The best way to find a rent roll really depends on what you want, and what’s happening in your local market. It’s important to note up front though that it can be a tough process.
Probably the most obvious way is via a rent roll broker, of which there are a few across Australia.
According to Gerri Keays, corporate property management executive at Ray White Group, the second most viable source is word of mouth, while the third avenue may be through larger agent networks, who often let their members know about available rent rolls.
Agencies with large, growing rent rolls may look to offload some properties in order to keep the roll manageable, she says. This allows the agency to maintain staff numbers at a consistent level.
According to Shaun Bassett, head of the residential real estate segment at Macquarie Relationship Banking, because there is no formal marketplace for rent rolls it’s important for a potential buyer to establish relationships with the industry participants who are closest to the sellers.
“We are across the majority of rent roll transactions that are happening within a market place,” he says, “and our strong relationships with the local market, local brokers [and] industry partners – including accountants and solicitors - afford them [agents] opportunities to buy.”
Westpac’s national industry leader for real estate, Jason Roach, says it’s also possible to be proactive when looking for a rent roll, including using a third-party professional to make the approach on your behalf.
“Sometimes business owners will talk to their accountant and ask them to draft an approach letter,” he says.
Being discrete, however, is likely to be important for the seller, says Mr Bassett. “If staff and landlords become aware of the pending sale, this can cause anxiety and uncertainty around ongoing employment (in the case of staff) and around future management (in the case of landlords),” he cautions.
KEY THINGS TO CONSIDER
First and foremost, principals looking to acquire a rent roll should be doing so to provide the business with a fixed income stream, according to Mr Roach.
“You’re trying to use the fixed income to try and carry you through or iron out some of the peaks and troughs that might occur through a sales cycle,” he says.
“In a perfect world, a good rent roll will cover more than 100 per cent of your fixed costs. Typically, most rent rolls will cover up to 40 to 50 per cent.”
Mr Roach therefore believes commission rates are important, as these need to match your own cost base. “It’s making sure you’re writing profitable business,” he says.
There is also an array of other items that require a buyer’s close attention, he adds (see sidebar, ‘Doing your due diligence’).
It’s important to see how much revenue is generated from ancillary fees, as these can be quite lucrative, says Gerri Keays. “These are a very important to me,” she says, “and it’s this revenue that can often be overlooked by lenders.”
Bob Walters, managing director of True Property and director of Leading Property Managers of Australia (LMPA), agrees. He believes ancillary fees should deliver an extra 20 per cent over and above what the property management fees provide.
The length of time a property manager has managed a rent roll can be both a negative and a positive, Ms Keays adds. “If the [landlords] have been there a really long time, they may feel like their trust has been misplaced.”
Yet, as Mr Bassett points out, “relatively” new rent rolls tend to be less ‘sticky’ than more established rent rolls. “[This] means there may be less loyalty and so more chance of a landlord moving their property to another property manager,” he says.
Ms Keays also likes to see “a good mix of the types of properties” on the rent roll.
“You can have all apartments, but you don’t want all one-bedroom apartments,” she says, “and the standard of the properties is important.”
Some agents have a preference either for units or houses, says Stephen Fisher, accountant at Jemmeson and Fisher and a specialist rent roll valuer.
“Some agents prefer to manage houses because the fee returns are better than for managing units, and some agents prefer to manage units because repairs and maintenance are not as extensive as with houses despite the lower fee returns,” he says.
Ian Farquhar, national manager, property and real estate banking at nabbusiness says it’s possible to assess the quality of a rent roll from a range of figures, including vacancy rates and tenancy arrears.
He admits, however, that the true quality often only comes to light a few months after the purchase.
Ironically, there are times when an imperfect rent roll is a better fit for some buyers, he says, “as this may create problems in the management if the purchaser is not able to meet the high standards of the previous owner.
“This can be mitigated if the property manager or managers are coming across as part of the acquisition.”
Of course, a rent roll purchase – like a home purchase – needs financing, and principals need to factor in this cost to determine the viability of the purchase.
Ian Farquhar says his bank allows agents to borrow up to 70 per cent of the rent roll’s value. But like any lender, “a key determinant would be the client’s ability to service the proposed level of borrowing.
“This is because every client situation is different. Some may be moderately geared compared to others who are more highly leveraged and such factors will need to be considered.”
“At NAB, it’s also important for us to meet with the principal or principals to understand the business model and what their aspirations are for the business. This is a very important part of the process – assisting the client to structure the facilities in a way that aligns with their ongoing requirements.”
Mr Farquhar says it’s important for the bank to get a sense of a principal’s ability to manage their existing property management division and how the new rent roll would be integrated with the existing rent roll.
Westpac will usually lend up to 60 per cent of the rent roll’s value, according to Mr Roach.
“We use an [external] rent roll valuer who determines the market value of the rent roll,” he says. “Together, we do our own due diligence and financial analysis of the customer. We’ll look at the qualitative factors [for] the borrower, or whoever owns the business, and the financial performance the business boasts – with or without the rent roll they’re buying.”
The fundamental aspects of assessing someone for credit are the same for a rent roll purchase as for any other facility, adds Mr Basset: a bank will assess character, capacity and collateral.
Character includes demonstrable abilities, experience, background, past loan and credit behaviour of the principal and any partners within a business, “all of which are important for a bank to understand.”
Capacity is “a simple question of whether the business generates sufficient cash to meet all of its obligations, including any proposed debt position.” For the principal and partners, this includes “providing a level of disposable income to cover the cost of living”.
“Any external income, such as rent from investment properties or spousal income generated outside of the business, will be taken into consideration.
“If a new business is being acquired, or the business model is changing materially, projected financial statements will be required, together with any assumptions underlying construction of the statements.
“For a start-up operation, the requirements will be more onerous as there isn’t a proven record of sustained profitability or trading performance,” he says. “This may include a detailed business plan and detailed cash flow and profit and loss modelling.”
THE FINE PRINT
While agency agreements and contracts vary between states and territories, there are general issues that need to be considered.
First and foremost, says Mr Walters, rent roll contracts should be prepared by people who have expertise in that area. “If a lawyer is used, they should be a lawyer who has experience in the sale and purchase of rent rolls,” he says.
Areas commonly covered by a contract include post-sale restraint provisions for the vendor; the amount of the retention sum – to cover client ‘fall outs’ – and the retention period; possible employment of the vendor’s current employees; and what happens with clients who do not agree to be transferred to the purchaser.
A buyer should also be advised clearly about the documents to be handed over to the purchaser for each property; the arrangements that apply when any of the landlord clients wants to sell their property; the supply of an audit certificate for the vendor’s trust account; warranties from the vendor relating to any current or future professional indemnity insurance claims; and warranties from the vendor that there are no encumbrances on the rent roll.
Price can also determine what’s in a rent roll contract, according to Mr Roach. “As a purchaser, if I’m paying a price that’s high, then I’m probably going to want a longer retention period and a larger retention amount to allow for properties that don’t come across to the new business, or that are subsequently sold,” he says.
As a general rule of thumb, these amounts are 10 to 20 per cent as a dollar amount, with a period of three to six months.
Unfortunately, the work doesn’t stop after you’ve purchased a rent roll – far from it.
Establishing a personal relationship with the landlords is of paramount importance, according to Ms Keays, particularly as they will need to sign new management agreements.
“I think it’s pretty simple,” she says. “First of all, the day the rent roll settles, you really need to ring every single one of those landlords that you’ve just bought.
“There’s no other way. You have to have personal communication, and it’s really got to be done almost within 24 hours.
“You can send out all the documentation by hand, but I think there has to be a personal phone call at the very least, and you have to get in front of them as soon as possible.
This is particularly important because, according to Ms Keays, most landlords dislike change and especially those who have taken a great deal of time to select a property manager.
Mr Bassett agrees. “If a landlord becomes unhappy, or if they are simply uncertain about how the new owner may operate – and this can often be through lack of communication – there is increased risk of eroding your rent roll.
“Perception is everything, and the transition phase is your one opportunity to make the right first impression on the owners, building trust and loyalty.
“Send information about your business, your services and your team to the owners. Be clear about your contact points and manage expectations from the outset.”
It’s also important that existing staff be engaged in the process, Mr Basset adds.
“They are the custodians of the new asset and will be at the coalface of discussions with landlords and tenants. The relationship with the vendor continues to be critical and transition can become difficult and protracted if the relationship breaks down,” he says.
“Be mindful of this, and if the vendor is retiring you might want to consider offering them a short- to medium-term role with your firm to provide consistency and to assist with the transition.”
“It would be a good idea to keep property managers as these are the people who have most interaction with landlords and tenants,” adds Mr Fisher. “Most vendors would insist on this at least for the period of retention. This makes the transition process much smoother.”