Buying a Rent Roll Business: The 3 Critical Things

Whilst buyers of a rent roll business will encounter similar issues to buying a real estate agency, there are some very specific issues that require particular attention to protect a buyer’s interest and their ability to maximise their returns after settlement.

In particular, the three critical issues that need to be examined: the multiplier, the retention and the restraint of trade.

The Multiplier

The market value of a rent roll in Australia is usually derived by applying a multiplier to the net property management commission. This is usually the most important issue for a buyer and it will be at the forefront of their mind. There are plenty of factors that need to be considered in determining the Multiplier.

• Ratio: a ratio of one property to one owner is considered to be excellent and most buyers will consider this ratio as extremely important.
• Term: what is the management term of every property? Generally, a property that has been managed for more than five years is a “blue chip” management.
• Location: properties located within 5kms of the office are ideal; those located outside are more costly (time and money) to manage.
• Averages: properties that achieve rents way above or below the average for the area usually have higher levels of vacancy, arrears, repairs and maintenance. High levels of vacancy and arrears are typical of low quality rent rolls.
• House v. Units: some managers consider units more profitable than houses, given that repairs and maintenance are comparably lower as the body corporate manages all external issues involving a unit.
• Condition: obviously the condition of the properties will impact upon the time spent in dealing with repairs and maintenance.
• Payment: the method by which tenants pay rent and statements are sent to owners is important (e.g. the monthly tenant direct-debit-rent bank transfer to owner considered most valuable); other less effective systems have a negative effect on the multiplier.
• Authority: agency agreements that provide limited or no authority to the agent result in time consuming and costly communication with owners on trivial matters.
• Relationships: are there any unusual connections between the seller and the landlords? Such relationships could impact on the loss of managements.

Aside from the factors that determine the multiplier, the buyer will need to properly consider the retention issue, which if not satisfactorily addressed, could undermine the value of the rent-roll business.

The Retention

For a buyer, the purchase of a rent roll is about ensuring that as many of the listings held by the business are transferred to the buyer after settlement. To achieve this objective, the buyer needs to consider the retention issue in order to deal with the fact that not all property managements can be immediately transferred.

Does the contract have a “claw-back” provision, which allows for a deduction from the purchase price in the event there are losses of properties due to a lessor’s authority to manage the property not being transferred to the buyer (referred to as “slippage”)?

The buyer and seller will usually agree on the extent to which the purchase price will be retained in order to deal with slippage. In some cases, there might be a significant portion of the moneys withheld.

The most common agreement is a three month retention period with a 10% retention amount. However, the warranty retention period and factor could operate by way of several stages and extended periods of time to ensure that the buyer has plenty of time to transfer managements from the seller or to be compensated for the loss of managements after settlement.

In any case, no buyer should risk everything by entering into a contract without a retention  period and a retention amount. Otherwise, the buyer risks losing managements that they have paid for.

The Restraint of Trade

Even if a buyer does well with the multiplier and the retention moneys, these steps could be undone by the seller capitalising on its goodwill and competing against the buyer, with a view to retaking the managements transferred to the buyer in the sale.

The REIQ contract restrains the seller from running a similar business, dealing with past clients, interfering with customers and poaching staff, but only within a prescribed area for a prescribed period. For a business whose clients are not tied to one area, that may not be enough, and the clause says nothing about the seller using or disclosing confidential information about the business after settlement.

Therefore, it is imperative to protect a buyer’s interest by including a comprehensive restraint of trade clause in the contract that is specific to the needs of the buyer and the professional service business being purchased.

Does the seller intend to continue a real estate agency business? What will be excluded? If the buyer does not satisfactorily address this issue, the value of the rent roll could be seriously undermined.

Conclusion

As there are many issues unique to buying a rent roll business, a buyer or seller should seek the advice of a specialist business lawyer prior to signing a contract to ensure that the contract includes all special conditions necessary to protect their interests.

Without these protections in place, a buyer may find they are unable to operate their rent roll business to its maximum potential.