Elite Agent TVEPM: TransformPM Transform Coaching 2016

Transform PM Ep 4: Grow the Rent Roll, John Knight

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CENTURY 21, the largest real estate sales organisation in the world, with over 250 independently owned and operated real estate agencies throughout Australia. For more information, visit century21.com.au

Coach:

John Knight

Coaching Transcript:

00:00 Introduction by Samantha McLean

01:16 Drivers of Value, Growth and Performance

What I’ve been asked to talk about today is, I suppose, share some of those stories, share some of those insights that we see out there with all these different real estate businesses. In particular, we want to talk about ‘value’. What are the drivers of value within your real estate business? Growth is such a big focus especially in property management; how do we get that growth? How do we get that capital asset? Performance. What is performance in a property management business, and how do we make sure we’re performing to the best of our abilities?

It’s interesting in property management because quite often we’ve got people that are either striving for profit or they’re striving for value or they’re striving for both.

I always use the tap analogy in property management because in property management, people are trying to grow. When you grow, you tend to be spending a lot in wages, don’t you? That’s your big cost of growth, especially organic growth, within property management. You can always turn the tap off growth within a property management business. How do you turn the tap off growth? That’s when staff are not replaced or you reduce the numbers, the headcount within your office. If you turn that tap off growth, then the profit goes straight to the bottom line. Whether we’re striving for profit, striving for capital growth or striving for both, there’s always something that we can get out of in property management.

02:39 The Profit Matrix

Property management has very few variable costs, so in sales you might be trying to improve the efficiency there. Then look at your fixed costs, and that’s where your big costs are in property management, aren’t they? It’s in those fixed costs, usually wages and your premises and so forth. Really we’re not trying to cut costs there, we just want to get more value out of those fixed costs so that we can get that bottom line to grow. That’s probably one of my first tips for you. Make sure you can track your performance of your business by division. It’s pretty easy to do it within most accounting softwares these days.

At the end of the day, you don’t know what you don’t know. It’s great to hear you’ve already had a discussion with Alister about realbenchmark. Now, that’s very property management and property-focused, but I love looking at benchmarks also from an overall business because I’ve got a bit of a line that I always use in real estate. That’s ‘sales are vanity, profit is sanity, and cash is reality’. We can be out there winning all the different awards for sales or property management or whatever but it’s actually profit that matters.

03:48 Profit Ranges

I always get asked, “What should my real estate business earn? How much profit should I make?” A little while ago, I did an exercise. I got a bundle of clients’ data together that I considered benchmark data to come up with a sample result. The first one that I thought I’d highlight there for you is within that sample, the property-management-only businesses range from about 20% profit margin to about 35% profit margin.

If we dig down into property-management-only businesses, the above average results tend to come from those businesses that are working at capacity. Something to be aware of, we might have a benchmark profitability percentage, but if you’re at capacity, that might not be sustainable and you might never be that profitable as a percentage. Again, I always remember I’ve got a great client and I think they’re probably the highest profit real estate business I’ve ever seen, except they were at capacity. The next year they had to go get second premises, they had to put some more staff on and those types of things. There’s always going to be a bit of a cycle somewhat within the performance of your business.

Integrated well with the sales division, again that comes back to your business model. If you’re property-management-only that becomes a bit tricky, but you might have some referral relationships in place. If you can have a property management business which is very integrated with the rest of the business, then you get those referrals flowing. I’ve seen many businesses where those team do not work together, but if you can get them working together, you leave a lot more money on the table for everybody.

The other thing I’d really like to leave you with is don’t forget about those 1 percenters within your business. If you know your business formula you can focus on those 1 percenters and tweak them so that you create this continuous improvement philosophy within your business. You can then focus on, ‘how do I get one more dollar to the bottom line?’ not just the top line, but, ‘how do I get one more dollar to the bottom line that focus on incremental profits?’ I always like to do the calculation for people around what is your income potential? Quite simply, you can look at where you are now, where we want to get you to, and then we can identify those gaps and a strategy to get you there.

06:05 Income Potential

For example, if we think of this as your income formula. Let’s say you’ve got 5 property managers, let’s say they look after 100 properties per property manager at the moment. Average rent might be $400 a week. You might see your gross office comes about 7 and a half%. I assume everybody has 52 weeks a year, so the income potential of that office is about $780,000. If you then look at: where would we like to take this? What if we did put another property manager on? What if we could improve our efficiency so that they could 110 properties each? Have we increased our rents? Is there any opportunity to improve the rents and just making sure that they continuously are doing that? Is there any tweaking of the comm. rate that’s available? Again, I’d like to think everyone has 52 weeks in their year.

We can see the gap then of by tweaking those little things within your business how much more income you can put on the top line. We haven’t even talked about wages here though, have we? No, because those things that we’re talking about there probably don’t require too many more wages except for that 1 property manager. If you had 1 extra property manager, irrespective of what that’d cost you, you’ve got incremental profits straight away. That’s probably a neat little exercise that I would urge you to do. It’s like your income formula. What’s your income formula as it sits now? Use your realbenchmark data to maybe identify where there might be some quick wins to improve those individual items in there. Once you identify your gaps, obviously you can go, “okay, well what do we need to do to allow each property manager to be able to handle another 10 properties each?’ and break it down into those little steps.

07:48 Raising the bar of average

Another neat little thing that I use a lot within real estate is a technique I call just ‘raising the bar of average’. I use this with sales people, but I use it in property management as well. By way of an example, you might plot on a board how many properties per property manager each property manager looks after. If you plot them on a board and then we draw a line across the middle where the average is, what do you think we’re then going to do? We might focus on those bottom 2. If we look at those bottom 2, we’re not necessarily saying, “Okay, they’ve got to go. They’re not performing.” We need to dig deeper to find out what is it that we can do to improve their performance.

Now if we improve the performance of those bottom 2 that are below the average, of course, the average line is going to go up, isn’t it? It’s a neat little tool you can use, I suppose, on many different metrics within your business. I love properties per property manager because I think it allows you to hone on where your capacity is, and where potentially you may have people who are exceeding their capacity and future problems. You could do this on vacancy rates. You could do this by looking at the average annual management income that comes in from each of your properties and start to question the lower dwellers, the ones that aren’t necessarily bringing in as much. A neat little exercise to apply to many metrics within your business.

09:11 Landlord Cleanse

As I said with waste, there is often some properties that just don’t fit or they’re not really worth their while. I always challenge people to think about doing what I call a ‘landlord cleanse’. How would we feel about doing a cleanse? Whenever I’ve asked any properties managers how they feel after doing a landlord cleanse, they like high-five and they’re like, “We love this.” The team love it. The team get more engaged, because they tend to be the properties that they don’t want to spend money on. They’d say there’s no improvements in there, so you can’t justify increases in rent and you’re always dealing with the maintenance calls and those types of things. They are probably lower rents and so you’ve got a lower income coming in from them as well.

One simple way to do that is just get all your properties. Look at the bottom 10%, and probably an easy metric is average annual management income from that property. Just have a look at how much income comes from that over a year. If you look at the bottom 10%, start asking yourself some questions. There might be some that you still want to keep because they’re a multiple owner or they’re really core or there might be a reason you can justify keeping them. Others, you might be better off looking at – maybe you can either bundle them up if they’re out of zone. If they’re out of zone, maybe you can bundle them and do a deal with another agent you know in that other area, and you might just sell them 10 properties or 20 properties.

10:33 ‘Value’ in further detail

I thought I’d share a little bit with you around value. These are probably some of the things that, I think, business owners sometimes get a little bit confused or a little bit befuddled from a value perspective. That is firstly, fair market value. A fair market value is not necessarily price. You all know the definition of fair market value, the price you’d negotiate between knowledgeable and willing and not anxious buyer, knowledgeable and willing and not anxious seller. Now remember that that’s very different to price. What a rent roll is worth to you in your business model, in your situation, may be different to what someone puts on it as a fair market value. If you go and get a valuation for purposes or something, don’t be surprised if it comes back different. If you are looking to sell, others might be more interested in your rent roll for reasons outside of the normal knowledgeable but willing, but not anxious buyer and seller.

When we’re talking valuation methodologies, of course in rent rolls, we always go back to the rule of thumbs which, in any other business, we would typically say never rely on rules of thumbs. But they’re so ingrained within property management that they are valuation methodology. It’s important to know that the rule of thumb is really just to proxy for the real valuation methodology which we call ‘capitalisation of earnings’. Really what we mean by that, what’s your future maintainable earnings of your business, and what capitalisation multiple or capitalisation rate do you apply to that? Essentially your rule of thumb being a multiple of income, really needs to come back to a multiple of profit, otherwise you’ll end up paying too much for your business.

12:16 ‘The big little things impacting the value of your rent roll’

I thought I’d share with you what I’m calling ‘the big little things impacting the value of your rent roll’. The first one is an obvious one. Of course your average annual management income, your AAMI. When you sell a rent roll, typically that will just be your management component of your income, it won’t include your let fees or your other charges. Although those fees will be taken into account when we make a call on your capitalisation multiple. Of course, that gives you your earning side of things, that’s the earnings that you can bring in, but it’s going to also be important what cost you have to spend on them.

That’s why the next big little thing is your property management wages to income ratio. That’s your biggest reflection of the efficiency of your rent roll. If you look at your wages, cost as a percentage of your income. It ties in very closely with your properties per property manager, of course.

Geographical spread. That’s the more spread, the more waste you have in the business, the harder it is to service the broader selection of properties and landlords that you look after. The more spread it is, I would suggest that the valuation multiple that we use will be less.

Multiple owners. Now multiple owners, tends to bring your value down. Typically, you’d say, ‘well, you’ve got 1 owner with 10 properties, that’s good’. But it’s all about risk here. It’s all about, ‘well, if we’ve got a multiple owner and we lose that owner, we’ll lose 10 properties,’ and so the risk there is quite big. You might find in a valuation that they actually put a different value on the multiple owner properties as compared to the rest of the rent roll.

Vacancy rates, of course. Now why vacancy rates are relevant is both from a risk and a return perspective. If you’ve got a higher vacancy rate, then there’s a risk you’re not going to get the full amount of income for the year. Obviously from a return perspective, it means you’re not actually bringing that income in, and so therefore it’s going to drop those earnings levels that you expect every year.

Rent arrears, of course. It’s probably a great indicator of quality. If you’re really on top of your game and the rent’s all up to date and your tenants are all paying on time, then you’re going to have a quality rent roll and you’re going to have very low arrears within there. It probably also is a reflection systems and your technology as well.

When we’re looking at setting capitalisation multiples, we don’t just look at all the negatives, the risks, we also look at, well, where are the opportunities to prove? I love it when we buy rent rolls or when you can actually see opportunities to improve within those rent rolls. It might be that that you’re buying a rent roll which is currently valued at, I don’t know, you’re buying it for $2.50 and you know that the bank values your rent roll at 3 times multiple. Then if you can get that into your systems, into your processes, then that’s going to push your overall, the multiple up of the properties that you’re purchasing. I’m always looking for those opportunities to improve upon those rent rolls. Otherwise why pay a top dollar for something, because you’re just going to be just paying for what you’re getting? If you’ve got an opportunity to improve, that brings around that incentive to add real value.

Of course, it’s a little bit boring, but you’ve got your compliance, you’ve got your stability, you’ve got your history. All about the transferability, because I see many businesses who sign the contracts for a sale but then they lose a heap of them through the retention period. You want to minimise that risk of transfer. This is where you need to work your hardest to make sure these properties, if you are selling them, are easily transferable when you’re facilitating that transfer. Of course, that works in reverse as well. If you’re buying a property, if you really want those properties, do the work. But if they’re not going to stay with you, then don’t pay for something you’re not going to keep.

16:07 Rule of Thumb Check

Another thing I thought I’d just share, now this is a bit of an exercise I did a couple of years ago around checking the rule of thumb methodology. Now this was a real life situation that I had here where we had a rent roll that was bringing in about $600,000 of commission in a year. They purchased it for 2.75 times income which meant that it was valued at about 1.65 million. When we looked at the actual profit of that business, before paying the bank and before taking anything out for the owner, the profit was about $330,000. We pay 2.75 income, but we’re actually paid 5 times profit and people often forget that it’s a multiple of profit that you need to be paying, even though the rule of thumb works off income.

If we take that one step further and allow for the bank interest, assuming you’re fully funding it, and allow for some wages for you guys, then that profit can come down. In this situation, it came down to about $210,000. Then the multiple in that case went up to 7.9 times. Now this might be a bit of an extreme case, but you’re really going to actually look at what is the true multiple of profit that you’ve got within your business? When you’re buying, if you are interested in sort of buying or acquiring one of these rent rolls.

17:28 Organic VS Acquisition

One of those big debates that I see in property management all the time is the whole ‘organic versus acquisition’. Do we want to grow organically or do we want to grow through acquisition? I thought I’d just summarise some of the key differences in there from my perspective as an advisor and being-counter. If we think about the organic sort of strategy it’s lower risk. Because yes, you go and incur some more wages but you’re not forking out a heap by way of capital investment. Acquisition, of course, the risk is loss-risk, that you pay for something and you don’t keep it.

Organic can be slower to build. So if you’ve got a strategy that needs quick traction, it may actually be better to go down the acquisition route so you’ve got money coming in the door from day one. Organic can be more targeted. So typically when you’ve got an acquisition, you sort of inherit the whole bundle. If you do go down that route, you might separate out some of those outliers that aren’t going to be ideal for you and have a different multiple on them. Organic, you can be a bit more picky as to what you’re focusing on. Organic, you tend to have a smaller team like acquisition, bigger team straight away. Organic lower market share, but you might be needing market share quicker. That’s probably one of those good differences between value and price, you might need to get quick market share in an area.

One of the fundamental differences between organic and acquisition is actually that the cost of organic growth is profit because you’re paying wages. Whereas the cost of acquisition is actually capital. It’s actually real after tax dollars. That’s probably where, when you do the numbers, and I’ve done the numbers on this in many ways lately, the numbers really show that if you can rely on the organic and you’re happy to take your time to sort of build, then it does end up cheaper. One of the big factors for that is actually tax. Who would’ve thought that tax actually impacts the strategic decision? But because you’re paying wages, you get a tax deduction for that. Whereas when you pay capital, that’s after tax dollars. You’ve got to actually make money, pay tax on it before you pay back the bank.

19:38 Combining Organic and Acquisition

The ultimate though, the ideal though, is probably a combination of both depending on your stage in the business life cycle. Quite often you might be, let’s say you’re at 300 properties and you’re looking to go to that next level, but now you need to put another property manager on. So maybe it’s better to do a small acquisition and put that other property manager on rather than put another property manager and start building up another portfolio again. Typically, the ideal is both depending on your personal circumstances, depending on your stage in the business lifecycle.

Of course if you are out there with a big growth focus, one of the things I see people do poorly is they don’t fund for the growth. If you’re putting more people on, putting more wages on, maybe even taking out some more premises or more space, you need to actually leave more money behind in the business because your working capital requirements have just increased. I see people go on these aggressive growth strategies but they think they don’t need to leave more money behind, and you do, especially to provide for those leaner sort of months that we do sometimes have.

20:42 The 3 Russian Brothers

Those are a few insights, I suppose, a few tips from the accountant and advisor sort of perspective. I’m always a big fan of ‘okay, what are you going to do about all of that?’ How are you going to condense that back into the things that you’re actually going to do? It’s great to hear you’ve had a great session already with Fiona. I thought I’d share with you one what I call ‘the quick and dirty strategic plan’ that I use the time. I call it, my friends, the 3 Russian brothers and their cousin. It’s a long name, I know, but it will all make sense in a moment.

The 3 Russian brothers and their cousin are simply, given all that, what are you going to do more of (Morov)? What works well in your business that you’re going to do more of? What are you going to do less of (Lessov)? There is something in there that maybe the principal shouldn’t be doing as much. The most important one, which sounds like you’ve spoken to Fiona about is well, what are you actually going to get rid of (Ridov)? Because I see principals all day, every day take on new responsibilities without actually taking anything off their plate. It’s great to see you’re already having some discussions about getting rid of things. Then of course there’s the cousin, Tossin. What are the other strategies that you’re going to toss into the mix?

Hopefully there are some different ideas there of different things that you can toss in, but also some different things that you can think about whether you need to do more of, less of, or get rid of to make your property management business. Now I’ve got a worksheet that’s available on that that I’ll make sure you can download and have available for you. It’s a great tool also to take with your teams. It actually works really well as a workshop. If you get a whiteboard and you’re doing a workshop with your team, you just ask them, “Who are our Russians?” You can do it in a cascading style in different segments of your business, different divisions of your business. Ask yourself who are your Russians and share that with your team.

Guys, I hope that’s been of some value to you there. I’m always happy to take questions, but if you are looking to really make it happen in your business, there is a stack of insights on our website, on the blog as well; past presentations, tips, newsletters, videos, and so forth. Feel free to go on there. Just click on the real estate filter and that will drill down to the real estate specific items for you. Thank you very much.

22:57 Conclusion

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