A Guide to Buying or Selling a Rent Roll

201905.28
The sale or purchase of a rent roll involves different considerations to many other types of businesses due to the nature of the assets being sold and the way rent rolls are valued.


1. Valuing a Rent Roll

The value of a rent roll is usually determined by applying a multiplier to the annual management fee income.  The agreed multiplier will be affected by a range of factors including:


  • the average annual rent and management income of each property;

  • whether properties are largely owned by a single or multiple property owners (a higher proportion of multiple property owners increases the risk of loss to the vendor on sale);

  • the geographic spread of the properties (management of properties spread over a large area is likely to increase travel time and costs);

  • whether the properties are predominantly commercial or residential (with commercial properties usually attracting a higher multiplier);

  • the location and desirability of the properties; and

  • the type and duration of the leasing authorities.

Depending upon the above factors, the multiplier will typically be between 2.5 – 3.5 times the annual management fee income.  However, this will also be influenced by the ordinary principles of supply and demand. 



2. Retention

From a purchaser’s perspective, to protect the goodwill of the business, it’s critical to ensure that as many leasing authorities as possible are transferred to it on the settlement date. 


A retention sum is usually negotiated to ensure a smooth and effective transfer of the authorities to the purchaser at settlement.  This will be adjusted if properties are terminated or lost at settlement or by the end of the retention period. 


The retention sum will typically be between 15 – 20% of the purchase price negotiated at the time of sale, and will be held for between 3 – 6 months after settlement in the selling agent’s trust account.


A retention sum also will usually be required by the purchaser’s bank if the purchaser is obtaining finance.



3. Adjustments to the Sale Price

It’s important to ensure that there are appropriate adjustment mechanisms in the sale agreement to vary the purchase price (and the calculation of the retention sum) if:-


  • any leasing authorities are terminated from the date of the heads of agreement or during the retention period;
     
  • any properties become vacant prior to the settlement date or during the retention period;
     
  • any properties are in significant arrears of rent or outgoings on the settlement date or during the retention period;
     
  • new leasing authorities are entered into between the date of the heads of agreement and the settlement date or during the retention period;
     
  • any properties, which were vacant at the date of the heads of agreement, become tenanted by the settlement date or during the retention period;

A well-structured agreement will also ensure that the purchaser is obliged to manage the roll in accordance with best commercial practice and all relevant statutory obligations until the conclusion of the retention period, and stipulate relevant circumstances that will not result in an adjustment to the sale price, including where:- 


  • there is a failure by the purchaser to properly manage the properties after the settlement date (and this results in a loss of management);
     
  • a management is lost because it is sold by the purchaser between the settlement date and the end of the retention period.

Unfortunately, many of the agreements in the marketplace fail to deal with the above issues adequately (or at all). 



4. Assignment or Grant of New Leasing Authorities

The requirement to assign existing leasing authorities, or to procure new authorities by the settlement date, will partly depend upon the type of leasing authorities used by the vendor, and on the purchaser’s requirements at settlement. 


In Victoria, for example, the REIV Authority allows assignment to another agent by giving written notice to the landlord.  If no objection is received within 14 days, then there is effectively a “deemed” assignment. 


However, if non-standard leasing authorities have been used, then the parties need to consider:

  • whether the authorities are personal to the agent (and therefore can’t be assigned); or

  • if there are specific assignment provisions, the requirements that need to be met to ensure a valid assignment.

5. GST

There is some uncertainty as to whether the sale of a rent roll (and particularly the sale of part of a rent roll) qualifies as a sale of a GST-free going concern. 


The GST legislation provides that the the sale of a business as a going concern is GST-free if all of the following apply:


  • everything necessary for the business’s continued operation is supplied to the buyer;

  • the seller carries on the business until the day it is sold (that is, until settlement);

  • the buyer is registered or required to be registered for GST;

  • payment is made for the sale; and

  • before the sale, the buyer and seller agree in writing that the sale is of a going concern.

The issue as to what is “necessary” for the business’s continued operation arises particularly in circumstances where a contract does not, for example, provide for the assignment of the lease, the transfer of employees, or the business name. 


In light of that, it is prudent for parties to seek their own tax/legal advice on this aspect of the transaction having regard to the specific terms of the sale. 


6. Conditions Precedent

A condition precedent (CP) is merely a condition that needs to be fulfilled before performance of the contract becomes due.  The following are some common CPs in rent roll agreements:-


(a) Due Dilligence

This provides a purchaser with a period in which to undertake its own legal and accounting due diligence.  It will usually be for a period of between 14 to 30 days. 


(b) Finance Approval

This condition ensures that an offer is made subject to the purchaser’s bank approving finance.  As with due diligence, this will usually be for a period of between 14 to 30 days.


Following the Hayne Royal Commission, and a tightening of lending criteria, finance approvals are becoming more difficult to obtain, and the process is becoming lengthier.


(c) Franchisor Approval

If the vendor operates under a franchised model, then it would be typical to include clauses which make the sale subject to (as applicable):-


  • the franchisor not exercising any pre-emptive rights to purchase the rent roll from the vendor;

  • the franchisor consenting to the transfer of the rent roll and the franchise agreement to the purchaser; and

  • the franchisor providing all necessary releases to the vendor and its directors from the franchise agreement.


7. Restraint of Trade

A restraint of trade clause is critical to protect the goodwill of the rent roll after the settlement date. 


Most restraint of trade clauses only operate to restrict the vendor from competing with the business in terms of time (e.g. 3 years from the settlement date) and distance (e.g. 10 km from the business premises). 


However, it is typical in rent roll sales to include a restraint that restricts the vendor, its directors, and related entities from soliciting, canvassing, inducing or securing the custom or patronage of any landlord’s property on the rent roll for the entire restraint period. 


However, it may also be necessary to structure the restraint to ensure that a vendor can continue to operate as a leasing/sales agent after the settlement date but subject, of course, to the above limitations.



8. Dispute Resolution

The risk of disputes in rent roll sales is somewhat increased as a result of the fact that a proportion of the purchase price is held back at settlement for the duration of the retention period. 


A well-structured sale agreement should contain detailed clauses which outline the way that any disputes are to be resolved.  This might include provisions which require:


  • the parties to initially negotiate in good faith to resolve any issues; and

  • refer any matter to mediation or arbitration before court proceedings are issued.


9. Conclusion

There are numerous legal issues which arise in the context of rent roll transactions.  It’s recommended that you seek the advice of a commercial lawyer who has experience with these types of transactions to ensure your rights are properly protected, and the process is managed efficiently.


About the Author

Matthew is an experienced commercial lawyer who regularly advises parties in relation to rent roll transactions.  He is a member of the Law Institute of Victoria (LIV).

Matthew Baker-Johnson
Principal
Avery Commercial Lawyers






















Disclaimer:

The information contained in this article is intended to provide general information only and is not legal advice or a substitute for it.  You should always consult your own legal advisors to discuss your particular circumstances.