Legal Guide to Buying or Selling a Rent Roll

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Authored by: Matthew Baker-Johnson

Principal
Avery Commercial Lawyers

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.

Buying a rent roll

A good quality rent roll, which is properly managed, will provide stable management income for an agency even during challenging times.  It can also be a highly saleable capital asset.

According to research by Macquarie Bank, residential property management now typically accounts for between 40% to 50% of agency revenues in Australia.

A rent roll is essential to maintain and grow a successful agency because of the income it generates, and also because of the way it ‘feeds’ or drives the sales business.

Whilst there are risks associated with purchasing an existing roll, the purchase of a good-quality roll can assist with rapid business growth.

Positives

  • Increases cash flow and provides stability of income
  • Eliminates a competitor from the local market
  • Drives opportunities for the sales department
  • Turbo-charges business growth
  • Increases database and marketing opportunities

Negatives

  • Legacy issues (e.g. maintenance issues, pending tribunal hearing and insurance claim
  • Lost managements on the sale of the roll
  • Non-confirming managements

Due Diligence

If you are purchasing a rent roll, it’s strongly advised that you engage an experienced team of professionals to advise you on the transaction.  This might include:-

  • An accountant to advise on all financial due diligence enquiries;
  • A rent roll broker who negotiates a sale or advises on the value of the rent roll.
  • A property professional to assist with all relevant operational due diligence enquiries.
  • A finance broker to assist with funding; and
  • A lawyer to advise on all legal aspects of the transaction (e.g. legal due diligence, and advising you in relation to the sales contract)

One of the most important considerations when purchasing a rent roll is determining whether, having regard to the purchase price and the level of investment required, the roll is profitable, or has a reasonable prospect of becoming so.

A thorough financial due diligence should be undertaken in conjunction with your business advisor and/or accountant to determine if the purchase price is justified, and to provide some analysis of the business’ financial records.

If you are purchasing a rent roll, the sort of questions you would be seeking answers to include:

  • What are the average rents and management fees?
  • How many properties are owned by the vendor?
  • Are all authorities and files up to date?
  • What is the location and type of properties being managed?
  • What is the ratio of landlords to properties?
  • What is the current staff structure? Will they stay on? How much do they cost?
  • Are there outstanding tribunal hearings or insurance claims pending?
  • What is the current level of demand for rent rolls in the area?
  • What property management software is used by the Vendor? Will this present integration issues?
  • What percentage of properties on the roll are in arrears? Or vacant?
  • Are there currently properties for sale? Will these be ultimately lost from the roll?
  • Are rental bonds held for each property?
  • Are there outstanding maintenance issues?

Valuing the 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 single or multiple property owners (a higher proportion of multiple property owners increases the risk of loss 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, and the answers to the due diligence questions, the multiplier will typically be between 2.0 – 3.5 times the annual management fee income.  However, this will also be influenced by the ordinary principles of supply and demand.

“The value of a rent roll is usually determined by applying a multiplier to the annual management fee income”

Legal Documents

  • Confidentiality Agreement

If purchasing a roll, the broker will usually require a potential purchaser to enter into a confidentiality agreement before disclosing confidential information in relation to the rent roll.

  • Terms Sheet

If a sale is negotiated, the broker may require the parties to enter into a terms sheet which sets out the principal terms of the proposed sale. This is sometimes prepared as a non-binding agreement which is subject to the parties entering into a long form contract of sale.

  • Contract of Sale

The contract formalizes the deal and can address any issues identified in the due diligence process.  It is important to ensure that you have either completed your due diligence before entering into the contract, or that a due diligence period is specifically negotiated in the heads of agreement.   Your lawyer should assist with negotiating the terms of sale.

Retention

From a purchaser’s perspective, to protect the goodwill of the business, it’s critical to ensure that as many leasing authorities are validly 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.  This will be adjusted if properties are terminated or lost at settlement, or at the end of the retention period.

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

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

Adjustments to the Sale Price

The long form contract needs to have appropriate adjustment mechanisms to vary the purchase price (and the calculation of the retention sum) if:-

  • any leasing authorities are terminated from the date of the terms sheet to completion, or during the retention period;
  • any properties become vacant prior to the settlement date or at the end of the retention period;
  • any properties are in significant arrears of rent or outgoings on the settlement date or at the end of 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 until the end of the retention period.  It will also set out 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); or
  • 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 rent roll agreements in the marketplace fail to deal with the above issues adequately (or at all).  This can impact significantly on the financial outcome for both vendors and purchasers”

 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.

For example, in Victoria 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.

Your lawyer should be able to advise on all of these issues.

GST

There is some uncertainty as to whether the sale of a rent roll (rather than a sale of the agency business itself) 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’ continued operation arises particularly in circumstances where the sale does not, for example, provide for the assignment of the office premises 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.

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:-

  • Due Diligence

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.

  • Finance Approval

This 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.

Banks will generally lend up to 60% of the value of the rent roll without requiring separate security.

  • Franchisor Approval

If the vendor operates under a franchise, 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.
  • Restraint of Trade

From a purchaser’s perspective, 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.

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.

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 and rent roll broker who have experience with these types of transactions to ensure your rights are properly protected, and the process is managed efficiently.

 

Matthew Baker-Johnson

Principal

Avery Commercial Lawyers

Matthew is an experienced commercial and corporate lawyer who regularly advises on the sale and purchase of rent rolls.

He is valued by his clients for his ‘no-nonsense’ approach to legal issues, his excellent project management skills, and his commitment to delivering sound legal outcomes.  He is a regular commentator on legal issues, and enjoys working closely with clients and their advisers to ensure matters proceed smoothly.

He is a member of the Law Institute of Victoria (LIV).

Feel free to contact me at any time to discuss your proposed transaction.

Phone: 03 9020 7344

Mobile: 0438 029 433

Email: mbj@averylaw.com.au 

 

Testimonials:

“Matthew was great to work with on a recent transaction. It was complex and testing at times, and Matthew’s advice and guidance was excellent. I would highly recommend”

Nick Dowling, CEO, Jellis Craig Group

“I’ve worked with Matt on a number of transactions over the last few years, including the sale of my real estate business. He has a very good ability to work through complex legal issues, and is very much ‘in the trenches’ with you as you navigate legal problems. He’s become a trusted commercial advisor and I have no hesitation in recommending for commercial legal services.”

Robyn Adair, General Manager, Box + Dice

“I have recently used the services of Matthew for the transaction of 3 separate entities. Throughout the process I found Matthew to be extremely attentive and thorough. But most of all I found that he not only protected my interests at all times he CARED about achieving the best possible outcome for ME whilst not running up the costs of his professional fees for self serving reasons.” 

Troy Sheehan, Managing Director at Jellis Craig (Whitehorse)

 

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.

 

Copyright:

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