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Rental Portfolio Profitability Master Class

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Presentation on theme: "Rental Portfolio Profitability Master Class"— Presentation transcript:

1 Rental Portfolio Profitability Master Class
Underwritten by RMB Structured Insurance Limited Practical strategies for profitable portfolio’s 7 – 22 September 2014 An authorised financial services provider – FSP 43441

2 First, a note on CPD points
60 points need to be earned in a 3 year cycle (20 points per year) Points are split into 2 categories, namely verified and non-verified Currently the EAAB is the only body allowed to provide verified training Non-verified training has to conform to time and content requirements (duration & relevancy) Verified (45 points) 3 Year Cycle (60 points) Education and training Non-verified (25 points) Professional development (max 5) Corporate Social Investment (max 5) Mentoring and coaching (max 5) Reading and publishing (max 5) Personal development (max 5)

3 And then a word on who we are
5 5

4 Our agenda for this morning
An authorised financial services provider – FSP 43441

5 The next few hours 09:00 – 09:30 PayProp State of the Rental Industry update 09:30 – 10:30 The rental portfolio business model 10:30 – 11:00 Tea Break 11:00 – 12:00 Valuation of a rental book 12:00 – 12:30 New in the industry 12:30 – 12:45 Summary & Closing

6 The State of the Rental Industry
Q2 2014 An authorised financial services provider – FSP 43441

7 Our predictions for the remainder of 2014
Average rental growth will settle in the 8% - 10% range Consumer payment data will continue to deteriorate Damage deposits will become un-affordable to tenants and deposit replacement products will become more commonplace Property investors will not see net yields of above 6% for some time Watch the Northern Cape!

8 Average rentals break the R6 000 barrier
Current weighted average rental in South Africa is R6 144

9 Growth has stabilised Growth rates are slowing down after having hit a high of 10.8% in October 2013 Current year-on-year growth rate is 8.9% and we expect it to stay there for some time

10 Limpopo normalises Limpopo is starting to slow down
Mpumalanga continues with stable growth Eastern Cape has an impressive recovery Northern Cape is the new emerging start Freestate continues to struggle Western Cape, KZN and Gauteng continue to experience stable growth Very little movement in the North West

11 Damage deposit ratios stabilise
Stabilisation in damage deposit ratio Currently at 1.34 It seems that there is a limit to what tenants can afford Growth of deposit replacement products

12 Low, but stable investor returns
Both net and gross yields remain stable – despite rental growth Consummate increase in property values neutralise gross yield gains Consummate increase in cost of ownership neutralises net yield gains Remember that the yield calculation does not take capital growth into account – if that is added in, it increases to 12.81% Rental yields therefore only cover the cost of ownership and investment opportunity costs

13 ‘Counter-intuitive’ provinces lead the pack
Northern Cape, Limpopo and Mpumalanga offer the best returns for investors High cost of ownership in the Western Cape and Gauteng limit what investors are able to take home

14 Agents defend their commissions
Agents seem to have taken a deliberate decision to defend their commissions There was a time that the data showed a declining trend, similar to that of sales commissions However, we are increasingly hearing of non-metro commissions being under increasing pressure

15 Our first lesson on profitability
You will only do well, if your landlord does well Current national average cost of ownership sits at 33% and is increasing Agent commissions Rates & taxes Repairs That means that on an average rental of R6 144, a owner only takes home R4 116 There is little room for error in making sure that your landlord is happy

16 The rental business model
An authorised financial services provider – FSP 43441

17 Basic assumptions We built the model based on a set of assumptions developed through our exposure to hundreds of rental portfolios The model is meant to help test some of the most important assumptions the owner of a rental business faces It is not meant to provide definitive answers, but to help you stress test different scenario’s for your business A model like this should not be viewed as investment advice, but merely one of a series of tools that you could use to better understand a business We will all attendees the model tomorrow You cannot break it – so feel free to play with it However, you also cannot edit detailed assumptions

18 Let’s define average This is the typical rental portfolio that we come across (and that we have used for modelling) 100 properties with 10% managed commission No real introduction rentals 98% collections each month 1 Admin and 1 agent Admin on fixed R7 500 and agent on 50% commission split Charging lease fees, and little else Results-wise, this agency produces R in commission each month Retains R as profit (48%) That is R3 800 profit per property per year

19 The first, most basic income principle
Tenants vs paying tenants According to the latest TPN report 6% of tenants are not paying rent You can legally only take your commission once the rent is received – so without rent you have no commission On a typical portfolio, you make an additional R350 net profit for each percentage point in collection improvement The difference between the industry norm of 94% and the 100% collection is just over R per year This does not begin to include the cost, time and effort of dealing with a non-paying tenant How to increase collections Better tenant selection Early detection Credible threat Rental/deposit guarantee products

20 And what if they don’t pay?
Debt collection fees There are legislated fees up to a maximum of R841 R17 per fax, , phone call, letter, “necessary expenses” R2.20 per SMS R166 for serving physical documents R33 for drawing up settlement accounts R41 per consultation R8 for correspondence received You can only charge these fees if you are a registered debt collector Late payment penalties Some leases make provision for the use of a ‘late payment penalty’ if the tenant does not pay Take note that this is interpreted differently in different provinces – in Gauteng it is illegal and in the Western Cape it is not Understand why you are charging this fee (and explain it accordingly) Is it to compensate you for reasonable costs of collection? Is it to compensate the owner for lost interest Do not confuse why you are collecting with who you are collecting for!

21 Other income variables to consider
Transaction fees and tenant admin fees Tenants have a number of payment channel choices, some which are cheaper than others Depending on the conditions of your lease, you may be able to recover some of these costs Don’t limit your options by only stating ‘cash deposit fees’ as this is an area of growing diversity (rather use “transaction fees” as a descriptor) Sources of incoming funds Average transaction charges Banking Fee Comparison Average Account Fee R EFT's R 7.60 Debit Orders R 8.60 SMS's R 's R Fixed Cash Deposit R Cash Deposit % 1.22%

22 Recovering transaction fees
Just recovering cash deposit fees equates R873 per month in additional net income for your business However, per tenant recovery can be cumbersome and some agencies are resorting to a fixed ‘tenant admin’ fee that spreads total bank fees across the entire tenant pool As long as it is in the lease and the tenant explicitly agrees to the cost, either route is feasible

23 Some income variables to consider
Credit check fee Credit check costs can vary from R68 – R138 per check In many cases it takes up to 5 checks to find an appropriate tenant, and you are bearing the cost of this each time With the escalation in these fees, many agencies are asking an up front application fee In a typical agency, a R100 per check recovery adds R per year to the bottom line Refunding successful tenants drops this saving to R7 200 Lease fee Traditionally charged because lawyers were used to set up legal agreements, but the availability of specialised (and free) contracts has reduced the need to do this Accordingly this is pure profit and at around R750 a time adds almost R4 500 to the profit pool On introduction rentals the result is even greater However, section (p) was added into the Rental Housing Amendment Act in 2008 “any costs in relation to contract of lease shall only be payable by the tenant upon proof of factual expenditure by the landlord”

24 Some income variables to consider
Damage deposit management fee The Estate Agency Affairs Act and EEAB guidelines state that you can keep the interest on a deposit only if you have clearly informed the tenant of the interest and your intention to keep it If you retain interest, you have to pay 50% over to the EAAB However, the law does not prohibit you from charging an administrative fee for managing the deposit Your fee is justifiable as you incur transaction, service, audit and direct administrative costs in keeping the money Administrative fees don’t have to be shared the same way as interest retained In determining what is a feasible charge, consider the interest that an average deposit earns The average damage deposit is R7 930 (1.3 x rental) 5% interest rate earns it R371 per year in interest 1% interest rate earns it R75 per year in interest It would be grossly unfair to the tenant (and the landlord) to charge more than the interest earned Checking the boxes Remember that you cannot levy any charges that are not explicitly agreed to in the lease Be upfront with landlord on additional charges you levy Ensure that you provide a post-payout breakdown of all deductions

25 Procurement vs managed rentals
Typically procurement rentals attract a lower commission (7.5%) Interestingly, not really dissimilar from a margin % perspective However, on actual cash contribution to the business, managed rentals deliver double the income Managed rentals Monthly income per property R Monthy expenses per property R Annual once-off income per property R Annual once-off expenses per property R Total profit per property per year R Net Margin % 43% Procurement rentals Income per property R Expenses per property R Total profit per proptery per year R Other reasons why we believe that managed rentals are a smarter option You stay closer to the owner and more likely to get the renewal You are closer to being the effective cause of a sale

26 And this is what the sandbox looks like
In the model we have provided you with an ‘Income Variables’ play-space where you can adjust the different variables to see what effect it is likely to have on your income By just adjusting some of the basic variables (transaction fee recovery, lease admin fee, credit check fee), we were able to show R3 500 pm more in profit That’s more than R per year

27 Some expense variables to consider
Manual vs automation When starting a portfolio this is of minor concern – the average ‘manual capability’ seems to be in the region of 50 properties Not investing in automation is a self-limiting and expensive decision when you are trying to grow

28 Some expense variables to consider
Bank fees A ‘rule of thumb’ is that bank fees generally equate to 0.5% of turnover PayProp saves you at least 30% on published bank rates Use batch-remittance fees as far as possible Credit check costs Watch this space… Accounting You are required, by law, to reconcile your trust account every month Time estimate is 1hr for every 25 properties Cost estimate is between R350 – R450 per hour That’s around R1 350 per month just to reconcile a 75 property portfolio’s trust account Just having ‘a system’ does not absolve you from this responsibility

29 Employment structure considerations
Basic role differentiation Growth and maintenance Typically we find that without automation a single administrator can manage properties We find that mostly there is a evolution of staffing in a typical agency, namely me; me + part-time admin; me + full-time admin; full-time admin + agent It is important to consider your growth horizon when you make remuneration decisions early on, for example: Sharing commission from day 1 when you have 5 properties, means that you will be sharing commission when you have 100 properties The various means to pay and their relative benefits Fixed salary Lease fee split Managed lease commission Procurement lease commission The cost associated with commission generation Bank costs System costs (i.e. PayProp) and how to adjust for them

30 And this is what the sandbox looks like

31 Other issues to take into account
Money is not only a means of reward of services done, but is also a powerful motivator Understand the type of behaviour that you would like to see in your business, for example Motivating administrative staff on retention of the existing book Motivating agents on constant flow of new deals Some things to watch for… “Nest building’ Unintended behaviours Reasonableness of income generated

32 Finally, a thought on growth
Economies of scale work up to a point, then your business settles at a stable margin % At below 50 properties, you are still absorbing a lot of fixed costs

33 Valuing a rental portfolio
An authorised financial services provider – FSP 43441

34 Main schools of thought
Net Present Value (NPV) Method The basic principle: R1 today is worth more than R1 next year Cash flows are projected forward, and discounted back to today’s value Risk factors are taken into account when determining a discount factor You are paying for the current value of all future cash-flows Earnings Multiple Method The basic principle: How many months is it going to take for this business to pay for itself Typically expressed in number of months that relate to net profit earned I.e. 30 times earning multiple = 30 times average monthly net income Practical Method A business is only worth as much as a seller is prepared to pay for it

35 The same rules apply when using this model
We built the model based on a set of assumptions developed through our exposure to hundreds of rental portfolios The model is meant to help test some of the most important assumptions the owner of a rental business faces It is not meant to provide definitive answers, but to help you stress test different scenario’s for your business A model like this should not be viewed as investment advice, but merely one of a series of tools that you could use to better understand a business We will all attendees the model tomorrow You cannot break it – so feel free to play with it However, you also cannot edit detailed assumptions

36 The most important variables to consider
Investment horizon How far are you prepared to look forward How far can you look back to confirm the trend Realism of earnings assumptions How do I interrogate the assumptions given (especially when they look forward) Is the infrastructure in place to support the projections? Assessment of risk – what to look for Staff turnover Remuneration package effects (look at all contracts) Landlord mandate losses Deposit risk (is it all there?) Regulatory compliance Reputational standing

37 Practical considerations
What is the current financial status of the business? Is there pending legal action? Are there major debtors? Advertising the sale to potential creditors See section 34 of the Insolvency Act (1, 2 &3) What legal agreements are in play? Are you legally allowed to buy this business? Are you an estate agent? What is their standing with the EAAB? Grey area of FFC renting

38 What am I buying? Two main considerations: The legal entity Risks
You assume all debts and obligations Benefits Easy transition The contracts of the entity You have may loose a lot of what you have bought You know nothing is going to come out of the woodwork

39 Structuring the deal Full cash-up front Once-off transaction
Clean split But what if worms come out of the woodwork…. Share purchase with earn-out Buy a share now – and I pay for the rest with earnings from the business Give your share of the earnings each month to buy back more shares until you own them all The better the seller does in the transition, the quicker he gets his mone Risk: loss of interest after having sold Deposit + repayment plan Helps if you don’t have al the cash now Be prepared to pay slightly more Consider the claw back Escrow -based release plan Give all the money to the lawyers Release on the achievement of key milestones i.e. reconciliation of deposit account Meeting of budgeted turnovers

40 So what are the general trends?
With the regulatory compliance burden growing, we have seen an increase in the rate of portfolio acquisition Typically it is rare to take a view of more than 3 years on a rental book – and most at a NPV level gravitate to a two year view at medium to high risk This usually equates to around an 18 x monthly earnings multiple Interestingly, at these levels, the valuation is not far of the ‘rule of thumb’ of one month’s turnover We have seen a few instances where, despite the valuation work being very well done, that the deal structure turned everything into a mess

41 An authorised financial services provider – FSP 43441
New stuff! An authorised financial services provider – FSP 43441

42 We’ve summarised our previous learnings…
Go to the events page on PayProp Select Rental Industry Session #4 Click on “five things we’ve learnt from the conference” Enjoy

43 So we released some leases…
Thanks for the feedback Changes made How to get them

44 And we are about to make you feel safer…
Beneficiary validation available at the end of September 2014 Cost R3.80 per validation Confirms identity and bank accounts match at the bank

45 And then you asked about tenant assessment…
Colin Habberton: PayProp Capital: CEO

46 Understanding Tenant Risk
In the May Masterclass we covered the following points: What are the risks and how can they be mitigated? Explain the importance of tenant assessment and some tools What to look out for - contracting party vs. the tenant – identity fraud The purpose of using credit history in evaluating tenant risk The requirement for consent - the relevance of the POPI Act Knowing how to use credit reports – the basics What can be buried in the detail - number of accounts, recent checks How are these reports are compiled - credit bureaux and the CPA Why tenants can be declined - case study: DepositGuarantee rules

47 So what is our experience?
DepositGuarantee On average between 60-70% of tenant applicants are ineligible Using a firm but fair set of rules to assess total rental and indemnity exposure Differences between our results and their current reports – affordability checks

48 How does that leave you feeling?

49 Introducing more than just a credit check…

50 Assessment of Tenant Risk

51 Elements of the Report Identity Verification Fraud Check
Delinquency Report Credit Behaviour Indebtedness Affordability Rental Risk Matrix Eligibility for DepositGuarantee Detailed Underlying Data

52 Format of the Report Decision-making tools Graphic representations
Indicators & Icons Comfort level categories

53 Rental Risk Matrix Summary ‘Heat Map’

54 Underlying Components
Arrears, Timespan, Indebtedness & Affordability Algorithms

55 The Report Itself Summary Results Identity Verification
Personal Information Financial Profile Analysis Clear, concise explanations 11 Pages in total

56 The Report Itself Detailed Analysis & Commentary

57 The Report Itself Detailed Analysis & Commentary

58 The Report Itself Immediate DepositGuarantee Elgibility Results & Extra Benefit

59 Compuscan Partnership
1 of the big 4 Credit Bureaux in SA In operation since 1994 20 million credit records 150 million accounts Credit data provider Source data included

60 Availability & Cost?

61 A Final Word: The Importance of Consent
Protection of Personal Information Act (POPI): Covers information relating to clients, suppliers, employees, persons receiving marketing information, persons present on premises etc. All personal information which is protected incl.: race, gender, sex, marital status, sexual orientation, age, physical/mental health, religion, criminal and financial records. Sources of information impacted include payroll data, CVs, employment applications, HR & security records, standard information, even internal s. Existing manuals created in terms of the Promotion of Access to Information Act which spell out the company’s policy must be updated in line with PoPI. Explicit permission needs to be given for collection and use before data is collected. Data can only be collected from public domain; no more rented database lists Companies will also need to motivate why they need to keep certain data. Individuals need to be informed for how long information will be kept. (Institute of Directors SA, 2014)

62 We hope that leaves you feeling more…

63 Thank You! We welcome your feedback See you again in Q2 of 2015

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