Beyond the horizon - 2012

It can be a difficult question to answer for real estate agency principals. Just how long do I want to remain as a principal? And how will I go about exiting the business?

It’s a sobering thought for principals who are nearing retirement age, more so when you consider that the majority are aged over 55. In some markets, particularly in regional Australia, it may be the case that all the local principals are set to leave the industry around the same time.

Multiple businesses and/or rent rolls on the market at the same time can undermine the price a principal can get.

What is a succession plan? Put in the simplest terms, succession planning is really another way of saying you have an exit plan.

You should have written up a succession plan before you commenced operating your business. That was the unanimous response from the numerous industry professionals Real Estate Business spoke to about the best time to plan for your exit.
The reality though, appears to be much different.

According to Mark Sinclair, CEO of Perth-based Realestimations, brokers, advisors and consultants to the real estate and broader property industry, the vast majority of principals do not have a structured succession plan in place.
He says only the larger organisations generally have a plan prepared.

PRDnationwide’s managing director, national franchise services, Tony Brasier concurs. “I’ve seen a lot of very good independent real estate businesses that are controlled by one person, and along the way they haven’t shared equity, or haven’t tried to bring in other partners to the business over a period of time.

“At the end of it, they don’t face too many options on how to get out, and in a lot of those cases it’s just, here’s the value of the rent roll, and that’s it.”

Thomas Le Hoang, CEO at Wiseberry Real Estate, which has 18 shopfronts across NSW, says not paying enough attention to succession planning can ultimately hurt the agency’s staff and, in turn, the business. “Doing this process wrong puts at risk the entire organisation, and employees are always the first to pay when the wrong pass-over is done,” he says.

“It is quite common to see the biggest human resource change after a succession.”

“Weaker succession plans occur when the principal is forced to pass it over, due to an illness or personal circumstances...you then take on someone who is nearly right for the job and find yourself having to compromise on important issues.”

Tas Demos, a partner at BDH & Co, who has 15 years’ experience in helping real estate principals with business planning issues, agrees many aren’t taking enough time to plan for their exit. This is particularly important when the exit relates to retirement.

He says principals usually haven’t calculated how much income they’ll earn and/or need in retirement. This becomes problematic in areas where agency businesses have declined in value, on the back of stagnant property markets.

They can also make simple errors that sap thousands of dollars from their final payout.

“I had a client of mine who, 12 months before he sold his business, signed up a lease on a new photocopier,” Mr Demos recalls.

“To get out of it was a $65,000 exercise. A lot of these people don’t think about their window displays, or anything that’s under lease.

“And they don’t take into the equation the fact that they’ve got to pay out the annual leave entitlements, or long service leave entitlements, or the leases on their photocopier because the purchaser might not want them, or window displays.”

NOT TOO LATE
But it’s not all bad news. Principals who don’t have a clear plan in place can still do so. You will need time though to see a succession plan through to fruition. Just how long you’ll require depends – one professional suggested 10 years was a minimum time frame, another said 12 months, although most felt two to three years would suffice.

A key to effective planning is giving it the attention it deserves, says Ross Hedditch, director at Melbourne-based BDH Solutions.

Mr Hedditch, who helps principals with rent roll and agency business sales, says succession planning is often undertaken on a part-time basis. This often leads to frustration when the parties involved – often high-performance employees working within the business – fail to see progress after months of inaction.

Jason Roach, national industry leader, real estate and professional services at Westpac, says he witnesses this regularly.

He says principals tend to be focused on generating cash flow and running their business, making it easier for things like succession planning to get pushed to the side.

“You do need to set aside time, and understand what you’re trying to achieve through your personal goals and your business goals. For most small business owners, which is most of the [real estate] industry, it’s a business they’ve lived and breathed seven days a week, and there’s a huge emotional attachment to it.”

Stuart Cox, the recently appointed CEO at Harcourts WA, says a previous 10-office real estate business that he jointly founded and operated gave him a solid grounding in succession planning.

“We put in very specific exit plans,” he says. “We actually spoke to an accountant and solicitor before we [started the business]...covering things like the ownership structure, family trusts, to make sure the tax reasons for doing it were right.”

“At that time we determined that if either of us wanted to exit, we would have a pre-determined method, not a figure but a method, on how we would calculate [the business’ value] out,” he says, “which we did work out on a valuation of rent rolls, and the written down book value of plant and equipment – that’s technically the Tax Office valuation.

“We then put on a figure for ongoing profit, basically a goodwill figure that was derived from an average of the previous three years’ profits.

Mr Brasier adds that it’s imperative that principals keep the ownership vehicle of the business clean.

“In other words, don’t complicate the structure of the business so that when it comes time to sell it, it makes it difficult for you sell because you’ve complicated the structure by maybe buying other assets in that business.

“Keep that structure as simple as possible, so at any time you can actually sell that structure, or sell that business without too much trouble.”

SUCCESSION STRATEGIES
There’s a variety of approaches to exiting a business. Some of the more common ways see principals groom someone internally to take over the business, or discretely seek out a buyer via the services of a business and/or rent roll broker.

In Mr Cox’s case, he developed a structure whereby equity stakes in the form of shareholdings were distributed to relevant candidates.

“We put in a model that, similar to a doctor’s practice or an accountancy practice, where the business itself never actually sells,” he says. “What you sell are shares within that business.” You can do this provided your company is owned as a proprietary limited, he adds.

Another popular strategy is grooming someone from within the business to take over. But this needs to be a long-term process, industry professionals caution.

“If you’ve got young people coming through, not always can they afford to all of a sudden raise capital to be able to buy a share of the business,” Mr Brasier says.

“If you can ease them into a business, there might be situations like forgoing commissions in exchange for equity over a period of time, or a profit share arrangement...It doesn’t mean you have to go to the bank and raise a whole lot of capital, and get yourself into debt if you buy into the business.

INTERNAL SALE
This is where a staggered sale plan to someone within the business has advantages. Given enough time, an interested party can build up their stake in the business, spreading the financial burden.

Moreover, Mr Cox says an internal sale will always be worth more than one made to an external party, most of whom will seek to knock down the price you want.

“If you sell [the business] over a period of time internally, it becomes your most valuable sale because they know your systems, they know your employees, they are your employees, and it’s in their interests that they make it more profitable,” he says.

“Quite often they’re prepared to pay any sort of slight premium that they need to, to buy a small shareholding, to keep the company stable. Those people within the company, they can see the biggest benefit of buying the shares within the company.”

It’s crucial to identify these employees, Mr Cox continues.

“Future leaders – I’d be highlighting who they were,” he says.

“The next step is to approach them – outline your five year plan to them. Put some performance hurdles in the way; maybe link how much profit they bring in to giving them a shareholding in the business, on an annual basis over five years, to a certain limit.”

Steve Martin, principal at Stanley&Martin, located in the NSW-Victoria border town of Albury, has made seeking out potential business partners a part of his agency’s recruitment process.

Put simply, he says principals should “manufacture their own buyers”.

“It is something we broach at the outset,” he continues. “If there is interest, we sort of park that and see how they go over a 12-month period.”

They then allocate responsibilities to those who have indicated they might want equity down the track.

“That has been done on the basis of, ‘this will give you a taste of what working to a budget is all about, what expenses are and the controlling of expenses,” he says. “It’s really interesting how people tend to change a bit. In both cases [where they’ve done it], suddenly what becomes important is industrial relations, or the things that weren’t [initially] so important to an employee.”

Chris Goodway, CEO at The Rent Roll Broker, recently wrote that one of the most daunting aspects about selecting someone to take over the business is the “niggling doubt of, ‘are they definitely the right one?’.”

He suggests principals develop a probation period of training for between six and 12 months, with a view to making “a firm commitment to either moving forward with the succession plan or walking away and starting again.”

Similar to the process instituted by Mr Martin, he says that the probation period should focus on giving the applicant more and more responsibility.

“People skills and managing people are probably the most lacking skills required in operating a real estate business, because salespeople learn to sell rather than manage,” Mr Goodway says.

“Then, they need to learn about the running of a real estate practice.

“Towards the end of the probation period they should have become your shadow assisting you in most of the management aspects of your business. Naturally you will also need to make sure they still have time for their normal duties of listing and selling.”

This process is important to principals who don’t have family members who they can pass the business onto, says Michael Davoren, managing director at RE/MAX Australia.

He says that if he was a sole operator, and he didn’t have family, he would look for someone who had spent the years in the business, and who had shown a capacity to do work over and above what their core responsibilities were.

But he cautions that’s just the starting point. “A lot of them think it’s a good idea at the time, but when they actually have to start paying for it, [all of a sudden] it’s a bit hard.”

He adds that it’s critical the principal stays in control of the business during this process.

Stuart Cox from Harcourts WA attests to this, particularly when you’re selling shares in the company.

“I would keep it very clear, that if you’re a proprietary limited company, you have a board of directors, and just because you’re a shareholder, it doesn’t necessarily mean you have to be a director. I would keep the two separate.

“If a person wants to become a director, that’s fine, but they then pick up all of the directors’ rights and obligations.

“One of the things we noticed, we were selling down [shares in] various offices, and those guys buying shares automatically assumed they would then become a director, and have a running in the company.

Once they understood what these responsibilities were, many just decided the stake in the business was enough.

MOTIVATION TO BUY?
Mr Martin says this is another problem principals might encounter when seeking out talented employees to take over an agency.

“With certain business models these days, it can be very lucrative for employees not to have their own business, and in terms of remuneration, they can be virtually running their own business out of, and under the umbrella, of an existing agency without the distractions of running a business,” the 2011 winner of the prestigious Woodrow Weight OBE Award from the Real Estate Institute of NSW (REINSW) says.

There is little incentive for these professionals who, happy with their salary, don’t want the pressure of running a business. He refers to Effective Business units (EBUs) as one example of this phenomenon, whereby (usually) three people will operate as a separate division under the banner of an agency.

“They don’t have the responsibilities of employing people, they’re running their own show and doing it very effectively. Their investment, if they’re very smart, is in professional development and training, and making sure that they can maximise their return out of themselves.”

Principals need to think long and hard about offering these types of arrangements to employees who might otherwise be ideal candidates to eventually take over the business.

“I guess they’re effective if that particular person is never wanting to buy in to a business, however, you could very much jeopardise a potential partner or owner in your business if that EBU is offered to them, because they could get very comfortable.

There are some flaws, however, in the EBU model.

“What can occur is the administrator thinks, it’s a little bit more glamorous being the lister or the sales person...it’s usually that person that causes some concern.”

“The other limitation with it too is there is nowhere to go after that. Once you’ve set that EBU up, it’s a little bit restrictive – yes, you can put another person on there but what happens if one of the three people want to have a baby?”

RENT ROLL GIANTS
Another important consideration is the size of the agency business – and the rent roll in particular – and the number of people who would be in a position to buy it.

Mr Cox says he knows of a few rent rolls in WA that, buoyed by the sharp rise in property values over the past decade, are now worth $3m to $4m.

“You’re not going to sell that to a young bloke in his thirties that wants to start an office,” he continues.

Additionally, as more principals seek to bolster their rent rolls – a response to declining sales in some markets and the need for a more stable source of recurring income, a point highlighted by the most recent Macquarie Relationship Banking Real Estate Benchmarking Survey in November 2009 – the asset becomes more valuable, and more expensive to purchase.

In Melbourne, for example, the Real Estate Benchmarking Survey found that it wasn’t uncommon for an agency’s rent roll to exceed 2,000 properties under management, and up to 4,000 in some cases.

This is particularly problematic for principals looking to exit the industry quickly, that is, within 12 months. According to PRDnationwide’s Mr Brasier, they usually learn they can’t get the value out of the business that they think they could.

“So, they end up breaking up their rent roll and selling it off, or hoping there’s going to be a big suitor that comes along and takes them over,” he says. “But that doesn’t happen very often.”

Michael Davoren, managing director at RE/MAX Australia, agrees. “If people have a really big business out there, there’s not many people that want to do that [buy a business].

“Even if it’s not a big business it is very difficult to find people out there that want to outlay reasonable sort of money to buy a business like a real estate agency. [Moreover], they’ve got to be licensed, and they’ve got to know the industry.”

FAMILY AFFAIR
Things can still be tricky for principals lucky enough to have children.

Mr Brasier says it all comes unstuck when the child decides they have no interest in working in the business.

Secondly, he continues, some parents accept that their child can’t pay them the market value for the business and, as such, they end up leaving some of their own money in the agency. This undermines what might be their retirement fund.

Mr Davoren says one principal he knows has developed a long-term strategy for handing over the business to her children.

“She is wisely staying in the business, and being involved in the property management side of it, until [the children] get to know the business. The mother is making a concerted effort to let everyone know the sale side isn’t her business now.”

He says this addresses one of the other issues that often comes up in family arrangements – the parent’s unwillingness to cede total control to the child.

“That’s something I experienced a bit myself,” he recalls.

“When I was first in real estate, I was in a business with my dad, and he wanted to exit but he didn’t want to hand anything over.

“I understand why [parents don’t do this]– they’ve spent 10 or 20 or 50 years building up a business, and they don’t want some young person coming along – even if it is their son or daughter – screwing it up in five minutes.

“That won’t happen if they go through a good transition period, and that period can be a fair while.”

Westpac’s Jason Roach adds that it can pay to also have an emergency succession plan.

This could relate to situations where a sudden illness or personal circumstance could arise. “[This includes] having your will specifically address things in your business; if you’ve got a business partner have a buy-sell agreement and, really importantly...how you fund the buy-sell agreement; business continuity plans; having insurance – all those sorts of things,” Mr Roach says.

VALUING A BUSINESS
Obviously, the rent roll is usually the most valuable asset of a real estate business. But there are numerous other things that help create value – and a bigger exit cheque – for a business.

One item that can create additional dollars is a well-maintained client database.

“If it can be shown that the database can generate a consistent number of sales over a period of time, then it becomes an asset with a real value,” says Rod White, chief operations officer and group trainer at Yong Real Estate.

But if the database hasn’t been used effectively then, according to Mr Martin, they can be overrated.

“You can have a thousand names on a database, but at the end of the day it’s what you do with that database. I think there’s a fair bit of historical clientele that’s on there that aren’t necessarily going to be putting income into an owner’s pocket within four to five years time.”

“If it was in reverse, and I was looking at a business, I couldn’t care less how many names were on that database,” he continues. “What I’d be looking for is the systems, and the manuals, and I’d want to know what the client care program is for past clients.

“I would then want to know what risk management programs or systems are in place, because I’d want to be buying into a business where all personnel are very much aware of legislation and risk management.

“I would also want to know what the training program is...and at what level. That would be very important. And I’d want to know the business plan, and the business plans from the past, and how and what’s been achieved.”

A high-performance team culture – one that embraces change – is also critical, he adds.

“If it’s a high-performance culture, I reckon that’s fairly evident. You can walk in and you can feel it and see it. That to me is getting a team that really wants to continue to improve, and get up-to-date with new marketing techniques, that would impress me.”

Wiseberry Real Estate’s Thomas Le Hoang agrees, although he acknowledges that, in some cases, if one doesn’t care about personnel retention, new values can be forced onto the business immediately.

Mr Le Hoang also wants to see each profit centre.

“Each business has its main income stream,” he says. “This knowledge can establish the following core components, for example, if a business receives most of its income from the rental department while the sales department is running at a loss, one may need to focus on changing the sales team.”

Mark Sinclair has seen how well-run and structured sales departments can generate a higher sales price for principals.

“The sales department has not been seen as a saleable commodity which is unfair,” he says. “Many businesses have profitable sales departments, and we see goodwill payable on those departments.”

One recent sale he recalls generated “substantial goodwill” for the sales department, largely due to the talented sales staff, the principal’s limited role in bringing in revenue (less than 10 per cent of sales), clear policies and procedures, and a sliding scale of commission payments.

Principals who dominate an agency’s sales are generally perceived to be the business, and as such, their departure signals to a sharp drop in revenue to would-be buyers.

It would appear the majority of principals would agree, with 63 per cent of agencies that responded to the most recent Macquarie Relationship Banking Real Estate Benchmarking Survey adamant their sales business did have a value.

Most of these respondents were based in the eastern states, where Macquarie said it was more common for sales goodwill transactions to occur.

Establishing this value was done by one of two methods, the survey found – namely, as either a multiple of profit, or as a percentage of gross sales commission.

When it came to determining the value of their sales business, the average profit multiple given by respondents was 1.75, while the average percentage of gross sales commission was 22 per cent.

EMOTION RULES
Mr Le Hoang says great care must be taken with managing what can be “unsettling emotions” during a sale process.

“One needs to avoid rumours,” he cautions.

“This is about collecting vital information in regards to the business. Frustrations and criticism will usually be made available. Without giving people too much importance, talking to people and getting their ideas about potential improvements can increase buy-in for the new business owners.

“After all, one needs to rate every staff member before dealing with any manpower change.”

Moreover, letting staff know about the change before starting on the plan can give them a clear understanding and lessen the pain of change.

Mr White agrees.

“Principals are often scared to tell their staff that they are selling the business,” he says. “In fact, they could be the best buyer. You are far better off telling people up front with a proper explanation that allowing the rumour mill to take over and create some obscure and often damaging reason for the sale.

“Do not allow yourself to believe that you can keep the potential sale a secret. You will do more harm than good if you try.”

TRANSITION
Opinions on how best to conduct the transition between the buyer and seller vary, and will depend on the type of transaction.

Mr Le Hoang advocates a swift and quick handover. “There shouldn’t be a need for the past owners to be involved after the hand-over.”

Mr Martin believes there can be a role for departing principals, when the situation warrants it.

“There should be a preparedness that the seller stays on in some shape or form,” he says. “So, for the outsider looking in, it’s a seamless transaction.

There is no dramatic change that has taken place. And then, at the appropriate time, [they should] exit out completely.

“It should be an agreed time, and I tend to think a minimum of 12 months, and perhaps a maximum of two years.”

“This gives confidence to the buyer, who might otherwise be concerned about this person’s absence and how this might affect the performance of the business.”

Westpac’s Jason Roach agrees. “In the very community-based service business that residential agents are in, there are a lot of relationships that are inside people’s heads. [This includes] a lot of the connections to the community...and they don’t get captured in a business plan.

“Having that steady changeover is a huge benefit to an incoming owner.”