How Hard can it be? – Off-the-Plan Revisited (Again!)
Welcome to 2013 fellow accommodation industry enthusiasts and let’s hope the slight feeling of confidence out there in consumer land continues to gain momentum.
If, like me, you spent your Christmas eating, drinking and sitting on your bum then I’m sure you are now looking down the barrel of some pretty ugly New Year’s resolutions. I’m going with the usual get fit, don’t be so stressed and be nice to my wife ones that have served me so well in the past. Should last at least until April.
As luck would have it as a finance person I can always restart the resolutions clock on 1 July with the start of the new financial year. Good to have a backup plan.
Anyway, on to more serious matters. I read John Mahoney’s article in last month’s Resort News with some interest. For those of you who missed it John wrote about the challenges of off-the-plan management rights transactions and the often competing interests that can be in play.
In particular John mentioned letting pool and claw back considerations. The article got me thinking that it’s probably timely to reflect on just how off-the-plan management rights are priced and sold. In these transactions most things are certain and some things are not. The manager’s unit price is set by contract and the body corporate salary is known. The costs of performing the resident manager’s duties can be calculated reasonably easily so that just leaves the letting side of the business and this is where things generally get interesting. It need not be the case.
I think with these sort of matters it’s worthwhile going back to basics rather than over complicating things. Management rights have an intrinsic value based on a multiple of net profit. That multiple is determined by a range of factors including net profit, perceived business risk, location, length of agreements, operating model and letting pool composition. As with all commercial transactions the less certainty the higher perceived risk and the lower value. With off-the-plan management rights the majority of the factors are known except the ultimate composition of the letting pool.
Given that, in most cases, the letting commission and associated charges income is substantial the value paid for these businesses is usually around 1 times NP lower than for an established management rights with historical trading reports. So all you need to do to arrive at a value is to know the ultimate composition of the letting pool and frame your contract accordingly. If the letting pool doesn’t hit the numbers you pay less and if you exceed expectations you pay more. Hence the clawback and claw forward provisions seen in a typical off-the-plan contract.
The trick at this point is to decide how much each of these letting appointments is worth. Again, it’s not that hard if you go back to basic calculations. The management rights will be sold on a multiple of a projected net profit. Remove the body corporate salary and any associated caretaking costs and you are left with the expected NP for the proposed letting pool. Apply the agreed multiple to the letting pool profit and divide by the number of letting appointments expected and you arrive at a value per appointment. That’s your dollar value for claw forward and claw back adjustments.
So far, so good. Here’s where things get a bit more complicated. On a sliding scale the business value multiple will move about depending on how many lots end up being the letting pool. At the bottom end there will be a number below which you simply would not want to purchase the business. At the top end there could be a number that generates a net profit above the multiple range agreed.
The challenge here is to frame a contract that is fair to all parties. Typically an off-the-plan will have an initial settlement and then a number of subsequent adjustment settlements as units flow into the letting pool. The final adjustment is usually between six and 18 months from the initial settlement dependant on the type of development.
My advice to potential off-the-plan purchasers is to get involved in the process as early as possible and try to understand who is buying the lots in your future business and what are their likely intentions. You should be able to work with the developer to promote your services and indeed a reputable and switched on resident manager can also be of great assistance to a developer in selling lots to investors.
Go to the sales office and present yourself as a prospective purchaser of a unit in the building. Listen to what the sales staff have to say and presume that all buyers have heard the same message. If they strongly present the development as a great place to live as an owner occupier be very careful.
I think it’s worth noting that back in the day developers simply did not factor the proceeds of management rights sales into their feasibilities and now a lot of them do. They are using these feasibilities to raise bank finance so there’s more pressure than ever on developers to maximise the sale of the management rights in their developments. In some cases the sale proceeds of the rights will represent a substantial portion of the total developer profit margin. Not ideal but a sign of times I suspect.
On a final note I couldn’t agree more with John Mahoney’s comments on vested interests attempting to influence the professional advice received by buyers. Not a good look at all and happily not an approach adopted by the vast majority of industry professionals.
Mike Phipps
Phipps Finance
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