In the second part of our rent roll series, we discuss the importance of due diligence when buying a rent roll portfolio and the pitfalls that are commonly encountered when transferring the rent roll management authorities.
Whether you’re an experienced owner of a rent roll looking to expand your portfolio or are entering the property management sector for the first time, the importance of completing thorough due diligence before buying a rent roll cannot be understated. [Read part one here].
what is due diligence?
Due Diligence refers to the process of investigating the economic, legal and financial circumstances of a business. In the context of a rent roll transaction, due diligence provides an opportunity for the buyer to check whether the claims the seller has made about the value of the seller’s rent roll are true.
the buyer’s perspective
The timing and scope of the buyer’s due diligence investigations will vary depending on the size of the target rent roll and scope of the overall transaction. It is common for a buyer to conduct preliminary due diligence before signing the rent roll contract [“the contract”]. However, the bulk of the buyer’s due diligence investigations will generally take place after the Contact is signed with a standard due diligence clause typically allowing a due diligence period ranging between 14 – 45 days.
scope of the due diligence investigations
The contract should specify the permitted scope of the buyer’s due diligence investigations by clearly stating what the buyer can and can’t investigate. The seller is expected to assist the buyer by providing access to all financial and management records of the rent roll business and the buyer is expected to maintain the confidentiality of any material disclosed during due diligence.
inspection of property management files
There is no single definitive checklist for conducting a satisfactory due diligence investigation. However, the value of a rent roll business primarily resides in the management appointments held by the seller. Therefore, the most important component of a buyer’s due diligence investigation will be the inspection of the seller’s property management files. It is generally accepted by most industry professionals that a due diligence investigation on a rent roll should include a full review of:
- the electronic and physical files evidencing the agency appointments and tenancy agreements for each rent roll property
- the electronic and physical records evidencing the entry condition report and confirming that routine inspections have been conducted on schedule
- the bond and key position for each rent roll property
- compliance with pool safety certificate and smoke alarm legislation
- all financial and management records of the overall rent roll business
We cannot understate the importance of conducting a review of the seller’s property management files. Regardless of how time consuming or costly this process may be, a comprehensive audit of the seller’s property management files must always be completed before the due diligence period expires.
This should be the highest priority for the buyer and is essential to protect the buyer’s interests after the purchase of the rent roll is completed.
benefits of a valuation
If the scale of the seller’s rent roll portfolio is substantial, the buyer should consider engaging a professional valuer to conduct an independent valuation of the rent roll portfolio. An independent valuation can provide valuable insight into the overall sustainability of the management appointments that underpin the rent roll.
Further, an independent valuation is an excellent way of assessing whether the purchase price and multiplier proposed by the seller for the rent roll is fair and reasonable from a commercial perspective. Stay Tuned – the third part of our rent roll series will focus on the in’s and out’s of rent roll valuations.
benefits of a due diligence consultant
In most cases, we encourage a prospective buyer to engage a due diligence consultant to conduct due diligence on behalf of the buyer. A rent roll is a unique business asset which has exposure to a range of regulatory and commercial risks specific to the property management sector. Accordingly, a suitably qualified professional with relevant industry experience can provide an enormous amount of value to the due diligence process.
the seller’s perspective
As part of the due diligence process, the seller will be obligated to disclose sensitive information about itself and its rent roll business to the buyer. A key priority for the seller will be to ensure this information is kept secret and is protected from unwanted disclosure or misuse by the buyer.
The seller should insist that the contract includes sufficient protections for the seller. In more complex cases, the seller may even insist on a separate confidentiality agreement to protect its interests.
transfer of management authorities
An agent cannot provide property management services if they have not been validly appointed by the property owner. In Queensland, a FORM 6 – Property Occupations [“Form 6”] must be completed in accordance with the requirements of the Property Occupations Act 2000 [Qld] and signed by the property owner before an agent can lawfully provide management services. If an appointment does not comply with the legislative requirements, the appointment is considered ineffective.
authority to manage rent roll properties
At the heart of a rent roll transaction is the transfer of the management rights to the rent roll properties. The transfer of the seller’s management appointments to the buyer is therefore key to completing a rent roll sale. Prior to settlement, the seller is generally required to provide an up-to-date list of management authorities with a warranty that the updated list is true and accurate.
approved form 6 – property occupations
Whilst using the updated prescribed form may seem like an obvious choice for most, you’d be surprised how many instances we encounter of property managements files comprising the outdated Form 20a. For the purposes of a rent roll sale, we take the position that all management authorities must be supported by an approved Form 6. In many cases, the buyer’s financier will also require that all Form 20a appointments be replaced with Form 6 appointments before finance will be approved. It goes without saying that the management authorities must be continuing appointments with no end date.
the benefits of a form 6 appointment
In Queensland, an appointment is automatically assignable if it is supported by a Form 6. In these circumstances, there is no requirement to obtain the consent of the property owner to assign the appointment to the buyer provided that the existing terms remain unchanged.
The buyer is required under the Property Occupation Act to give notice to each property owner within 14 days of the assignment of each respective appointment. The notice perfects the assignment and the notice must comply with the elements of section 113 of the Property Occupation Act.
the risks of a form 20a appointment
In limited circumstances, an appointment supported by an outdated Form 20a may also be valid and assignable. However, there are several drawbacks to relying on a Form 20a which usually results in unnecessary risk from the buyer’s perspective. Therefore, we recommend that the contract require the replacement of all Form 20a appointments with Form 6 appointments.
Form 20a appointments will often negatively impact the funding ability of the buyer and it is our experience that the buyer’s financier will place no value on a rent roll property if they are on the outdated Form 20a.
introducing the property owners to the buyer
The strength of the relationship between a residential letting agent and its property owners is critical to the success of a rent roll business. Therefore, arranging suitable introductions to allow the buyer to establish and develop a strong relationship with the property owners is essential.
The contract should set out a procedure for how the prospective buyer will be introduced to the property owners. We recommend that these introductions take place after the contract has gone unconditional with the buyer having a reasonable amount of discretion to direct what marketing and promotional material will be distributed to the property owners on the buyer’s behalf prior to completion.
In our experience, some buyers will have an interactive style of communication, whilst others will have a more conservative approach. With this in mind, the contract should be flexible enough to accommodate the specific needs of the buyer by enabling the buyer to prepare its own introduction packs for the property owners.
The complex nature and hidden pitfalls of a rent roll sale can increase the risk profile of the transaction from the perspective of the buyer. Unforeseen issues with the quality of the rent roll or an overstated price multiple are common issues encountered when transacting rent rolls. To navigate this, it is vital that the parties to a rent roll sale engage suitably qualified advisors to assist with the sale and purchase of a rent roll.
we’re here to help
If you are considering selling or buying a rent roll, feel free to reach out to us at firstname.lastname@example.org or give us a buzz at 1300BDEPOT to discuss the potential agreement and all aspects of the sale or purchase.
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general advice disclaimer
The information provided in this booklet is a brief overview of the subject matter and does not constitute any type of advice. We endeavour to ensure that the information provided is accurate however, information may become outdated as legislation, policies, regulations and other considerations constantly change. Individuals must not rely on this information to make a financial, investment or legal decision and should consult an appropriate professional before making any decision.