In Engines of Wealth I discuss at length how to interact with real estate agents from a buyer’s perspective, but when considering them as a tenant and agencies are one of my preferred tenants, there is a twist. When considering the viability of a real estate agent in your shop first you need to ascertain if they are among the 90% that sell residential properties only. Remember the catch-cry “Location, Location, Location”, all areas are not equal and if your shop’s neighbourhood is not providing attractive prices or has too much competition then a real estate agency may struggle.
Let me expand using an example, the average cost for a home in Sydney’s elite Double Bay is an eye-watering $4,000,000, compare that to an agent selling a property in Sydney’s West – Campbelltown where average prices are $650,000. Clearly if both agents charged the same percentage commission their returns would be far different.
I have a few real estate agents as tenants within my portfolio, two Ray White’s and LJ Hooker. Others like McGrath, CBRE, Savills, Burgess Rawson, Century 21 and The Professionals have fundamentally similar operating models.
The attached interview was conducted with one of the above franchise owners and provides insight into the financial operations of a local real estate agency. Understanding the business dynamics, competition (including online) and the surrounding area average house prices is key to understanding how many homes they need to sell each year to pay the rent, wages, expenses and make a profit for the Principal. The following questions provide some insight into an agency’s operation:
What do you charge as a commission on the sale of a property?
“At present I’m lucky if I can get 1.5% commission, more often than not people are shopping around and 1.1% commission rates are common place. I’d say the majority of my sales are between 1.1 – 1.25%.”
This is a nice beach side location what are the typical sale values you see?
“The area has an extremely high ratio of units versus houses, so we tend to list more units for sale than houses – I’d say 60/40 would be the split. The good news for us is that units here are expensive, two-bedroom units range from $750,000 up to $1,200,000 depending on views and proximity to the beach. A three-bedroom unit will sell for $1,200,000 – $2,000,000 depending on the views and beach access. I’m always delighted when we do list a house for sale as houses in this area range from $2,000,000 up to $6,000,000.”
How many people work in the business?
“I am the licensee and I have one other sales representative that works with me. We each have a full-time assistant to follow up leads and help out with marketing and other demand generation activities. All up we have 4 people in the business.”
How many properties do you sell each month?
“One to two properties a month is what we’ve been doing. We do get our stand out months where we can sell three or four properties in the month, we need those stand out months to reward all the effort and weekends we put in.”
What has been your best month and how many properties did you sell?
“Actually, last month, May was the best we’ve ever done, we sold 8 properties. I’d love another month like that.”
How much does your franchise chain take out of your commission?
“They take 8% of our commission, so a property we sell for $850,000 at 1.1% commission we take $9,350 in commission. We pay our franchise partner $748 (8%) leaving us $8,602 to put to the operation of the business.”
Do you generate revenue from managing rental properties as well?
“No not at this stage, we are relatively new to the area and initially we are just focusing on sales. I do intend to expand the business into property management down the track, but have not taken that step yet.”
I note your office is upstairs, I take it the rent is cheaper than prime retail street front exposure?
“Correct, rents on the main street are double what we pay for this upstairs office space. There is an argument that having retail street front exposure attracts more listings and elevates your presence but I needed to balance that with actually making a profit. I find that this office works really well for us. I’m always focused on our brand and I find the big levers are advertising in the weekly Domain, letter box drops and internet campaigns. Today digital media marketing is changing the landscape of a traditional business model that relied on a street front presence.”
How much is your rent?
“$35,000 per year plus outgoings.”
There are a few important tips on the business viability in these responses that you should investigate if you are considering a real estate agent as a tenant. Looking at the finances of this real estate business shows it can be feast or famine from one month to the next, winter to spring. The key challenge for a business is managing the cash flow as takings are not linear and depend on monthly sales and the proportion of high net worth properties sold. In my interview I believe a conservative assumption on sales numbers would be 24 properties a year, that’s two a month. When estimating an annual commission realised by this business it is important to make assumptions and remove the variables. Taking a conservative approach, we will assume the following for the 24 sales per year:
- 15 unit sales at an average price of $900,000, using a 1% commission after subtracting the franchise fees produces a return of $135,000
- 9 house sales at an average price of $2,500,000, using the same 1% commission after franchise fees leaves $225,000.
Therefore the total commission generated from a year’s selling would be around $360,000 annually.
Now removing the business expenses, the rent at $35,000 per annum, outgoings including Council rates, water rates, insurance, maintenance, stationary and electricity deducts a further $20,000 a year. Let’s also factor in the two office assistants subtracting another $45,000 per year for each assistant. That leaves $215,000 in net profit to be split between the licensee and the sales representative. This produces a conservative salary of about $125,000 for the licensee.
Considering the longevity of the business type and that over time with a better community reputation real estate agents will grow. Then they will expand to add a rent book to their business which generates a more stable rental income. We can conclude that $35,000 per year for this real estate agent in annual rent is manageable to provide a living with the potential for a healthy annual profit in the future. The considerations we have outlined above should form the basis for your questions when a real estate agent is interested in your empty shop or when talking to a tenant in a building you are looking to purchase.