House prices go up and down all the time but usually the fluctuations are quite gentle. In most years, the change is just a few percent up or down. A boom such as we are having right now means a 10% rise and a crash such as the one that followed the 2008/2009 financial crisis means a 20% fall.
Rents are a little more volatile. A crash such as the one that we saw during lockdown meant a reduction overnight in inner city rents of 20-30%. A boom such as we are seeing now means that rents have risen by the same amount.
The value of estate agency and letting businesses is, however, much more volatile. After Lehman Brothers went bankrupt, the value of a managed letting business halved overnight and the value of a residential sales business fell to almost nothing; but interestingly the recession in the housing market was quite short-lived especially in London and the South East, and house prices, rents and the value of both letting and sales businesses quickly recovered. In fact, they soon exceeded their pre-financial crisis levels.
The day after the Brexit Referendum vote, the same thing happened again. House prices fell, rents fell and the value of both sales and letting businesses dropped sharply. As a consequence, every single business sale that we had in our pipeline fell through the following week which was very frustrating for me and heartbreaking for our clients who had been looking forward to their retirement.
The most interesting part of this story, however, is that whilst the value of a letting business recovered quite quickly, the value of a sales business has not and even the best run and most profitable sales-only businesses are still selling for less than half as much as we were getting for them five years ago. Most are still selling for little more than the value of their pipeline.
After nearly two years of strong trading, the value of a sales-only business should have started to recover by now but it has not and in my opinion sales-only businesses are currently seriously undervalued.
The view of most of our buyers is that a managed letting business offers a good secure recurring income stream whilst the income from a sales business is transactional and can stop at any time. This might happen because a talented manager or owner is replaced by a mediocre one or because a new competitor opens up and takes market share. However, it can also happen due to factors that are outside the business owner’s control such as another lockdown or a big rise in interest rates. This is true but well-run sales businesses have proved themselves to be remarkably resilient.
In previous downturns in the housing market, well-run sales businesses have maintained their profit margins by increasing fee levels, winning market share and by improving their efficiency. They also cut their costs. The salary bill alone for most estate agents is 40-50% of turnover so prompt action can cut running costs by 20, 30 or even 40%.
Another factor that is often underestimated is the value of the data that forms part of the sale. Most residential estate agents will have records of vendors, purchasers, valuations that did not come to the market and withdrawn instructions that go back many, many years. If this data is properly managed, it can yield very significant amounts of new business.
Finally, there is the value of the trading name. Many trading names have been in use for decades. I remember an agent in the town where I grew up which went bankrupt in the crash of 1988. Twenty years later, the owner’s son reopened the business under the original trading name and became the market leader within a year. I don’t think that this would have been possible if he had opened up under any other name.
Some of the people who were brave enough to buy letting businesses in 2009 or 2010 have seen the value of the businesses that they bought more than double. I think that there is an opportunity for smart investors to achieve the same returns from buying sales businesses at a time when they seem to be out of fashion and so undervalued.
A managed letting business is currently selling for five or six times as much as a sales-only business with the same turnover. This is the biggest disparity between the two sectors that I have ever seen. Sales businesses do therefore seem to be extraordinarily good value and I will return to this subject in eighteen months’ time by when events will have proved whether my view was correct.
Adam Walker is a management consultant and business transfer agent who has specialised in the property sector for more than forty years.