It is becoming increasingly clear to me that a lot of letting businesses are not going to survive the tenant fee ban that is due to come into force next spring. The businesses that seem destined to fail are the let-only businesses, many of which were set up by residential sales agents in response to the sudden drop in house sales that followed the financial crisis of 2007/2008.
These agents did not want the hassle of managing properties so they encouraged landlords to instruct them on a let-only basis. With no experience or track record to offer, they were forced to sell their service on price alone and many charged fees of just 4 or 5% of the annual rent for a tenant find-only service with no renewal fees.
They quickly found that it was impossible to make a profit from such a low fee so they started to make up for their low fees to landlords by charging extortionate fees to tenants. Many of these firms are currently earning 30% of their fee income from tenant fees.
The maths for a typical small let-only business might look like this:
- Average rent – £7,500 per annum x 4% fee to landlord = £300 fee
- Other landlord set-up fees = £300
- Tenant fees = £300
- Total income per property = £900
Let’s assume that they now turn over £150,000 per annum and make a profit of 20%, i.e. £30,000 per annum from letting 167 properties per year. After the tenant fee ban, they will lose £50,000 of income. They will not have the selling skills to increase their landlord fees by 30% so a £30,000 profit becomes a £20,000 loss. A business such as this therefore simply cannot survive.
Contrast this with a well run managed business. From the same 167 properties with an average rent of £7,500 per annum, their income will look like this:
- Average rent – £7,500 per annum x 10% management fee = £750
- Other landlord set-up fees = £300
- Tenant fees = £150
- Total income per property = £1,200
From the same 167 lettings, this firm will earn income of £200,400.
However, the differences don’t stop here. Statistically at least half the tenants will stay on for a second year, so the landlord will pay a further £750 in management fees. This produces another £62,625 of income. And half the tenants who stay on for a second year will stay on for a third year which produces £31,312 more. From the same number of properties, the managed agent therefore manages to earn £294,337 per annum. Of this, tenant fees comprise £25,050 which is just 8.5% of turnover.
Generally speaking, the long-established managed letting firms also have a better service to sell and better selling skills. This means that they are far more likely to be able to pass on the extra 8.5% onto the landlords who will in turn recoup the extra charges by charging higher rents to their tenants.
The largest and most sophisticated firms are already planning an even more sophisticated response to the tenant fee ban. I can’t give details yet due to commercial confidentiality but in essence they are planning to offer a range of additional services to both tenants and landlords. The commission earned from these services should be enough to compensate for the impact of the tenant fee ban.
Interestingly, a number of large firms are also reconsidering whether they will be prepared to offer any landlords a let-only service in future on the basis that without the tenant fee, the service will no longer be profitable. This will be a massive change for the letting industry to get to grips with.
The mathematical analysis that I have set out above has led to a huge drop in the value of let-only businesses. Before Brexit and the announcement of the tenant fee ban, a let-only basis was worth perhaps two thirds as much as a managed business with the same turnover. Now, let-only businesses only sell for half as much as managed letting businesses and their value is still falling.
So, if you own a let-only business, what can you do to stave off disaster? In my opinion, the only permanent solution is to persuade your let-only landlords to switch over to a rent collection service either immediately or next time there is a change of tenant. It is not easy to do this and it will take you several attempts to persuade some of your landlords to make the change but many of my other clients have achieved it successfully and the profitability of their businesses and their capital value has been improved significantly.
We probably have about nine months left under the tenant fee ban comes in so the time to start implementing these changes needs to be now.
Adam Walker is a management consultant and business transfer agent who has specialised in the property sector for more than twenty-five years.