Credit providers have become increasingly focused on understanding what drives behaviour and credit risk in specific industries, and setting lending policies accordingly.
There are now a number of established policy guidelines across traditional service industries such as Real Estate Agencies, Financial Planning, Finance Broking, Insurance Brokerages, Legal Practises and Accounting Firms.
If you are involved in these industries, funding growth via acquisitions or expansion, or to help in succession planning, is a viable option to explore.
Real Estate Agencies
SMEs in the Real Estate Services industry primarily appraise, purchase, sell, manage or rent residential or commercial property.
Accordingly to IBIS World data, there are around 43,000 businesses in the industry with combined Revenue over $30 Billion and circa 125,000 staff. Not surprisingly, the industry has undergone considerable growth in recent years. Along with the strength of property prices, the availability of credit and other demand-led factors have seen valuations climb materially.
Like other professional service firms, these businesses often have excess capacity and are chasing a better recovery of fixed overhead costs. Therefore, they often need to acquire new people to meet growing demand for services.
Despite top-line growth, many in the SME Real Estate Services industry haven't always translated this into sustained profitability.
Tomas Oliver, Brokerage Advisor at Real Estate Dynamics, sees a wide range of operators in the Real Estate Industry. "The participants are diverse. We have been involved with some great operators that have made acquisitions and successfully integrated these into their business."
Though there is always room for improvement.
"Multiples remain strong, and on the whole banking support remains in place. This said, so many Real Estate Agencies miss the opportunity to also leverage their profits and entrench their market positioning," says Mr Oliver.
Lender Appetite - Real Estate Agencies
Banks have grown their appetite for lending to Real Estate businesses. Historically, this has been based on the nature of recurring revenues through property management services (Rent Rolls) which builds confidence in the continued ability to service debt.
In terms of participants, ANZ, NAB and Westpac, plus other providers such as Macquarie Bank, Judo Bank, Bendigo Bank, Bank of Queensland, all have policies in the category.
Debt Strategies
Real Estate Agencies as a cohort don't have a track record at being great at administration matters, as (let's be honest) they often don't get across the detail. As a result, success in managing money and debt typically embraces the following strategies.
- Match the loan term to the period in which benefits are generated.
This is always true for acquisitions or expansion in the REA sector. The benefit generated by the acquisition is unlikely to sustain forever, despite good management. A longer-term P&I facility is usually a better option than an interest-only term, followed by aggressive amortisation.
- Consider the security profile and how it links to credit terms.
One of the positive things about borrowing in Professional Services is the ability to borrow without tangible security such as property or varying levels of guarantees, etc. However, make sure the nature of the security provided fits the resultant impact on price and/or terms.
How much can I borrow?
Lender philosophy has advanced in assessing professional services firms, including Real Estate.
Typically, this is based on a percentage of the valuation, which historically focuses on the recurring income of the Rent Roll. Financiers will consider the strength of other cashflows but Rent Roll quality remains the critical factor. This percentage has historically floated at around 50% but can nudge higher for quality assets.
So what are these Worth?
According to Mr Oliver, "There are lots of buyers, not as many sellers. Like much of the investor and business community, there are a lot of 'cash resourced' or 'finance approved' looking for opportunities. Historically we see valuation multiples of around 2.75 - 3.25 recurring income, though market values are being tested with demand factors."
When talking with the bank, it is important to determine what the actual income is to use for loan servicing. EBITDA is the most familiar measure, but what about adjusting for a market salary for the owners? When putting in a market value of the Owners' contribution this can change this number materially. This is what we call EBITDAO.
Once the income is normalised, borrowing limits are generally based on the following guides:
1) Maximum loan amount to be less than around 2.5 - 3.0 times EBITDAO
2) Interest Cover Ratio (ICR) of 2.25 - 2.5 times
3) Maximum loan amount to be less than 50-65% of valuation as above.
Lastly, it is not just the size of the Revenue/Earnings but the quality of it that is important. The latter will drive the attractiveness for both lenders and prospective buyers.
Our Professional Services Industry Lending Guide can provide more insights.
Contact MCP
1300 510 816 or your Finance Partner
enquiry@mcpfinancial.com.au