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Venturing into the commercial side of property

Monday 26 March 2018

Many agents say they know nothing about the commercial property sector and that it is not something that appeals to them, but as the following case study from NAEA Propertymark member Richard Hare shows, it can be a viable alternative profit centre.

In a single office, located in a medium sized market town in the East of England, a company partners describes how a shift in practice overhauled their business in just 12 months.

“Our practice has been going for almost 30 years. Founded by my father, we concentrated on residential sales, expanding in the early 1990’s into residential lettings and property management. This expansion was as a result of the increasing demand for rental property, and I suppose we are no different to many traditional sales agency firms who have taken that same route. We are a now a two-partner practice with 10 members of staff, with an almost even split of work load between sales and lettings management. Our management portfolio comprises almost 300 properties, which provides a steady and reliable income stream.

“As with most practices, it is important to control costs but also important to increase revenue where possible. Our turnover and profitability whilst good, has remained at a similar level for some time. Two or three years ago we felt that we were reaching the point where it would be difficult to increase income (and profitability) without either merging or amalgamating with another practice, opening another office, or looking at other sources of income, such as surveying or commercial agency.

“Typically, we did nothing until the ban on letting agent fees seemed like a realistic outcome. On analysing the figures from tenancy fees, the effect of the slow-down in the buy to let market and the fact that there were fewer landlords out there, we realised if we continued to do, nothing we would have to make at least two members of staff redundant just to recoup anticipated losses.

“I think what clinched the decision to go into commercial agency was that over the years we'd had a number of landlord clients who also owned commercial properties, who asked us for advice, and we had to turn them away as we had no real expertise in this sector. And whilst we were dubious about going down this route to begin with, ultimately the commercial sector is still agency, it's just a slightly different product.

“We decided to market to the smaller landlord who had a handful or commercial properties, some of whom were existing clients. There was no way we could compete with the large national firms, or the better regional ones, so we thought it best to target our existing client bank to build up a stock of commercial property to both manage and sell/let from both recommendations and through a focused marketing campaign. We also decided to stick to our “patch” which we know well and look at no more than a 10-mile radius from our office. It was thought that going further afield would bring more problems than benefits.

“Whilst I won’t go into the mechanics of the set up, I would stress that you must inform your PI insurers that you are doing this type of work, and mention that both my partner and I went on a number of the NAEA Propertymark courses aimed specifically at commercial agents which were incredibly useful - but I will come on to some of the benefits later.

“Commercial agents fees do tend to be higher than for residential property. Our average sales commission is 1.5 per cent (+VAT) whilst our letting fees are on average 10 per cent of the annual rental achieved. We also have a minimum charge of £1200 (+ VAT) for lettings, as we tend to deal with mainly “secondary” properties, many of which have a rent of £6,000pa to £10,000pa - which at 10 per cent would mean a fee of £600 to £1000. For the work involved this is not a viable return, and we have been told by other commercial agents that a letting or lease assignment of a property rented at £8,000pa is in many ways more difficult than one let at £50,000pa, as tenants in lower rented properties require much more hand holding. We have also found that commercial fees tend to be much less negotiable than those in the residential sector, not least because there are fewer commercial agents in the market, so there is much less competition. We have also found that we can charge withdrawal fees and recover marketing expenses to commercial clients, which helps us to recover most, if not all, of our costs. This is on the basis that many clients are businesses, and they can legitimately include these as a business cost in their annual accounts.

“Similarly, we have found that our commercial management fees average (net) 10 per cent of the gross rents collected, which given most commercial property is let on full repairing and insuring (FRI) leases, means that the tenants carry out all repairs and our maintenance team do not have to spend their time chasing up contractors to repair broken boilers or leaking taps! They simply give the tenants the relevant contractor’s contact details and suggest they contact them directly to resolve the problem, which saves a lot of time.

“Our initial budgeting was to achieve between 12 to 15 lettings in the first year at an average net fee of £1500, producing £18,000 to £22,500 and six sales with an average net fee of £3,500, giving total sales fees of £21,000. We actually achieved nine lettings/assignments and three sales, producing total income from commercial sales and lettings of £24,000.

“We also budgeted to gain 10 to 15 new managed property instructions, acting for primarily existing residential landlord clients, and now have 11 commercial properties in management. These have a total rent roll of £92,000, producing (net) management income of £9,200pa, with the possibility of a small portfolio of seven more commercial properties to manage in the next tax year with a rent roll £62,000 a year, meaning another £6,200 a year in fees.

“I have also acquired two properties for clients, as property acquisition is something commercial agents also do. Some of our landlord clients are constantly on the lookout for new properties, and as commercial agents email details of investment properties to other commercial agents, it pays to be added on to the mailing lists. Again, fees for this type of work are usually between one and two per cent of the purchase price.

“The second property I bought for a client was purchased at £350,000 with my net fee being one per cent (£3,500). I’m half embarrassed to admit that this was an easy fee to earn, as all I did was forward the property details to my client, arrange a viewing via the agents, discussed the property with the client (including my opinion of the value), made a tentative opening bid to the selling agent and eventually agreed the price. In total this took no more than three hours as the negotiations were not drawn out, and so the net fee represents over £1,000 an hour. Whilst I accept that this was far easier than many future transactions will be, it shows that acquisition work can be very lucrative.

“In summary our income in the first year of venturing into commercial property amounted to £24,000 in sales and letting fees, management fees of £9,200 and acquisition fees of £5,600, totalling £38,800. As a practice we are very happy with these figures, and whilst it has been a steep learning curve, we are aiming to achieve a turnover from commercial fees of £75,000 to £80,000pa by the end of year three, which is next year. We are on target to reach £55,000 to £60,000 in fees this year and are steadily building up a stock of units to let/assign or sell and increasing our managed portfolio.

Now a legitimate department in its own right, existing clients are delighted we can assist them with their commercial interests and have no need to go elsewhere. There is no doubt the first six months were incredibly frustrating and slow whilst we tried to build up a stock of properties, as well as establish ourselves not only with our existing client base, but also other property owners, investors and tenants. Initially we had to allocate a fairly large budget for marketing, but this has paid off, and we are now better known for undertaking commercial agency work.

“The next step is to consider carrying out rent reviews and lease renewals for our landlord clients (and indeed other tenants with who we are not currently connected, as both landlords and tenants need this type of representation) but this is a specialist area and we feel that more training is needed. Whilst we have very little competition, we recognise that we will have to keep fighting to raise our commercial profile and make those with commercial property interests aware that we are here, and here to help.”

“Hopefully by sharing this with you, you will realise that commercial property agency is a viable alternative income stream which could go a long way to replace reducing income from elsewhere. It has been hard work, but the move into commercial has made us as a firm realise that being diverse is the way forward. So, what’s next for us? Who knows, maybe auctioneering and a survey department?”