In this live audience Q&A, Chris talks about the difficulties of scaling the guaranteed rent model, the impact of VAT, the management model, the 90-day rule in London and the impact of Section 24 tax changes on serviced accommodation.
Show Notes:

The Serviced Accommodation Podcast is a show brought to you by Chris Poulter and Ritchie Mazivanhanga aimed at new and experienced property investors alike. With each show we help you Start, Systemise and Scale your Serviced Accommodation Business.

If you would like to ask us a question or discuss anything in this episode, please join our Facebook group and ask away. To listen to more episodes or get more information go to www.thesapodcast.com.

 

Transcription:

 

Hi I’m Chris.

Hi I’m Ritchie.

Welcome to the serviced accommodation podcast.

Hi this is Chris and today’s episode is part one of a Q and A session which I did in London a couple of weeks ago. Hope you find it useful.

Who would like to kick us off with a question or topic to talk about, anything along those lines. Got one at the back. Phil is it?

Q: Yes. I was just going to ask about what you just said about the rent to rent not being as scalable because I guess it’s because of the cash flow around rent to rent versus VSO, is it cost to cash flow ratio, is that why it’s not as scalable?

A: Yes. So probably the biggest issue around is the VAT, because so many people were doing deal analysis and not taking the VAT into account. So there are two big costs which are going to have while you scale your business which you don’t on your first deal. The first one is going to VAT; the second one is going to be management costs. So for your first deal yeah you might be quite happy to kind of talk to customers and run around doing this doing that. But by the time you go up five 10 15 and some 20 maybe then you need to employ people and that’s going to be a cost. So actually you need to take that into account when you do your deal analysis and put away a little bit money to make sure that that happens because if you don’t, what you thought was your profit margin you might just be paying for someone else to run it for you and there’s no money left for you. Yeah. So that’s really important.

The fundamental issue with the VAT is that normally when we’re looking at rent to rent models there’s a lot of costs involved. You know we’ve got we’ve got rent to pay, we’ve got booking.com, we’ve got cleaning fees. All of these things really start adding up and take out a big percentage of the turnover. So a lot of the models I see for people with no VAT are operating at maybe around 25 to 30 percent as a profit margin.

So if you had a £1000 coming in you’d be looking at £250 to £300 as being your kind of gross profit if you like before you pay your overheads. Yeah. So if that’s with no VAT at all it’s not hard to see that when VAT comes in and it’s going to take a good couple of hundred quid out of that. It’s not leaving you with a whole lot left and you start looking at all the money you have to put into that deal to get that return. It starts to make a lot less sense and this is why when you look at your model you need to be very careful around it because it might look great on paper but once you start to delve into a bit deeper and you put some money aside for management costs, you’ve taken into account what VAT level you’re going to be running at when you scale your business at what level you want it to be. And it might suddenly not look so great.

Q: Sorry the VAT level? Is it VAT?

A: Sorry. What I should explain is I’m also very good, I’m also a very big proponent of using the flat rate scheme which essentially is a simplification and you pay a lower rate but you’re not able to claim anything back. So when I talk about VAT levels, Thanks for pulling me up on that, you might start off not being VAT registered, then you might hit the VAT threshold and in order to minimize your VAT bill you might register with flat rate VAT but that has a ceiling and that ceiling is £230k a year. So for most models by the time you get to 10, 15, 20 units you’re going to be way over that ceiling. And then you’re going to have to register with standard VAT which like you said it’s 20 percent.

It’s very important to take that into account from day one. But you contrast that with some of the other models I mean the management model is the one I use within my business and that’s a lot more scalable because you don’t have the same level of overheads which you have with the rent to rent business. Most of the money which is coming in can then be your profit margin and because you’re only invoicing out your management percentage as opposed to the entire turnover each month, it means that you could get a lot more properties before you even need to worry about VAT. So in our particular area again I was saying to someone earlier if you had more than two properties on rent to rent for typical two bed you’d hit the VAT threshold and that would wipe out a reasonable chunk of your profits whereas on the management model we could be managing 14 properties before we hit the VAT threshold.

Q: And your area is?

A: Southampton’s but it’s something which we typically see in a lot of different areas is that kind of once you, once you start to scale, once you get VAT involved, you might look at the percentage and go you know there’s more money in running it on a management deal than there is with having it as a rent to rent deal where I have to pay VAT.

Q: So can I just clarify that? I’m just a trying to be a bit thick here. And the reason for that Chris is because you’re the man, you’re doing the management service and it’s the owner who is effectively the operator of the business and it’s their business and they don’t reach the, they can reach the threshold or fifteen of them have to reach the threshold? That’s why management model is as better, is that right?

A: That’s right because you can be working with a bunch of different people and each one of them can have a different VAT status so you might have a load of small landlords who you work with. And they’re not, they’re not that VAT registered, you might have someone who’s got a smaller block that might then be flat rate. But it means that each of your properties which you’re working with, they’ve got different status because essentially you’re just a letting agent for serviced accommodation.

Yeah I think for a long time I was a little bit snobby about that because I had this phrase I used to say it’s like well I don’t want to just be another letting agent –no offence!

Because it’s like no I want to build my own assets and businesses and everything like that. But when you look at it in the cold light of day and you go, I can potentially make more money on this and I don’t need to put any money into the deal and there’s a lot less risk and the final benefit I see around the management model, and this one is a really big one for me – with rent to rent the seasonality of your income is based around the profit, right? So when its summer and you’ve got loads of guests in, everyone in the room is happy, I see lots of smiling faces. Who had a smiling face back in January. Put your hands up? Anyone- no! January rubbish right? And if you’ve got a rent to rent business you might be kind of trying to break even in January because it’s one of the crap months.

But breaking even means there’s no profit so what money are you going to live on? If you’re building a business around that how are you paying your employees? How are you paying your office? How are you paying your overheads?

With the management model your income is based on the turnover and not the profit. So if sales are down 20 percent in January, yes your income might drop 20 percent but it’s not going to drop to zero. So for me as one of the big benefits when scaling a business that’s really fundamental because if you are scaling a business you are going to have offices, you are going to have employees and you’re going to have those monthly overheads which I was talking about before which if you’re not careful with them they can really get in the way of running your business.

Q: This links back to your comments about scaling up the business which is a good point but my point to you then is you’ve got the 90 day rule in London. My question is then, is it scalable given you’ve got that restriction? Can you scale up? Can you ever scale up in London?

A: It depends, depends on your attitude to risk. I mean you talked about the 90 day rule before but I think it’s quite a hot topic and I can maybe have a quick look at that? Is that useful?

So. Again talking about this earlier because it always comes up with the 90 day rule is that it’s specific to greater London but it does cause a lot of headaches with what people are doing because while some boroughs enforce it quite rigidly you know Westminster, Camden being a couple of examples. There are other boroughs who aren’t really that bothered quite frankly. And typically as a general rule the more central they are, the more they’re going to be really sharp on these things and the further out you go from the centre, the more likely they are to be relaxed about it. Of course that’s a bit of an issue because the closer you are to the centre, the more demand there is and the higher rates you can charge. Because the second issue I see around operating serviced accommodation in London is that the rents are really high – especially when you come from Southampton!

So you really need to be charging a premium nightly rate in order to make your figures work, you know £150+ a night to really get some good numbers out of it. And it’s kind of hard to do that around the edge.

So in terms of when we look at okay, how do you turn this into a scalable business in London? Well there’s a couple of options really. You know you can just ignore it but you’ve got to understand the risk you’re taking and you’ve got to be comfortable with that risk. It’s a risk reward thing. And if you’re happy and comfortable with that risk then that’s absolutely fine.

But some of the other things that you could do someone mentioned Tonya earlier. And she was, I think she was talking before about doing the longer stays you were saying. She was one of my mentees and we kind of worked through it with her. She’s very risk averse, she wants to do everything by the book and she also wants an easy life and I’m with her on that! And one of the things that we looked at was what about these longer stays and while they might be hard to find through the traditional channels like Airbnb and booking.com, if you can build up corporate relationships or maybe with embassy’s, language schools, these kind of places which have longer term accommodation requirements. Then actually you can build a business model around that and the thing is was the 90 day rule is as soon as the stay goes over 90 days it’s not a problem.

What a lot of people are looking at now is in building up a model where you’re taking mainly these longer stays and maybe just filling some gaps in the middle and that way you know you still got 90 days a year to do it.

So another way you might deal with that would be to go down the management model. Because you’re not saying the problem isn’t there anymore but you’re saying I’m basically an agent acting on behalf of them. It’s their risk you know, I’ve made them aware of the risks and if they’ve accepted that and signed the papers to say they’ve accepted that then ultimately it’s up to them right.

Financially, when you’re running the management model there’s not going to be any major impact to you if there’s an enforcement notice and you need to shut down the property as opposed to with rent to rent where you might get your deposit back but you’ve got a bunch of furniture you need to do something with, you’ve got future bookings which are all in your name and you need to do something with them and financially that can be quite a big impact when you have to shut down a property.

Q: Have you crash tested that? I mean has anyone come to you when you’ve appointed the owner and not made a deal around that and things have been taken to court?

A: No, we don’t operate in London and the reason being that I’m not happy in my own mind in the best ways to get around that kind of 90 day rule really because the problem here is that one of the answers could be well go and apply for planning. But I’ve done quite a lot of looking through planning submissions because I’m that exciting and it’s the best place to find deals but that’s another matter!

And you know what. I haven’t really seen any existing residential property where they’ve allowed a change of use to allow shorter stays. The reason for that is virtually all the councils are looking for residential stock and they won’t allow loss of stock.

Then on the 90 day rule so yeah basically your options are ignore it, apply for planning permission and pretty much have it turned down, go for longer stays, do management or do something outside London. That’s pretty much your list of options on there I would say.

Q: You said that, if I understood you right, you said that you prefer management and letting agency style business rather than rent to rent. One thing you said was you don’t want to be just another letting agent?

A: Yes, that was that was originally my attitude!

Q: What I was going to ask you was what constitutes a management company or letting agent that’s not just another letting agent?  What’s the pitch if you like and from which I’m trying to learn, what are the things that you do that make you stand out versus other people?

A: So I think when I started off I very much wanted to kind of build up an asset base with what I was doing but doing that through serviced accommodation as we know with the mortgages et cetera et cetera can be a bit of a pain. We had a couple of purchased deals going through, one on a convent interestingly enough and that was a bridging and they were taken more than five months just to sort out some basic terms on a bridging loan. So while I kind of started doing this as an asset base strategy it quickly became clear that it’s probably not the easiest strategy to do as an asset base strategy.

So once that started to switch round to okay this is our cash flow strategy then your criteria is really around how can you generate the most cash flow in the easiest way. And that’s where the management model started to become a lot more attractive because I always think two of the biggest barriers to growth are around finance and are around deals. So can you get enough money to fund everything you’re doing? And can you get enough deals to actually keep up the rate of expansion that you want? Yeah.

Now with the management model again the finance it’s kind of taken out completely really because you don’t have any costs bringing on a new property and in terms of the deals well you’re offering a lot of value to people right. You are able to let them make a lot more money out of their property. But not have to do anything for it so because you’re offering that kind of value you start getting people coming to you going oh can I work with you on this? Can I work with you on that?

Q: Do you offer the owners more rent than they would get if they were letting their property on AST?

A: Yes and no. We’re not giving, we’re not doing guaranteed rent so we’re not saying you’d get £700 a month but we’ll get £900 but we’re saying yes that we’ll manage it for you, the money will be go up and down but for a £700 a month property, it’s likely to be – whatever the range might be – £900-£1200 a month, might be more, might be less, that kind of thing.

So yeah absolutely, that would be one of the things.

Section 24 was touched on as well in terms of being a big benefit and actually with what we do with our management business, most of our acquisition strategy is based around section 24. So we want to expand quickly and quickly means blocks. So our acquisition strategy is finding landlords who own blocks in their own name and they’re worried about Section 24. And it’s the easiest conversation ever because you just say did you know that we can sidestep section 24 for you straightaway in an HMRC approved way and they go right where do I sign? Let me tell you about it first! Okay because a lot of the time they haven’t heard about serviced accommodation. They certainly don’t know that this is a method that they could use to have a positive tax impact. And so that can be done, that is what we do as our main acquisition and growth strategy because it’s a real big opportunity.

Q: So if you’ve got no mortgage does Section 24 come into play?

A: So if you’ve got no mortgage then obviously section 24 is kind of irrelevant to you.

Q: Did you not say you target people with?

A: Oh sorry, they own it in their own name as opposed to kind of in a limited company. So they would be affected right.

Q: And I thought that you, when you talk about managing its sort of like a few steps, what do you actually do?

 

A: Yes, thank you. So the essence of the management model is like I say you’re essentially a letting agent for serviced accommodation. And you say that okay rather than paying you a certain amount of money or be paying based on the profit what I’m going to do is manage the property for you. Let’s say £2000 comes in in a month, I’m charging 20 percent, so here’s my invoice for £400.

And it’s that simple, it kind of takes away a lot of the risks like I said, the seasonality of the income is much better and all the other benefits we kind of talked around that. So rather than having to find a deposit, furniture money, first month rent, all these kind of things to go and do a rent to rent deal; your finance costs are down to zero because you’re managing it for someone, they’ll have to spend that money but it’s their property so they’re the ones spending the money.

Q: So it’s a letting agent for serviced accommodation people?

A: Yes, absolutely. That’s the bottom line.

 

Q: And the revenue? You charge the fee? The pricing structure of yours is roughly twenty percent?

A: Yeah. I mean it’s very area dependent because if you think about it, if you’ve got an apartment in Stoke or you’ve got an apartment in central London. In terms of your overhead costs for software, phones, people to actually talk to those guests, they’re going to be pretty similar right? But as a percentage in Stoke compared to London that’s a massive difference because 10 percent in Stoke might be £150 quid, 10 percent in somewhere in central London might be £500.

So what we tend to find is that the percentage will vary based on the area. London it might be anywhere between 12 and 18 per cent

Q: Plus the VAT?

A: Plus the VAT yeah. And you know for the “provinces” as we might say outside of London, kind of 15 to 20 percent is a typical amount on it.

Q: So you have like a chart, a rate chart for each client? For the same area different clients might have different rates?

A: We try and keep it consistent yeah, you’re less likely to run into issues but certainly going into a new area you’d look at it and go, does our existing pricing structure work? Because what we found is that going into some kind of higher value areas the 17.5 percent we charge in Southampton just doesn’t work because then there’s no money left in it for the actual owner of the building so you have to adjust accordingly.

Q: And the cleaning fees and everything? You are an SA right, not a rent to rent? So the cleaning fees and everything is added on top

A: Yeah. So basically the percentage that they’re paying is purely for the management so talking to guests, you know arranging not paying for cleaning, you know liaising with the maintenance staff, taking all the payments, all that kind of thing. So every cost on top of that the landlord is still paying for.

Q: And how much is the rough fee in a month or?

A: Again it depends what kind of systems you’re using, if you’ve got employed staff, self-employed. It’s theirs. Yeah. Again this is this is why I say with the management model you have as little overheads as possible because like I say the more overheads, the more risky basically.

Q: How does VAT come into play in this? You just said 18% plus VAT?

A: Yeah. So if you’re charging a percentage as a management agent then at some point you’re still going to hit the VAT threshold at which point you need to decide okay so I’m going to charge you 15 percent plus VAT eg 18 percent or am I just going to kind of swallow this as one of my costs and it’s going to depend a lot on the type of clients that you have. You know if they’re VAT registered it’s not going to make any difference to them actually but if they’re if they’re predominantly small landlords and you’re working with them because they’re the ones who’re going to make most money out of it then you need to think about that because that could have quite a big impact for them if that’s another say three percent of what they’re actually getting in at the end of it.

Don’t forget to subscribe to the podcast to hear the latest on serviced accommodation.

If you’re looking to start systemize or scale your accommodation business visit www.thesapodcast.com to see how we could help you further.