Lots of people talk about Rent to Rent serviced accommodation, and they usually mean guaranteed rent – but there are four different models that you can use, and guaranteed rent isn’t necessarily the best one! When considering these models, it’s very important to understand where they sit on the “Risk and Reward” spectrum.
If you think about putting your money in a savings account, then you know that the reward is going to be very, very low – maybe 0.05% interest. At the same time, it’s extremely low risk because even if that bank went out of business, your money is protected by a government guarantee.
If we look at the opposite end of the spectrum and consider investing in a tech startup, then we know that the chances are it’s going to go bust quite quickly and take all of our capital with it! But one in a million might become the new Instagram, WhatsApp or Facebook, and in the process turn you into a multimillionaire. So as an investment, it’s potentially very high reward but it is also extremely high risk.
If we consider these examples, it’s almost common sense that low risk is low reward and high risk is high reward. There is essentially a straight line between the two extremes – so for each model, we must think about where on this risk and reward line the model sits.
Guaranteed Rent Model
Guaranteed rent is probably what most people think of when they think of rent-to-rent serviced accommodation. It’s a very straightforward concept – you are guaranteeing monthly rent to a landlord, operating the property as serviced accommodation (obviously with their permission!), and making a profit from the difference between your cost base and what you are able to charge guests on a nightly rate.
If we consider the model from a risk and reward perspective, the landlord is taking very little risk as they’re going to get paid their money each month regardless of performance. At the same time, they’re getting quite a low reward, because they’re only getting the same amount of money as if they were renting it out as a single let property. Conversely, as a serviced accommodation operator you are taking all of the risk and benefiting from all of the reward.
This can, of course, be positive – you are keeping all of the profits for yourself. But one of the other strategies would work better if you either want to mitigate some of your risk by sharing it with someone, or you want to grow quicker by sharing the reward with others. And potentially the biggest consideration – VAT – we’ll come back to shortly…
Landlord JV Model
The concept of a Landlord JV is very simple. The landlord is going to have a set of costs for operating the property, as will you with things like cleaning, booking fees and maintenance. With a Landlord JV, you split the profit after all of these costs, usually on a 50/50 basis.
There are two ways of considering the landlord costs. You can work on a true cost basis for the landlord, considering their mortgage, insurance, ground rent etc. Alternatively, you take the single let rent as their total cost, which is inclusive of all of their costs.
The latter is certainly the more popular model, but typically a landlord would have to pay letting agent fees in order to let it out as a single let. It is not unfair to deduct a similar percentage to a letting agent – say 8-12% – from the amount which is considered as the landlords single let cost.
Considered from a risk and reward perspective, you are sharing the risk and reward with another party (the landlord). This might work particularly well if, for instance, you are going into a new area. Rather than take on all of the risk yourself, you can share that risk with someone who will also benefit from the reward.
There are two other areas we should consider around this model that offer substantial benefits above the guaranteed rent model.
First of all, when growing a serviced accommodation business there are likely to be two main things which will you hold you back – getting enough deals through to continue to expand your business, and being able to fund them.
One of the fantastic thing about this model (and the other two we will discuss later), is that they remove these growth barriers from your business. Because you are offering massive value to landlords – the potential to earn more money from their property – rather than having to go out and chase deals, the deals will come to you. People will start approaching you, and you will start generating referrals because most landlords want to make more money from their properties.
Funding deals is another area that holds many people back from growth, and this is negated by the Landlord JV model. There are no deposits to pay, no first month’s rent up front – and you agree with the landlord that they pay for the furniture and preparing the property for serviced accommodation. This is an easy sell, as in order to “unlock” the additional income of (for instance) £300-500 per month, they must first spend a few thousand to prepare the property. In terms of Return on Investment (ROI), this is probably the best money they will ever spend!
Even if you are well funded for your guaranteed rent deals, not having up-front costs still fundamentally changes the model. There is no an “earn back” period, or calculating loan repayments into costs – you are profitable from day one. In small business terms, a profitable business from day one is pretty much the holy grail!
The second area we should consider when comparing with guaranteed rent is VAT. With guaranteed rent, all of the guest revenue will be in your name, meaning that after a couple of properties you will most likely hit the VAT threshold (and consequently lose a big chunk of your profits to HMRC!).
With a Landlord JV, you structure the deal so that the income is in their name, and you are essentially acting as a management agent. In the same way that in residential property a letting agent deals with tenants and takes rent on behalf of the landlord, you will deal with guests and take payments on the landlords’ behalf. Each month you invoice your share of the profit, which is the only money which contributes towards your turnover.
The easiest way to understand the impact of this is to look at an example. Consider a property that turns over £2,500 per month, or £30,000 per year, and generates £800 per month profit with no VAT.
Under the guaranteed rent model, after taking on three of these properties your turnover would be £90,000 per year, and so you would end up over the VAT threshold. You would most likely register for Flat Rate VAT, and each property would start earning you around £550 per month instead of £800.
If you continue to scale your guaranteed rent business, after 8 units your turnover will be £240,000 (including VAT) and you will no longer be eligible for Flat Rate VAT. You’ll start paying VAT at the full rate, and your profit will go down to less than £400 per month (£383).
Consider the alternative – growing and scaling a business around the Landlord JV model. We’ll assume that you work with landlords who have one or two properties, and so they themselves never reach the VAT threshold.
At three units your turnover will be £1,200 per month, or £14,400 per year – a long way below the VAT threshold. In fact, you can continue making £400 per property per month without worrying about VAT up until your 18th property!
Upon your 18th property, you’ll be turning over around £7,200 per month, so with Flat Rate VAT, you’ll end up with around £6,500 per month. You’ve not spent a penny on any of your deals, and your network referred you to most of the landlords you work with.
Compare this to 18 properties on the rent to rent model. With a turnover of £540,000 per year, you are well into VAT territory, and your ego probably likes the vanity figure too.
If we consider the monthly profit, it’s very similar to the Landlord JV model, at £6,894 per month. But to achieve this profit, you had to find nearly £100,000 in funds, spent most of your time hunting down deals, and are taking on all of the risk yourself.
Can you see now why we always tell people that guaranteed rent is not usually a good model to scale your business with?
Sourcer JV Model
The Sourcer JV works in exactly the same way as the Landlord JV, except you are working with a Sourcer rather than a Landlord. Generally, the Sourcer has agreed guaranteed rent with a landlord, and you are working with the Sourcer to run it as serviced accommodation while splitting the profit.
This model can work really well for Sourcers, who rather than taking a one-off fee for sourcing a property, can turn it into true “passive income”, as they will not need to do any further work but will receive income from the property for the length of the deal. Like the Landlord JV, they will need to put the initial cash in – but with good negotiation skills, this could just be the cost of the furniture (and there is always the option to rent).
The issue with this model is mainly the scalability – as it is based on guaranteed rent, it comes up against the same issues that the guaranteed rent model does, as discussed above.
The Management Model is very different from the other models, as you get paid as a percentage of the turnover and not the profit. To reuse the previous analogy, you are acting as a “letting agent” for serviced accommodation in the truest sense. The money that you take in is on behalf of the landlord, the money that you pay out (for instance, cleaning or booking fees) is on behalf of the landlord, and each month they receive a settlement for you for the balance of income minus outgoings.
When we consider the risk and reward of this model, then you are taking very little risk. Should the property underperform and be losing the landlord money – you will still get paid your set percentage of the turnover. What really makes this model interesting is that it’s the only model that can move away from the established “Risk and Reward Line” – as although the risk is very low, the reward does not have to be. If you are charging around 20% for management, then typically your income is very similar to the Landlord JV model – but with much less risk.
The reason that we have chosen the Management Model within our serviced accommodation business is that we are scaling to a large level in a relatively short space of time. We’ve had a full-time property manager from day one, are regularly adding new team members, and these staff need to get paid regardless of business performance.
Seasonality is something we strongly feel is not talked about enough in serviced accommodation. Even in Southampton, which has a strong all year round market, it is typical to see a 20% drop in turnover for 3 months over winter.
If your income is based on the profit of the deal – as with all of the other models – a 20% drop in turnover is going to significantly impact your income, reducing it by anywhere between 50-100%. With the Management Model, your income is based on turnover, not profit – so if the turnover drops by 20%, your income drops by 20%. When you have significant overheads such as staff costs and offices, ensuring a regular and stable income is of greater importance than squeezing every last penny out of a deal!