We are at the front end of a new trend where brokerage firms will look to apply their acquisition talents to the scalable systematic team.
The development of how brokerage firms are valued has taken place over nearly 30 years now. Before then, there were a variety of ways to value them, including a multiple of pretax income based on the average of the most recent 3 to 5 years, a multiple of the synergistic cash flow resulting from a combination of two or more firms and a percentage of gross margin from multiple years past results. The terms of deals were far less generous to sellers back then, and often a seller would be expected to wait up to five or more years to get a full payoff of the purchase amount.
As merger and acquisition activity picked up with the entry of Realogy (then HFS), HomeServices (then Amerus) and PREA in the late 1990s, the market adjusted and valuations were based on the most recent 12 months of EBITDA times a multiple that was far higher than in years’ past. A big part of the difference was that, in the case of the three firms mentioned above, public capital entered the market. Further, in some cases these firms could arbitrage the difference between their public equity prices and the prices paid for brokerage firms. Most other large, privately owned regional firms desiring to grow through acquisitions followed suit.
A new form of business has arisen in the last 5 to 10 years—the large agent team. There are several types of teams. One model is a team that consists of 1 to 3 people who combine their efforts in order to share administrative costs and give each partner some scheduling flexibility. Another general form is the team that is headed by a large producer who still generates the majority of the business through their referral efforts and remains, if you will, the personal rainmaker for the team. The third kind is the team that has built some system for procuring clients and customers through a systematic approach, whether it is online marketing, cold calling, direct mail or some combination of these three general channels.
A New Trend
While we do not believe that the first two kinds of teams are going to receive much attention in terms of acquisition activity, we do believe that we are at the front end of a new trend where brokerage firms will look to apply their acquisition talents to the latter team—the scalable systematic team. The reason for this new trend is due to the need for brokerage firms of all kinds to continue to grow. After all, the development of new agents is time-consuming, and high risk. Teams that are not driven so much by a personality but more by a business system and effective leadership can be a good investment. Brokerage firms may see that whether purchasing a team that does $3 million in gross commissions or a brokerage firm that grosses $3 million, the lesser risk and immediate accretion of earnings is more evident in purchasing a team of this kind.
Issues to Address
There are several issues that a brokerage firm will have to address when seeking these opportunities. First, assessing the relative importance of the team owner/leader to the team. How much of its success is based on personal business and how much is derived from a business system? Second, how will the team be incorporated into the brokerage in terms of commission and other policies? Lastly, what will be the price and terms for such acquisitions? In our examination of several top system-oriented teams, their profit margins before adjustment for comparable cost of management are 25 to 40 percent, compared to a general brokerage firm of similar gross revenues, which are in the 4 to 8 percent profit-margin range.
Too High a Price?
The question of what market multiples and what terms will evolve for these new opportunities are unknown and not confirmed by any large number of transactions. It is likely, however, that system-based teams will seek higher prices than brokerage firms are willing to pay, at least initially. We do believe that, over time, with the need to boost earnings and grow share among many of the national and regional realty firms, prices will find a level that suits both parties to the transaction.
Today, there may be only 30 to 50 teams nationwide that fit the criteria for such an acquisition. We do believe, however, that these numbers will grow once the best and the brightest see that not only can they produce strong earnings for themselves, but that they can build equity value as well.
This article appeared in REAL Trends Newsletter and is being reprinted with permission of REAL Trends, Copyright 2015.