Is it Time to Change the Management Rights Model?

13 May 13

I think the time is right for the management rights industry to explore the creation of a new model. I point out however, that my comments below relate to new complexes only. I accept that it is impossible to change the model for existing complexes. Managers have invested their life savings buying in based on the current model and they are not about to accept a change to that model midstream.


Why do we need to change?

I’ve said it before and I’ll say it again – nearly all of the disputes which I see involving management rights come out of the caretaking agreement. How often do you see a manager fighting with his Body Corporate over letting issues? – hardly ever!


No matter what angle you come from, owners by and large dislike being locked into long-term caretaking agreements. They perceive only one winner – the developer. Sure, we can argue that owners knew (or should have known) what they were buying into when they bought off-the-plan or on a subsequent resale, or we can argue that long-term caretaking contracts have been disclosed to buyers in off-the-plan contracts for well over a decade now and that buyers of second-hand units are dills if they didn’t discover, before purchasing, that there was a long-term caretaking contract in existence.


While we are busy arguing the pros and cons of these agreements nothing is going to change. We will continue to have the same old disputes over the same old issues and we lawyers will continue to live a happy life. The reality is however, that long-term contracts with fixed fees, fixed duties, and no right of review will continue to be a festering sore.


The Current Model

I’ve always argued that management rights aren’t for every building. Predominately owner-occupied complexes and long-term caretaking contracts don’t co-exist. Management rights work best in complexes with a substantial number of investor owners. History shows us that the industry commenced on the Gold Coast three decades ago to cater for the needs of absentee investor owners. These owners felt secure having someone living onsite looking after their investment.


Over the years, we have seen this concept grow into what is now a multi-billion dollar industry where management rights are bought and sold on multiples ranging from 3 to 6 times net profit. These multiples are virtually unheard of outside of the management rights industry. They exist only because investors and banks regard management rights as safe investments. This has proven again to be the case post the GFC. The number of management rights businesses which have failed during this period is next to nothing compared to other businesses. They continue to be great cash-flow businesses with no debtors, no work in progress and no write-offs. Banks continue to lend between 50%-75% against the business value. The only continuing issue facing managers is tenure and the pressure from banks to top up terms.


A New Model?

Why can’t we take a fresh look at the industry and revamp the model moving forward? Building managers make the majority of their income from letting (contrary to the myth constantly propagated by unit owner groups). Caretaking agreements generally do not (and should not) have huge profit margins. In my view, caretaking agreements should attract profit margins of 15% to 20%. No sane person is going to take on a fixed price contract unless they expect to make a profit. Even unit owner groups have to concede this. Resident managers are asked to deal with many emergencies which crop up outside of ordinary business hours. Consequently, it is not unreasonable to expect that a resident manager will be paid more than the local contractor from Jim’s Mowing or Jim’s Cleaning. They are unfair comparisons. The resident manager is on call 24/7.


However, the caretaking remuneration should never be “loaded” by a developer simply to achieve a higher sale price for the management rights. The Governments in nearly all Australian States have mechanisms in place to allow caretaking agreements with excessive fees to be reviewed downwards by Tribunals.


My view is that in the future, developers and the management rights industry should look to a model which basically consists of short-term caretaking agreements coupled with long-term letting exclusivity. This would better align developers with their obligations at law to act in the best interests of their buyers. I can tell you from first-hand experience that only a handful of new developments in NSW have incorporated management rights in the past 7 years. Developers simply don’t see management rights as adding value to their sale process because there is a perceived stigma of tying buyers (post-settlement) into long-term caretaking agreements. Short-term agreements take the heat off the developer and leave future owners with the ability to make decisions which they consider is in the best interests of their buildings.


Caretaking agreements could be for terms as short as 1, 2 or 3 years. At the end of the term, the caretaker has to tender for the next contract like anyone else. If the caretaker is providing value for money, he will be re-engaged. If he is not, the contract will be let elsewhere. However, owners aren’t silly, most realise that an onsite caretaker is of considerably more value to them than an outside contractor who is contactable only during business hours. They will be prepared to pay some premium to have an onsite caretaker. If the caretaker does a good job, he can expect that his 1, 2 or 3 year caretaking agreement will be continually renewed. This is no different to any other business where you are rewarded for performance and you are punished for non-performance. If owners feel that they have control over these agreements, 99% of the disputes between resident managers and Bodies Corporate will evaporate.


Developers harnessing and selling a rent roll has nothing to do with owners, however it puts into place a form of governance which controls the destiny of the building. Most owners recognise that an onsite manager who controls the vast majority of lettings within a building is a good thing. A resident manager lives with the tenants that he puts in. He knows what’s going on in every unit almost immediately. Outside real estate agents cannot compete with onsite managers. They don’t know there’s a problem until the damage is done. It’s not their fault; it’s just the way it is.


Bodies Corporate pay no money to resident managers for the granting of long-term letting agreements. These letting agreements simply give the manager exclusivity to operate a letting business onsite. Owners still have the choice to rent their unit themselves or to use outside agents. Most letting agreements do no more than state the obvious – that the manager must act fairly and honestly in relation to his dealings with owners and tenants and often, minimum office hours are incorporated. This degree of control is a good thing. It’s a no-brainer. Look at the alternative. In the absence of a letting agreement, the Body Corporate has no control whatsoever over lettings in a building. A committee cannot exercise any degree of regulation over whether units are going to be made available for schoolies, bucks parties etc, however they can with a resident manager controlling the majority of rentals.


Summary

My model for new buildings moving forward would be 1, 2 or 3 year caretaking agreements and 20 25 year letting agreements. Alternatively, I would have “supervisory” agreements (where the Body Corporate decides what they want done and how often they want it done and the manager supervises these outside contractors on behalf of the Body Corporate) replace “do” agreements. The fees payable to a manager under these “supervisory” agreements are less than half the fee paid for “do” agreements. Bodies Corporate control their own destiny and are not at the mercy (or perceived mercy) of an under-performing manager locked into a long-term agreement with fixed duties.


If this model is adopted, banks would still lend against the management rights structure – but not to the same percentages as presently existing. There is no doubt that banks and valuers like the current model of fixed recurrent income derived from long-term caretaking contracts. However, the multiplier under this new type of arrangement would come back substantially and the barriers to entry into the industry would be lowered.
 

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