Operational real estate: an introduction to management agreements

A management agreement, sometimes called an ‘operational management agreement’ or ‘operator agreement’, is one vehicle for accessing operational real estate and seeks to harness third party operational expertise.

A management agreement is an agreement between a property owner and a management company, or operating company, under which the property owner pays a fee in return for the management company operating the owner’s business from the property. The model is focused on the successful operation of the business. It is the property owner’s business, so costs and operational risk will ultimately sit with the property owner. However, the profits achieved by the business are also the property owner’s and such profits can be maximised by appointing a management company with a strong brand, operational expertise, marketing excellence and traction with customers and end users. 

Management agreements have become more popular in the last few years, but they are not a new concept. The management agreement took over the more traditional sale and leaseback model operated in the hotel industry well over a decade ago. Since then, management agreements have become the go-to mechanism for numerous markets across the real estate sector, including build to rent (BTR), student accommodation, later living, flex and service offices, self-storage, and even more specialist sectors such as sports, and film and media production.

The anatomy of a management agreement

Term and termination

Management agreements are often long-term contracts. In the hotel industry, where branded management companies wish to secure longer term commitments, a management agreement is typically for more than 10 years and regularly up to 30 years. Markets that are more recent adopters of the management agreement model, such as build-to-rent, are more likely to have shorter term arrangements; typically, three to five years. This is becoming less common as the market matures.

Termination rights are often a subject of robust negotiation. Whilst each contract is deal-specific, owners will typically seek to include some level of financial performance-linked termination right and provisions dealing with the position on a sale of the property.

Cost management

As the management company is acting as an agent to operate the owner’s business – as opposed to the tenant’s business, like in a traditional lease scenario – owners will seek to retain a level of control by including parameters around expenditure by the management company. In most cases, this will take the form of an agreed budget for operational costs and also capital expenditure. The management company is typically given general authorisation to incur expenditure in accordance with the agreed budgets, whereas any expenditure outside of the budget would need additional approvals.

In relation to capital expenditure, it is also common practice to agree a “required standard” for which the capex might be incurred, to give both parties comfort as to the agreed level of repair, maintenance and any improvements to the property. Where an established brand is central to the appointment, the agreement is likely to include very prescriptive brand standards. These can include specifications for everything from the colour of the walls to the thickness of the carpets to ensure uniformity across the brand portfolio. Owners should ensure they are comfortable with such standards as they will necessarily impact on the costs of development, maintenance and renewals.

Services

The description of the services in the agreement can be prescriptive but the core principle is that the management company will be operating the owner’s business within the parameters of the brand standards and agreed budgets in line with certain service warranties, to maximise returns. In some sectors, such as build-to-rent and the flex office sector, management companies can offer real value in getting an asset up and running by providing design and consultancy services, which may be included in a separate agreement, typically called a technical services agreement.

Fees

There are many ways to structure the fees payable to the management company but, typically, they will involve a 'base fee' which is a percentage of revenue, and an 'incentive fee' that is a percentage of operating profit.

From an owner's point of view, a greater emphasis on the incentive fee will align the management company more with the owner's commercial position. In some cases, a management company might go further and guarantee minimum levels of profit, usually subject to some sort of cap on exposure; or alternatively agree not to take or defer its fees until minimum levels of profit are being earned for the owner. In addition, management companies often charge fees for the owner’s uses of any centralised, or ‘head office’, services, such as marketing, payroll and accounting, as well as design and consultancy fees.

It is important for the parties to agree the finer details of the charging mechanisms, including agreeing what constitutes “revenue” and “profit” for the purposes of the fees.

Personnel and TUPE

The personnel engaged to operate the property will be managed by the operator, however different approaches may apply in relation to their employment. In the hotel market, staff are typically employed by the owner, whereas in other subsectors the management companies usually employ their own staff. In either case, it is common for the parties to agree bespoke provisions in relation to the recruitment process and retaining any key personnel.

Owners are well advised to tread carefully in relation to TUPE, particularly by including risk protection for any TUPE costs on exit so that any replacement management company – and, ultimately, the owner itself – is not hit with costs for employees unexpectedly transferring from the incumbent management company.

Deciding if a management agreement is right for your business

A management agreement is a vehicle to operate the owner’s business and, whilst day-to-day operations are put in the hands of the management company, it is a much less passive approach to property ownership when compared to a traditional lease. The model offers potentially greater rewards than the steady income offered through some leases – but with those rewards comes additional operational risk.

As with any third-party appointment, finding the right partner is vital and the management agreement model has opened up the market to entrepreneurial operators and brands that are achieving success in an ever-increasing number of markets across the real estate sector.