Alan McKernan Partner Mahoney Lawyers

There are few simple reasons why people want to buy management rights off-the-plan. A major reason is that there is no stamp duty on the initial grant of the management rights. There is still duty on the unit. Other reasons include expectations that:

• the multiplier will be lower when buying from the developer; and

• the profit could ultimately be a lot higher than that projected by the developer (especially for short term accommodation).

Although there is GST on an off-the-plan management rights purchase that is eventually remitted back to the buyer as an input tax credit. Also the legal fees and general delays can be much greater than a normal purchase. The stamp duty saving more than makes up for that!

Of course, there are also other risks. But, if the items in this article are considered and acted upon, the risks can be substantially minimised.

Tip number 1

Trust but verify. The agent and the developer can be an excellent source of information.

But it is critical to distinguish between information and ‘blue sky’. Information can be verified, blue sky cannot be. Blue sky includes, for example, unsupported estimates about likely rental or occupancy rates.

It is important to identify, check, and verify any important assumptions about the business.

Tip number 2

Deal with competent and respected people and get good advice early.

Importantly, the first person you need to check out is yourself!

Do you have the skills to bring this kind of business together? Permanent complexes are fairly straightforward. Many of my existing clients hear about a holiday building years before it is completed. Developers often approach experienced managers directly. Warning bells should ring if you have no experience and are approached six weeks before a major holiday building is to be finished!

Never sign an off-the-plan management rights contract without expert legal and accounting advice. These contracts are never standard.

Dealing with an experienced management rights agent is important. Remember, they are the developer’s agent. Nevertheless, experienced agents will not want to risk losing a sale or your future patronage and will usually be honest with you. Remember, those agents are not solicitors or accountants! They cannot provide all of the detailed advice that you will need before the contract can go unconditional.

Tip number 3

The developer and its selling agents – ideally, the developer will have a good track record – find out about the developer’s other complexes. Speak to the managers of those buildings.

What support will the developer offer you? This could include marketing support for web sites and advertising and assistance with identifying and rectifying building defects. Managers often need to spend significant time and money setting up the business and fitting out the office in the months leading up to settlement.

Who are the selling agents? What have they promised the buyers? Obtain copies of marketing material.

Tip number 4

Obtain copies of the off-the-plan unit sale contracts and disclosure statements. The developer and its selling agents should have copies of these to provide to you. These documents should have all sorts of useful information: copies of survey plans, floor plans, budgets, lists of inclusions, caretaking and letting agreements, by laws and so on.

Tip number 5

Initial financial due diligence, what is the settlement time frame? Is there enough time to obtain form 20a from owners? Enough time to find tenants? Some marketing and advertising needs a long lead in time especially in holiday buildings.

Often, the developer or its selling agent will provide you with a projected profit and loss statement. That projection will usually be for the second or even the thrid year in a holiday complex.

Make sure your own accountant verifies the projections and identifies and checks any underlying assumptions. It could take three to six months to fully tenant a permanent complex. My clients tell me it can easily take 18 months to achieve projected occupancy levels in a holiday building.

Projected profit does not equal cash flow! Consider preparing separate cash flow forecasts.

Tip number 6

Establish price calculation and related assumptions. What is the breakdown between body corporate remuneration and letting income? What expenses have been allowed for? What is the expected occupancy? What are the other income sources (electricity supply, Internet services, parking fees)? Is it appropriate that those income sources be included in the projections for sale purposes?

Nobody ‘buys’ GST. The figures quoted for remuneration and the off-the-plan management rights price, are usually plus GST. The unit price would normally include GST.

One of the things that you need to determine is how much each unit is worth in the letting pool. For example, if the projected letting income from a unit is (say) $6000 and the multiplier on your purchase is 4.5, then that unit alone is worth $27,000 to your letting pool.

Tip number 7

Initial legal due diligence, you should make sure your lawyer has a copy of the unit contract and disclosure statement very early in the negotiations.

There will be items of critical importance that need to be resolved before the contract can be signed. Your lawyer should identify any immediately obvious issues in the agreements. Developer’s solicitors frequently use ‘off-the-shelf’ caretaking and letting agreements. Often, we see permanent townhouse complexes with agreements that seem drafted for a high rise holiday building and vice versa. High risk items that might need to be considered include, for example, strict office hours or window cleaning requirements.

Are the duties, office hours and remuneration appropriate? What are the rubbish removal arrangements? Is it a holiday or permanent complex? Are the courtyards accessible for maintenance? What degree of office fit out will the developer supply? Consider PABX, Internet, electricity supply, car parking, furniture packages and the like.

Developers are usually highly reluctant to make any changes to the caretaking and letting agreements. That is because any changes have to be disclosed to all the other buyers. If those buyers are materially prejudiced by the changes, then they are allowed to terminate their contracts. Developers usually don’t want to risk that.

It is important for buyers of off-the-plan management rights to distinguish between their ‘wish list’ and ‘deal breakers’. Given the understandable reluctance developers have to making amendments to the documents, my view is that if there are significant pre-sales, only deal breaking amendments should be put to the developer.

Tip number 8

Minimum available units in letting pool at settlement? A critical question that is sometimes ignored is, “How many units do I need in the letting pool to settle?”

You can have the best claw back clause but if there are not enough sales to investors, the business might not stack up even with a major price reduction. This can be a difficult issue for all parties: You may not want to settle unless a certain percentage of units in the complex are sold to investors who have signed a form 20a with you.

In a holiday complex, consider if you require a minimum number of units to be fully furnished.

Tip number 9

Claw backs are probably the biggest single bone of contention when buying off-the-plan management rights. Some developers simply refuse to consider claw backs or minimum numbers to complete. If that is a commercial risk that you are prepared to take, then in some ways that can be a relief. It can certainly save a lot of negotiating, legal costs and delays!

But most managers would require a claw back. Consider the example in Tip Number 6. If you are expecting 50 units in the letting pool and there are only 45, the value of that discrepancy is 5 x $27,000, that is, $135,000.

Ideally, other features of claw back clauses include: not paying for units retained by the developer or its associates, only paying on receipt of a signed form 20a, and only paying for completed, furnished units (if applicable).

All of these items are negotiable.

Tip number 10

In principal agreement of developer to claw back/other amendments.

An expert lawyer will be able to help you with straight forward ‘in principal’ clauses for the purposes of negotiating with the developer. The final contract will of course be quite detailed.

It is important that in principal agreement be reached on critical items such as price, claw backs, minimum numbers to settle, and any obvious due diligence issues, before a contract is signed.