Mike Phipps Suncorp National Business Development Management Rights

With the continued upward pressure on multipliers and purchasers looking for some ‘upside’ in their management rights purchase, off-the-plan opportunities can be very tempting. Indeed, when I look at some of the most successful industry operators, that success can often be tagged to a past off-the-plan decision. Many of them either started with a new building or make a business of buying new projects.

I believe that while established management rights businesses can be run successfully by otherwise inexperienced parties, the same cannot be said for green-field sites. This view appears to be shared by many developers. In the past the sale of the management rights to a new building was a bit of an afterthought with the developer spending little time considering the impacts of the on-site manager. However, many developers now understand the important part that the on-site manager plays in the performance of a building and are marketing the management rights accordingly. In many cases the ongoing reputation of the developer’s product in terms of both overall presentation and investment return is in the hands of the resident manager.

Off-the-plan opportunities are available across a wide range of permanent, short stay and holiday business models. While my remarks are pertinent to all sectors I believe they are most relevant within the holiday and short stay markets.

So, you’ve run a building or two and now it’s time to have a crack at starting from scratch. Where to start?

First, if it’s true that you need expert advice when purchasing an existing management rights then it’s doubly true for off-the-plan. Make sure the sales agent, solicitor, lender and accountant have extensive experience in these types of deals.

There are off-the-plan management rights specialists out there and you need to use their expertise.

The sales agent will be involved in negotiating not only the sale price but also the peripheral arrangements with the developer. An understanding of the off-the-plan purchase process is essential if these negotiations are to be satisfactorily concluded. Your lawyer will also need to understand the peculiarities of new site contracts and in particular the conditions required to protect your interests as the project comes together.

As the purchase will be predicated on projected figures it’s imperative that your accountant have an excellent knowledge of the industry. This should include the performance benchmarks and likely profitability of sites comparative to the one you’re purchasing.

While there are a myriad number of individual considerations when purchasing management rights off-the-plan, I’m going concentrate on a few of the key areas. My definition of a key area is based on a very complicated mathematical formula, “If we get this wrong will I go broke?”

The critical factor in purchasing off-the-plan is the projected composition of the letting pool. The accountant will use an estimate of the letting pool numbers and letting arrangements as the basis for a set of income projections. While other income can be generated from management rights and while there will be a body corporate salary, the letting pool is critical.

Contractually, your projected letting pool risk is mitigated by a claw-back clause. This clause is designed to ensure that you only pay for the units that are in the letting pool at settlement. The clause should state a minimum number of units at settlement with a per unit adjustment amount formula.

The balance between the actual amount paid at settlement and the contract amount is then provided via bank guarantee. At a point in the future known as the adjustment date, the bank guarantee is used to ensure payment for any additional units in the pool and the balance, if any, is returned to the purchaser.

While all this sounds a bit complicated it’s essentially a partial payment for the units available at settlement with a further payment when the balance unit numbers are achieved. The trick is to make sure the claw-back clause covers your letting pool risk. There will be a minimum number of units below which the business is not viable. This should be made clear in the contract. Also, the definition of a letting pool unit needs to be clear and accurate.

Simply defining a pool unit as one purchased by an investor is not good enough. An experienced lawyer specialising in off-the-plan transactions will be invaluable in framing a contract that protects both you and your bank from letting pool risk.

This is also the time to clarify any intention by the developer to hold onto any units in the building. Concentration of unit ownership can be a real business risk and needs to be investigated.

It’s worth mentioning that a contract can also contain a claw-forward provision. This essentially means that you may have to pay a premium for any units in excess of the maximum letting pool total on which the contract is predicated.

Once you have some idea of the probable letting pool composition it’s time to have your accountant consult the crystal ball. In order to project a likely achievable net profit your accountant will need to understand your business model. Are the units to be let permanently or short term? Will there be a mix of both and what’s the likely tariff structure? How will initial advertising costs be met and will the developer or new unit owners be prepared to assist with marketing the site? Will initial bookings come from wholesalers and if so what’s the likely commission rate?

You and your accountant will also need to determine likely occupancy rates and any other income streams. These may include room cleans and other services to unit owners. A clear idea of operating costs including any additional staff required to cover the duties of the on-site manager will need to be determined.

Once all the relevant data is to hand your accountant will complete a set of projections. Ideally these will be supported by documented underlying assumptions and industry benchmarks. It’s important to ascertain the likely performance of the business in the first year as well as the expected ongoing year in, year out profitability.

Most new sites will take a period of time to hit their stride. It’s vital that new managers take this lead-time into consideration when planning appropriate levels of marketing and working capital. I would encourage any new site purchaser to have their accountant do up a set of sensitised projections. These are designed to show the impact of higher or lower than expected occupancy levels, letting pool numbers or tariff rates.

As mentioned earlier there are any number of additional but perhaps less critical considerations when purchasing management rights off-the-plan. If the site is predominantly short stay or holiday based it’s a great idea to encourage unit purchasers to also purchase a furniture package. Consistency and quality of product is paramount in creating the right first impression. This option should be discussed with the sales agent and developer as soon as is practicable.

It’s also a good idea to review the manager’s exclusive use areas and the general logistics of running the site. Little things like office layout or the location of rubbish bins can make a real difference to the day-to-day life of the on site manager.

Get in early and work through these issues with the sales agent and developer.

So, on balance we’d have to say that an off-the-plan management rights purchase can be a great opportunity. Just make sure you understand the industry very well and take advantage of the services of professionals with off-the-plan experience.