Operational Living Insights: operating and managing living sector assets

LIVING IN LONDON – EPISODE ONE

Speakers: Danielle Klepping and Dominic Morris

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In today's podcast, I am joined by Danielle Klepping from our Commercial, IT and Outsourcing team. We will be looking at the growing use of management agreements in the operation of living sector assets and some of the key issues to be alert to when using these.

As a heads up, in our second podcast we will talk about some of the legal considerations for operators harnessing the rapidly growing potential of AI and prop tech within the living sectors and how clients can prepare for the rapid innovation we expect to see coming down the tracks.

Then in our third podcast we will be considering the impact of advertising and marketing regulation within the living sectors, looking at the impact of recent legislation and some of the key factors to keep in mind when it comes to marketing materials for living sector assets.

So, thanks for joining me, Danielle. Management agreements! Let's jump in.

Given that there are lots of acronyms and different descriptions of management and operational agreements, can you please kick off by giving us or giving our listeners rather a brief overview of what these are and when they are used?

Danielle Klepping: Yes absolutely, great suggestion. As you say there are lots of acronyms in this space so you might hear the expressions DMA, AMA, PMA, SMA, OMA, HMA, there are lots of others as well. And that can create quite a lot of confusion particularly because you also see combinations of those.

So if you strip things back to basics, when we talk about management and operational agreements for the living sectors, we are talking about contracts which relate to the provision of services and those services really have been given in the context of a residential real estate asset, so that could be a block of apartments, a development of new build homes, an integrated retirement community, or maybe even a mixed used development with some kind of housing involved.

So the different acronyms and the names all indicate the types of services that those agreements cover.

Very broadly:

• a development management agreement or a DMA relates to oversight of the development process for a building or a development that is undergoing construction;
• an asset management agreement or an AMA, and to a degree an investment management agreement, relate to advisory services that are given in the context of a specific asset or a specific property, or a portfolio, and usually those tend to be linked to a business plan for the same;
• property management agreements very much relate to day to day running of a property or a portfolio of properties, and when it comes to operational management or housing management those are usually property management agreements just with different names; and
• then we come on to sales management, so sales management agreements as you might expect relate to sales and marketing of relevant property or parts of it, so sometimes that is freehold homes, sometimes it is long leasehold, sometimes it is apartments with tenancies and sometimes it is a mix of all of those.

I could go on as there are others too, but hopefully that gives a good flavour.

Dominic: Yes, no, that is a really helpful overview. So, I suppose for a lot of lawyers there is a sort of question mark as to who is disciplined does this fall into, they have got real estate elements, they have got construction elements, they have got commercial elements. How do you deal with that with your management agreements?

Danielle: That is a really good question. It comes up a lot for me because, as you said earlier, I am a commercial IT and outsourcing lawyer, I am not a real estate lawyer. Basically, the reason I end up looking at a lot of these agreements is because of the fact they involve services, and services contracts are very much are what a commercial contracts lawyer does.

My day-to-day role does not particularly including all of those one's that I mentioned. So my focus and my area is on the post construction services, so that would be the asset management, the property, the sales agreement, not so much the development management agreement which would sit more with my construction colleagues. The common theme really is that they all relate to operating a real estate asset, and more specifically for this podcast, a real estate asset within those living sectors.

I would say that entering into these types of management and operational agreements allows property owners and investors an alternative to a traditional lease. So, again you would expect that traditional lease to sit more with pure real estate colleagues than you would myself, but because these are more of a service agreement that is why they sit more in my domain. To put that another way, they are sort of a different route to securing revenue and profit from an asset, so you get a return in a different form whilst reducing the burden of actually operating that asset yourself.

Dominic: These management agreements we seem to be sort of seeing them used more widely across real estate particularly in living sector deals and transactions. Is that fair to say, and why do you think that is?

Danielle: I think that is very fair to say. They are not new concepts, hotel management agreements and care home operator agreements, office management agreements, these have all been around for a long time, I think I looked at my first office management agreement way back in 2006. All I would say is I have been seeing an increasing range of services and pricing models, depending on the asset and the sort of living sector that the management agreement relates to. I have also really been seeing them increase in popularity generally over the last few years.

I also see quite an increase in those related service agreements, so gym hire agreements, laundry services, catering agreements, things like plant hire to make the apartments look nicer, and all of that stems from this shift to wanting to offer consumers more of a lifestyle and not just a home.

Dominic: So that is really another layer of contracts, sort of service contracts, that site beneath the main operational management agreements if you like.

Danielle: Yes, very much so.

Dominic: So, following on that growing popularity for use of management agreements, can you tell us a bit more about how you are seeing that manifest?

Danielle: Yes, I am seeing that it is being driven by lots of different factors, and I would say some of those are more relevant to certain assets than others. So the sort of immediate one that comes to mind is the growing demand for rental. I think that stems from quite a lot of factors. One of those is a shift in consumer attitudes. So, to borrow a phrase that I heard one of our colleague Anjali Bancroft use, in the context of single family rental, I think consumers are getting to the stage where they are more comfortable with subscription based lifestyles. Whereas I think perhaps in years gone by there was much more of a need or a desire to own in a different way than we see now.

Finances I think play a part, mortgages remain really expensive for many. And also when you start getting into some of the market data the average household is shrinking, so that is driving urbanisation, and I would say that all of that is leading to what we are seeing which is more investment in build to rent, and we definitely see a lot of interest in management agreements in that space.

Dominic: So a growing focus on operational management rather than a traditional development?

Danielle: Yes very much so. We see that in the student sector as well, there are similar drivers there. So, the rise in student numbers is really pushing up investment and interest by investor landlords who might not necessarily have considered that space before.

Any listeners that follow me on LinkedIn might have heard me mention this already but JLL did a really interesting global living investment report last month, and that gave some good data around that drive of rental. It mentioned a 10% increase in rental demand, but it also mentioned, which I thought was really interesting, was a 60% increase between, I think it was 2020 and 2024, of larger transactions involving institutional investors, and we are definitely seeing that have an impact on management agreements because those institutional investors are not always geared up or interested in self-operating particularly when you start to think about how intense that operation can be, regulation in this space, so we have renters rights and we have complex legislations, such as building safety, and we also have reputational risk if they enter that space and it does not go to plan.

Dominic: And indeed many investors for regulatory reasons literally cannot operate.

Danielle: Yes that is it, yes.

Dominic: So management agreement I can see become increasingly important.

Danielle: Yes and I think I also see interest in it being driven by their wider stakeholders. So, we have seen schemes where the debt funder required various developer entities to have a suite of management agreements, largely to contractualise internal arrangements so that the lenders could take security.

I have also seen that with the growth of living sectors we are getting this emergence of sector specialist developer operators for certain asset classes. So, some clients I am aware of have set up their own operational arm and they have decided that part of their strategies for growth will be to turn those internal processes and capabilities into a wider market facing offering.

And then I think we also see developers in this space looking to sort of combine resources and work together so that they can build at scale and operate efficiently. So sometimes they are capable of doing this by themselves but they do not want to for various reasons, and other times it is because they want to share sort of skills and work together to create something.

Dominic: And that is one of the other sort of macro trends we are seeing growing use of, I guess, strategic partnerships with various stakeholders bringing sort of different skill sets and I guess risk views to the party and management agreements allow you to plug in and take on your particular risk and bring your particular expertise to there.

Danielle: Yes it allows you to sort of work together and both combine your strengths and also share those risks, and I think you see things like ESG and sustainability feeding into that because that is pushing this sort of portfolio diversification I would say in lots of spaces. So we are seeing more opportunities for flex management, which I appreciate is perhaps not so relevant to living but we are also seeing that result in mixed-use developments, so those then require a range of services, and you might have a developer or an operator that is not as well versed in that type of asset as the other partner in that arrangement, which is where you then see the sort of pooling of resources and skills.

We are also seeing increased awareness of certain sectors, so senior living for example has been a lot more in the spotlight I would say over the last couple of years with things like the Older People's Taskforce Report, commentary around retirement operational contracts, and also commentary around the ARCO Consumer Code, I think that is all helping to drive a bit more investor understanding and interest in that space which could again lead to more management agreements because those are very lifestyle focussed sort of space really.

And we have cost pressure as well driving up interest in management agreements because operators are very much, and developers as well, very much looking at how do we do this efficiently which feeds into using things like AI and prop tech, and I will not go too deep into that because obviously we are covering that in episode 2.

Dominic: Great. So we have looked at the sort of the types of management agreement you might come across, and we have looked at some of the reasons why management agreements get plugged into deals and projects. So could we perhaps go under the bonnet a bit about what the management agreements look like themselves, some of the key terms and what they are trying to do and how they do it?

Danielle: Yes absolutely. I would say the nuts and bolts of most management agreements will be similar, so at their core they are usually, an agreement involves an operator providing services for a certain amount of time in exchange for a fee, but there will be a lot of variety depending on what those services are and what the property or properties they relate to are.

In terms of common themes, you usually see term and termination, typically these will be long term agreements, very detailed termination rights, and if you get into that kind of strategic partner space you might be looking at things like cross default across suites of management agreements as well. You will have quite detailed provisions in these about when and how the services will be provided, and you will see across these agreements references to the operator being appointed as agent and/or being able to sub-contract, and then certain controls on that, and we will touch on that a little bit later perhaps in a bit more detail.

We see a lot around service standards, and they we see a lot around calculation and payment of fees, and you might also have some clauses around how termination impacts on those. Then you might, well you will always see clauses that relate to limiting and controlling risk. So dare I get into sort of the technical terms, but liability caps and limitations and indemnities will always feature.

You then get into specialist areas where you will have TUPE and data protection clauses, and then you get all the sort of what we call the boilerplate which is sort of the governing law and the entire agreement provisions.

So you can expect to see those kind of clauses in any kind of management agreement. Where we get more into the differences, sort of looking at that a bit more, one of them will be the services, and those do vary hugely across all the different types of assets. I mean managing a mixed use development with office blocks is going to look very different to managing a block of affordable apartments or an IRC an Integrated Retirement Community, with an integrated retirement community or new build homes I would expect to see detail there about things like managing green spaces, possibility by biodiversity spaces, and with new build homes you often get play areas, I would not expect necessarily to see all of that in a block of apartments, particularly something like affordable, you would be looking for services around signposting support which you would not have in that sort of new build agreement. So you do get a lot of variety when it comes to the services.

You also get a lot of variety when it comes to the fees, so I mentioned early about different pricing models - for rental assets, so build to rent and student, it is quite typical to see a base fee and then an an incentive fee which is linked to occupancy levels, but you would not expect to see that in a new build housing management agreement, where you tend to get a more fixed management fee that perhaps is phased depending on how many units or freehold homes are sort of handed over at different times. And as you know in senior living you have a different fee structure there because you quite often see deferred charges, so payments that are made at a later stage, so they can be quite different.

And then actually still on the topic of fees, how they are paid can vary a lot. So, for certain agreements like property management agreements, some of those fees will be partly or potentially 100% recoverable from underlying tenants and that very much depends on the leases and licences in place with those actually living there and the services themselves.

And then I would say going back to that point I made about you typically see agency and subcontracting provisions, you see very different models when it comes to appointing third parties. So, in a sort of new build housing management agreement you will typically see property managers appointing third parties as agent, which means that the owner of the land is entering into the contracts with those third parties directly, even though it is actually the property manager putting them in place.

You tend to see different models for areas like student, not exclusively, but a lot of student providers will subcontract and that is because they tend to have arrangements in place where they benefit from commissions and efficiencies of having all of those suppliers set up directly. So you get a lot of differences around that, and it is really important to sort of be clear as to what the offer is around that when you are looking at these agreements.

And then you get lots of extras, so I mentioned that I do not tend to get involved in development management but you do see a lot more in those agreements around appointments of professional teams, and you might see construction specific provisions around things like the CDM Regulations. And then in a sales context I would be expecting to see things like sales rates and velocities and details about marketing strategy and budgets which I would not expect to see in every type of operational agreement.

Dominic: Yes, the word "bespoke" is leaping to mind. I think clearly across different asset classes and across different schemes and across as a different skillsets, and just in terms of commercial deals, there is I guess no management agreement that is the same. We have obviously a lot of standardisation in a lot of real estate documents, leases for example, but with these management agreements they are clearly quite bespoke and that I guess presents challenges and makes it very quite interesting for you.

Danielle: Yes it certainly keeps life interesting for me!

I sometimes get asked "don't you get bored looking at management agreements", but as you can tell from the discussion they are really not one of the same, the variety is huge. And I think there are lots of challenges that that can present. I get asked to review these and I often find that I get presented with things that are not entirely fit for purpose, they might not have started from the right place, the look and feel might not quite fit what it needs to fit, and the agreements can offer a different deal to what your client expecting. So I might look at them and say actually that is not quite what this says.

It does sometimes take a bit of decoding to understand the offer on the table. So going back to the comment I made about student operators often having more of a subcontracting model, whilst a lot do and some take a lease and they manage it in that way, other do not, others act more like an agent. So you really have to get under the skin of these and understand what the offer is. And you see that outside of living as well. So you see that with those flex management agreements because none of those are entirely the same, there is a big range.

It can also take I think some time to understand the risks involved for each party. So different structures have different risk profiles. I think, and you might correct me if I am wrong because obviously this is sort of veering more into your turf than mine, but leases are often a bit easier for a landlord to understand and they can be quite comforted I think by the prospect that once they are signed they have got this guaranteed return, and they do not feel like they have to do that much after that point, particularly if you get into the nitty gritty of passing certain responsibilities down within that lease.

There are terms under a management agreement can be volatile at places and I think particularly at the early stages where you might have mobilisation and a need to get the building full, so in the context of BTI you often see stabilisation dates and a period for getting those apartments full of tenants.

I think it is really important to keep in mind how much risk remains with the landlord, thinking about what happens and what does that mean, not just for the fees if you are acting for the operator, but if you are in the landlord's shoes what does that actually mean in terms of how much money am I going to make during that period. And you can balance that by having the right incentives in place. So you might see operators taking on those incentive fee arrangements that I mentioned, and you might also see them taking on some risk aspects around things like fit outs where they might be responsible for some of those costs. But it really is a case of sort of properly getting into that detail and making sure it is what everyone is expected and onboard with.

I think, I guess another challenge that I see is just generally parties coming to the table with different commercial positions and attitudes. So with those larger sort of investor partnerships, you sometimes see an investor wanting an operator, particular if it is an operator that has got a bit of a stake in the situation, wanting them to take on more risk than perhaps that operator is willing to take on.

I get involved quite a lot in occupational building safety, and that is a really interesting example of where you might get that conflict because the landlord is often the entity that has legal responsibilities but will usually look to the operator as the expert and rely on the operator to support and then that leads to quite a lot of interesting discussions about what support actually means and where that risk sits.

Dominic: One of the many challenges of building safety.

Danielle: Very much so. When you start counting the storeys of buildings and you walk around London you know that you are doing too much thinking about building safety.

There can be issues going back to the challenges around being locked into these inflexible and long term so you can see market conditions changing, so you might have a lack of flex around base sale values in a sales agreement, or you might have uncertainty about what the tenure for the underlying residents is going to be when you think about renters reform and the fact that certain asset classes, like build to rent, focus very heavily on using AST's. So all of that can present challenges in terms of the drafting.

There can also be issues that sort of stem from the early outset, if you do not get that scope of services and the budgets and the finances all kind of agreed, you can have issues later where it is not quite clear who is committed to what or to what extent the services are being provided or procured, and then you might end up with costs that sit alongside the management fees that were not quite expected.

So yes, there can be lots of challenges.

Dominic: OK. We have worked on many of these management agreements over time and we have obviously a very good insight from that, and you have highlighted some of the challenges, the pinch points. How would you recommend that investor and operator clients go about tackling management agreements and management agreement terms most efficiently in their deals? So that I guess (a) they are easier to negotiate and (b) they do not get left with unexpected restrictions, challenges, problems?

Danielle: I would say I really do not think you can stress enough the value of spending time early on really getting into the nitty gritty of what the deal is. Thinking about understanding what the assets are and their ownership structure in terms of how they are going to be owned at landlord level, but also how they are going to be owned by underlying residents, that is really important.

I think carefully scoping their services, being really clear about who is providing what and how, and how that sort of sits contractually, you know, are there additional third party costs and how does all that fit into the piece. And I think it is really important that you get into the detail of revenue collection and how that revenue is used because you need to have those discussions early on about, OK, those early stages when you have got that mobilisation period, what if there is not a profit, what happens then, Does the operator still get paid anything or are we both sharing that risk, or what is the operating expenses are more than what has been collected, how does that work? So really getting into that waterfall and having those discussions and making sure everyone is on the same page is so important.

I definitely see certain aspects of those management agreements getting left later. So it is quite typical to focus on the development management and the asset management, and to see the property management as the agreement that is not quite so essential because if you are dealing with a sort of more of a construction situation and you have not necessarily got that building ready or it is retrofit or something like that, you might not think that you need to worry too much about the day to day yet, but it creeps up and leaving that too late definitely causes issues. So very much thinking about all of this early on has a huge, huge, benefit.

In terms of that sort of early stages, thinking about what you are trying to achieve, how are you going to manage the risks, all those pieces about acting as agent, performance management, say KPIs and whether they link to termination or not, liability caps, all of that, having those discussions, you know, really put the value in at heads of terms stages, it will pay off later definitely.

And then I think there is also a piece around when you are working with another party on these kinds of projects and using those kind of operational agreements, it is really important to get that relationship right and to find the right manager or the right partner. So these can be great opportunities and great ways for owners to manage diverse portfolios, but whilst on the one hand that can mean tapping into specialists in a new sector or those with expertise, it is really important not just to assume that one manage can provide everything you need for every answer. So having that kind of thought process is really important. And then thinking about how you are going to work together longer term, so how are you going to drive value together, how are you going to deal with reporting and meeting and governance, what support you will need from each other, it is not a one way thing, you know, in terms of things like building safety the operator might need information from the owner, so thinking about that is really key.

I hate to say it but also planning for that worse case scenario, a dispute, I try very hard to make sure that my contracts do not end up being one's that are disputed, but I do often see expert determination in management agreements and I think parties should be really cautious about that and think about what kind of disputes there could be, whether that is the right route because you would not want for example an accountant determining a dispute about a liability cap, you would want a judge, so just sense checking, OK if something does go wrong where do we end up with this.

And so I guess the only other thing to add really is about the legal issues and thinking about the fact that the increase in mixed use developments, building safety that we talked about, but also consumer law which Dan Smith our colleague will talk about a little bit in episode 3. There are lots of regulatory changes at the moment impacting on its space and management agreements, and we have talked about renters reform but we have also got things like Martyn's Law, so the Terrorism Act, it is really important to be alert to those issues and really important to get your legal advisors involved in that early stage of discussion.

Dominic: Fantastic. Well that seems like a great point to end on. So, thanks Danielle. Lots for our listeners to consider. I think a very good overview of some of the commercial and legal regulatory considerations around management agreements. I think we are only going to see them used more and more across the living sectors and probably wider real estate, you certainly hope so, a vested interest there.

So thank you to our listeners for joining us for this podcast and we hope you will be able to join us for our next podcast in this series which is as I mentioned we will be sharing some insights around the growing importance of Prop tech and AI for the living sectors.

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