Why management agreements are growing in popularity with landlords

Flexible workspace is here to stay. In London, flex space now represents 10% of the office market and regional demand continues to grow. Businesses are attracted to amenity-rich flexible working environments that can attract and retain the best talent as well as enhance brand image, without tying themselves into onerous long lease provisions.

So, with an ever-increasing range of operators, what is the best way for landlords to enter the market or provide a flexible offering within a wider property estate?

Of the large property owners, few are geared up to deal with the operational intensity that often comes with running their own flex space. Even a more ‘managed’ solution requires greater operational engagement than most are used to.

Typically, only those that have in-house operational capability, a clear strategic vision of how flex fits within their estates and the necessary scale will attempt a self-managed solution. Most don’t have these attributes and therefore need to partner or engage with an operator, either by entering into a lease arrangement or a management agreement.

Lease options have been around the longest and range from traditional ‘rack rented’ leases through to some performance-based leases. The benefits of traditional leases are their simplicity and clarity of responsibilities together with fixed rent and a structure that is well known and comparable. Whatever the covenant of the occupier, that lease will be capable of being valued.

However, the operator takes on significant financial commitments, which will account for two thirds or more of their cost base when combined with the costs involved in funding fit out and fixtures and fittings and the substantial working capital required to pay rent and service charge in advance. The operator makes that commitment in anticipation of income in the future, but apart from rent and service charge payments, the landlord has no visibility of the underlying operation or how well it is going.

So, from a landlord perspective, real visibility of covenant is critical. Is the operator proposing to form a new special purpose vehicle (SPV)? If so, is there a guarantee of sufficient value and substance, and where does that sit within the capital structure of the guarantor? Even with an established operator providing an existing trading company covenant, what is its financing structure? These are all areas that landlords need to pay increasing attention to, as highlighted by those landlords who got “burnt” by SPV structures in the sector recently.

In addition to lack of visibility of the operation, does the tenant operator have an incentive to engage in a broader estate amenity strategy for the building?

A management agreement with a professional operator provides a hybrid option. The operator deals with the operational and trading aspects of running the flex space, while through reporting structures the landlord retains much greater visibility and oversight of the business. Such agreements also provide the potential for landlords to achieve greater income returns over the long term and, in larger buildings, to proactively support lettings in other parts of the building and run common amenities.

That said, with usually no fixed rent payment commitment and a requirement to fund fit out, the main financial risk is with the landlord. So, it is key they find the right established partner and structure, ideally involving some form of risk sharing – capital investment is important, as is certainty on costs. At Orega, our landlord partners invest in fit out – anything that needs to be “screwed and glued” to the building – while we invest in furniture, equipment, AV and IT.

A well-structured partnership deal incentivises the operator to maximise income to the benefit of both parties. This also means that in tougher times there is a genuine partnership to work together and there is much greater transparency over the operating dynamics. In return, rewards are also shared.

Management agreements are growing in popularity. They accounted for just 9% of flex deals in 2019, but this rose to 41% in 2022 and 43% in the first half of 2023. They have the potential to deliver greater long-term income returns while allowing much greater oversight for the landlord of their asset and the underlying business.