Buying a management rights business off the plan
By Frank Higginson18 Jun 2014
Economic cycles absolutely come and go. This is an article we wouldn’t have needed to write in 2009 or 2010 as the GFC was in full swing and development largely ground to a halt with all of the financial uncertainty.
In the last few months we have acted in more off the plan management rights matters than we have in years. That is a happy by-product of property coming back into vogue – particularly in the south east corner of Queensland, and also in New South Wales and Victoria. You only have to keep a cursory eye on the media to see all the positive property stories which are (depending on what you think) are either reporting on or driving property investment.
With property development comes bodies corporate and with those bodies corporate usually come management rights.
Buying a business or a unit off the plan is a far different process from buying an existing asset. The key issue is being able to effectively ‘draw’ a picture of what the unit and business will look like on settlement as they do not yet exist.
This is more easily done with a unit as the purchase contract for that unit will describe what it will look like when it is built. The contract will include floor plans and other specifications of the unit itself. You can see what you are buying.
From the business side of things what you are buying is a prospective net income. That net income will be derived from the management rights agreements and a certain number of units in the letting pool. The skill in drafting or negotiating an off the plan management rights contract is to ensure that what is being sold is delivered – and that there are mechanisms in place to change the price based on certain parameters.
There are many legal issues that arise when buying a business off the plan that do not exist when you buy an existing business. The below is not an exhaustive list of the things that need to be considered but merely some of the big ticket issues. These include:
- Is there a sunset date for delivery of the development, or individual stages in it? One of the risks for buying a management rights business off the plan that is being built in stages relates to the development actually being finished. What happens if the developer builds the first two stages and not the third? There are a few of these incomplete, but functioning, management businesses out there as a result of the GFC.
- What actually constitutes a unit in the letting pool? Is it an owner who has settled or just signed a letting appointment? What are the key terms of a qualifying letting appointment? Up until the 2014 Federal budget we would have had to deal with NRAS too in this component.
- Is there a minimum number of letting appointments to make the business viable? There is usually the need to balance the competing interests of the developer in knowing it has an unconditional sale it can use for development finance purposes as against your commercial driver to ensure the business generates a profit substantial enough to wait for the project to be delivered (which will usually be months, and sometimes years, away).
- How long will the developer be paid for new letting appointments? For quite an extended period it was common for developers to still own units after registration and the first settlements as they tried to sell units in a slow real estate market. The arrangements where you are obliged to pay for letting appointments on an ongoing basis and the security for those payments are known as claw back or claw forward arrangements. The detail involved in clauses of this nature is critical, particularly with who bears the risk of lost letting appointments.
- The last one is that sometimes you can negotiate changes to the management rights agreements as part of the legal due diligence. This has to be balanced against the developer’s statutory requirement to disclose any changes to the management rights agreements to prospective buyers of units. If the changes ‘materially prejudice’ buyers they can terminate contracts and get their deposit back. This can be quite a fine line at times.
That will do for the moment, but the list of things to consider goes on for quite a while yet. An off the plan management rights purchase requires an enormous amount of detail in a relative contract sense when you compare it to the REIQ contracts you use when purchasing an existing management rights business and unit.
Managed correctly, the buyer can avoid paying stamp duty on the business purchase as well. Stamp duty will be payable on the unit though no matter what.
When it comes to buying a management rights businesses off the plan, you cannot be too careful. What is said at the time of the initial handshake on the deal or at the offer and acceptance stage is very important to document, as those things are sometimes forgotten months (or years) later on registration.
It is said that buying a management rights business off the plan is not a place for the inexperienced buyer. The same can absolutely be said of lawyers too! It is only when your lawyer knows all of the ‘what if’ scenarios that can occur on an off the plan purchase that you can ensure you are protected.
Let us know if you need help.