Demystifying Management Agreement Myths in the Flexible Office Sector

Once upon a time (pre-covid), there was as little as 9% of deals secured on management agreements in the flexible office sector.  Fast forward to 2024 and they now account for 50% of deals. The increase has generally been driven by operators looking to grow on a capital light model and landlords having an increasing interest in having input and control over the offerings within their building. Additionally, in larger buildings or estates, landlords can collaborate with operators on how amenity space interacts with the remainder of the building driving asset value and customer retention. However, whilst we have seen a growth in the number of management agreements, there is still less understanding of what these deals entail and how they work across the sector. Below we address some of the most common misperceptions associated with management agreements.

“There is no risk to the operator in a management agreement.”

The perception of many landlords and agents in the office market is that serviced office operators are taking no risk in these management agreement deals because they typically put little to no capital into the transaction. However, an operator not placing capital into the transaction doesn’t mean there is no associated risk.  The landlord will usually provide the capital for the fitout, furniture and cover the working capital requirements, however, these are not the only cost-sensitive elements required in a good management deal. Serviced office operators often have to invest considerable time and resources into the business and floor planning, and the early stages of designing, preparing and opening a site will come with a large drain on time and resources.

Additionally, in nearly all new sites there will be a ramp-up period between 9 and 24 months where the operator will be receiving minimal income above the management fee, which tends to be a loss maker in most cases. Therefore, even though the operator hasn't invested capital, they are still incurring losses during the ramp-up period.

Despite the resources required from both parties and potential losses incurred in the early stages, a management agreement for operators is still a relatively capital light model in comparison to taking on a full lease and landlords benefit from the added income that could be gained from a well-structured management agreement.

“The landlord puts all the capital into the deal”

As we have established, most management agreement deals do not include capital input from the operator. However, more operators are now offering to pay for an element of the fitout or the furniture or some operators are willing to take on the working capital risk rather than the landlord. We have seen operators that are willing to hold this risk in order to win the best buildings, not to mention, it adds a layer of incentive for them to make the site successful.

Additionally, whilst the landlord may be taking the capital risk, they also own the fit-out and furniture and when this is compared to the alternative of a capital contribution or lengthy rent free period on a lease arrangement there would be no on-going ownership.

“Landlords have little to no data on the performance of sites.”

In the past, operators have been known to take bigger revenue shares leaving no profit for the landlord, and some landlords still believe that this is the case.  However, there are operators in the market with a sole focus on partnering with landlords, providing open book accounting and live dashboards showing all the key information they need to understand the performance of the sites, like Spacemade.

Spacemade’s landlord dashboard provides real time data across over 30 different data points relevant to the landlord, all of which can be accessed at any time. Transparency is key to some operators, as this is how they ensure a strong reputation. Landlords appear to be more interested in operational real estate and therefore have a keen eye on how these businesses are run, therefore we expect that the most transparent operators will continue to grow the fastest.

“The operator is not motivated to maximise returns”

There is a very wide range of operators and management agreements, and the type and structure of a management agreement are important. For example, an agreement that rewards an operator largely on profit rather than a sole focus on revenue will be more motivated to drive profit. The more a landlord sees the operator as a partner the better. Partnership and full partnership agreements are usually the highest ‘risk’ for the landlord but if well-structured should align the interests of both parties the best and therefore maximise the returns for the landlord.

 A good management agreement should motivate both the landlord and the operator. In the partnership, the landlord will benefit from the operator's expertise in designing, delivering, selling and managing the building which is costly to enter alone. Landlords also stand to receive a higher income than what they might receive as headline rent for an asset, in the right building and location as flexible space operators can charge a premium.  Operators on the other hand benefit from not having to take a full lease on space with greater opportunity to make a profit.

Most management agreements also include KPI linked termination clauses meaning that a Landlord can terminate the management agreement if they do not see the minimum returns or even the level of service agreed.

Management agreements have risks – like everything– but they also have advantages to landlords and operators when well-structured. Whilst we know that some landlords have their challenges with management agreements, we expect that their take up will continue as landlords look to work with partners rather than tenants. There will always be a place for leasehold operators but with the growing trend towards top class amenities and bringing staff back to a more collaborative workplace, management agreement operators will certainly have their place in the market.