Management agreements – will they be a long term change or short term fix for the flexible office sector?

Management agreements in relation to flexible workspace have always generated mixed feelings in respect of the wider real estate sector, this is despite the fact that they are very much a common structure in the hotel world. However, the perception of management agreements in flex space is changing in the UK, with more and more owners and operators adopting the model. In fact they could even be the key to the revival of the flexible workspace sector following the impact of Covid-19.

The definition of a management agreement can be somewhat ambiguous as there are in fact many different ways to structure an agreement, however the overarching format is a revenue and profit share model between an owner of an asset and an operator of the asset.

We believe there are three core variations of the management agreement model. The first is the base rent model, whereby the operator guarantees a base rent to the owner, any profit at EBITDA is then split between the parties. The second is the hybrid model, whereby there is no base rent, but a notional target rent which the landlord receives as a priority return and then again any profit at EBITDA is split between the parties at fair ratio. Finally, the partnership model, where the operator charges a management fee and then revenue is shared between both parties at a ratio that reflects their respective input. The many variations that follow are largely a result of the negotiation of how costs are accounted for and how revenue and profits are split.

So why are management agreements making a comeback?  For many operators they prefer them for their capital light model and flexibility without having to take a full lease on space, while many landlords have historically been less enamoured due to the perceived risk associated with not having a formal lease in place and the associated implications on asset value.  

However, over recent years we have started to see a visible shift towards a greater number of operators favouring management agreements. Historically, it was only really the likes of Orega and IWG looking to take new space on a management agreement basis, but fast forward through the last decade of the flexible workspace revolution, and we have started to see multiple brands seeking to take space on this basis such as FORA, BE Offices and X+Why. Landlords have also become more receptive to the concept driven by an increasing awareness of the added income that could be gained from a well-structured management agreement, as well as the growing investor expectation that an asset will need some form of flexible workspace as part of the offer, there is therefore a need to deliver it.

While we were anticipating an increase in management agreements, as with previous recessions, the Covid-19 pandemic has fast-tracked the potential of their use. Management agreements often arise in recessions, typically because, in more challenging markets operators are more likely to look to expand via a management agreement as it is more cost effective even forsaking the higher return they would get if it was on a lease. This approach left those landlords wanting to lease space with little choice other than to accept a management agreement.  The difference in the current environment is that landlords are more compelled to enter into a management agreement. In fact, in a recent landlord survey conducted by Savills, 31% of landlords were open to considering a management agreement with a flexible office operator, with 25% more likely to consider a management agreement out of choice (29% out of necessity).  

Whether or not management agreements could be the answer to boosting more confidence and activity in the flexible office sector is very much dependent on how they are structured. Those that are not too heavily biased to one party and reflect a true partnership with both parties fairly incentivised for their role in the agreement will fare better and generate the best result moving forward.

For landlords, a well-structured management agreement, in the right building and location, would be expected to deliver a higher income than what they might receive as a headline rent for the asset. It also allows them to benefit from the premium that a flexible space operator can charge and presents an opportunity to leverage the brand and expertise of an operator. There is also the potential for an operators brand to add real value to the landlord’s wider building or estate. 

Of course there is the question of why a landlord wouldn’t seek to create their own flexible workspace products that they would lease directly and we have seen several successful examples of this such as Storey (by BL), Myo (by LandSec) and Capsule (by L&G). These are all landlords with significant resource and expertise to design, deliver and sell the space and they have all been willing to go on a learning journey. The size of their operator brand also allows them to operate from multiple buildings creating economies of scale for their platform. Many landlords however do not have the same resource and therefore building the infrastructure and sales platform themselves is very costly.

The hotel sector has proven over time that the management agreement model can work for both the owner and operator and we expect this to also become the case for the flexible office market with Covid-19 facilitating a shift in perception. Investors are also increasingly warming to the need for a flexible offer within a building and management agreements will be key to delivering this, enabling owners to leverage the expertise of an operator to create the space in a more flexible model, where both can share the risk and reward. Partnership will be the key to success.

Find out more about Savills Flex here.