Published: 03 September 2007.

by Clayton Glenister, Associate
McDonald Balanda & Associates

General Comments

An experienced buyer of Management Rights when looking to buy off the plan looks seriously at the potential to procure units for the letting pool and the number of likely units that will be in the pool. To make a calculated assessment of this potential an experienced buyer will look at issues such as, how are the units being marketed, their location, and the type of units. If the units are being marketed or only being sold to interstate or overseas residents then there is more likelihood, of course, that they will be placed in the letting pool. If the units are on the Gold Coast Highway and are smallish with no views, then they are also likely to be placed in the letting pool.

Units which however have good views, are spacious, in a quiet location and are located in an established residential area are more likely to be occupied by owners. Careful consideration therefore needs to be given to the method by which the units are being marketed and there also should be a careful perusal of the plans and the location of the complex. The Buyer needs to compare these matters with what the developer has told you. A Buyer cannot rely on what the developer has told them and must look at these issues themself and not fall into the trap of selling themself the complex.

Compensation for Units Not Placed in the Letting Pool

a. The Buyer’s Position
The new business will have been sold by the developer on the basis of anticipated or projected returns which will assume a certain number of units being in the letting pool. Ideally, the Contract of Sale should be subject to every unit upon which the Buyer has based their projected returns being in the pool, or at least a minimum number being in the pool, that minimum number being a certain size below which the Buyer would not buy the business.

b. The Developer’s Position
This issue will usually be a sensitive one for the developer who generally will put it to the Buyers that they need to make a commercial assessment of the matter and purchase the complex without the benefit of any such protection. Such a proposal is of course very unfair to the Buyer. In many cases there will be a negotiated compromise on this issue and there are a number of ways in which this compromise can be reached. The first way is where the developer compensates the Buyer for the capital loss to the Buyer of the units not being placed in the letting pool. The Contract might still also be subject to a minimum number of units being in the letting pool on settlement (but not the full compliment of units) and for those units (above the minimum level) that are not placed in the pool the developer would agree to pay capital compensation to the Buyer.

Capital Compensation

How is a Figure Arrived At?

The Buyer will have paid a capital cost for the purchase of each unit which it expects to be in the letting pool. For example, let us say that the Buyer expected to receive on average $1,000.00 income from the letting of each of the units in the letting pool in a permanent let complex over the first year of operation of the complex. Let us assume that there are potentially a maximum of 50 units that could be placed in the letting pool. If the Buyer had made an offer to purchase the Business on the basis that it expected all of the 50 units to be in the letting pool the sale price for this anticipated business would probably be $300,000.00 i.e. the likely income from 1 unit for 1 year X a multiplier of 3 X the maximum number of units in the pool i.e. 1,000 x 3 x 50 = $150,000.00 (the multiplier of 3 is the formula used on average to calculate the capital value in a new complex of the income derived from letting of a unit)

Therefore the capital cost to the Buyer of every unit not being placed in the letting pool would be $3,000.00.

The negotiated compromise would therefore require the purchase price for the business to be reduced by $3,000.00 for every unit that was not placed in the letting pool.

Compensation Based on Lost Income

Another method of resolving the issue of compensation would be for the Buyer to be compensated for the lost income which it would not receive for any units not being placed in the pool for a maximum of 1 year from settlement. This proposed compromise is usually more acceptable to most developers as they obtain more of the sale price of the business than where compensation is based on the capital cost of the lost units to the Buyer.

The compromise is not as attractive to the Buyer, however in all fairness to the developer there is a real likelihood that a competent Manager will persuade quite a number of the owners who initially elected not to place their unit in the Manager’s letting pool to do so within a year or so of the settlement of the purchase of the Management Rights Business simply by virtue of the fact that they are the Resident Property Manager and the most attractive person to engage for the management of the unit. Their position as the on site Manager gives them an ideal opportunity to remain in contact with owners who have utilised other people to manage the letting of their units and eventually persuade them to bring their unit back into the Manager’s letting pool.

How Do You Calculate the Lost Income Payable to the New Manager?

Lost income should be calculated by multiplying the likely rental income for the units concerned by 7.5% (in the case of a unit likely to be permanently let) and 13% (in the case of a unit likely to be holiday let). In the case of a holiday let unit there will also be added the other lost nett income which could have been achieved from Management of the unit for such matters as linen hire, cleaning, PABX, sale of tours and hire of equipment. In the case of a permanent let unit at least 1 re-let fee (one week’s rent) should also be added to the figure to calculate lost income.

It is also usual for the amount of lost income to be held in the developer’s solicitor’s trust account and each month the Manager be compensated from these monies for a maximum period of 1 year from settlement.

Unsold Units

If on settlement of the Management Rights Business the developer still retains unsold units in the complex it is reasonable for the developer to place these units in the Manager’s letting pool and undertake to use its best endeavours to get the buyer of those units from it to appoint the Manager as the Letting Agent for the unit. If the developer agrees with that proposal then this will reduce the number of units in the complex for which either capital or income compensation would have to be paid. A proposal by the developer to place its unsold units in the letting pool is usually attractive to the developer unless they are marketing their units to foreigners in which case the Foreign Investment Review Board guidelines require them to ensure the units have never been rented at the time they are sold to the foreigners.

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