Contracts — Blog — JDF Management Consulting

Our post today is about a topic I have often encountered as an alternative assets manager: whether to engage in a lease or management agreement for parking garages in your portfolio.

I’ve fielded a lot of questions on what a management agreement actually is for third-party services and why they should be used, so just to clarify here: a management agreement is simply a contract in which the property owner or manager (client) outlines a scope of services that the third-party (operator) will perform in exchange for a management fee. Assuming the business is profitable, as parking garages often are, the management fee is considered an expense and after all expenses are paid, the net income belongs to the client. There’s no rule to how management fees are calculated, and they differ across alternative assets, but they are always negotiated. Management agreements include all the standard language on insurance, standard of care, operator representations, term, and compensation.

Typically, owners and managers who have parking garages in their portfolio will opt to lease it out instead. Here we will explore three metrics of the management agreement vs. lease decision: control, flexibility, and financial upside.

CONTROL

One of the most often cited reasons for why real estate owners engage in leases of their garages is because a management agreement requires too much co-management. The real estate guys don’t know about parking, and they don’t want to get involved. Makes sense. But in no way does a management agreement shift any day-to-day operational burden on the client. The parking professionals will run the day-to-day in a management agreement just as they would in a lease.

The “oversight” or “control” that is valuable in a management agreement is not in regard to co-managing a parking business, but rather in areas related to the core business interests of the client: customer service requirements, approval protocols, cleanliness, cooperation on marketing, and the ability to set and push budget targets. All of these important issues can be written into a management agreement and yet none have really anything to do with parking.

These measures are also good for the operator as well, ensuring that the business is being operated within the guidelines and best business interests of the client.

FLEXIBILITY

Terms for leases can be anywhere from 5 to 20 years. As I’m sure most of you have experienced, lease terms in general are difficult to amend mid-term and early termination clauses can be onerous. Management agreements are typically 3 to 5 years, often with 30- to 90-day termination clauses for the client. I’ll admit, this metric is pretty much a one-way benefit for the client.

FINANCIAL UPSIDE

Another often cited reason for engaging in a lease is that it provides a guaranteed income stream. The guaranteed income logic is true, if all market and business conditions remain unchanged. And that logic is also true with a management agreement, since the income to the property owner will be steady just as with a lease.

If, however, market conditions deteriorate, and parking garage occupancy decreases due to competition or other market factors, that guaranteed income stream doesn't stay guaranteed. Expecting a third-party operator with no ownership stake in the business to come out of pocket to make a lease payment is wishful thinking. The result is either a renegotiation of the lease payment, nonpayment, or some other stalemate. Thus, the financial outcome in a down market is no different than in a management agreement.

As for upside, in a management agreement there is opportunity for both client and operator to earn more. In a business setting where both parties have agreed to a detailed scope of service, the operator is operating within the budget and abiding by the operational expectations of the owner, the business will be set up to thrive.

In a lease, payment to the client is limited to the lease payment, with the possible exception of escalations. The operator will typically earn 100% of the upside in excess of the lease payment. With a management agreement however, utilizing a base and variable management fee, every dollar of net income can be split in a variety of ways between the owner and operator. Incentives are aligned, the goals are mutual, and it is not zero-sum.

In practice, then, a lease has the same downside exposure as a management agreement and far less upside potential for the client. From the operator’s perspective, they might argue that they earn less money in a management agreement. My opinion is that view is a little shortsighted: a well-structured management agreement creates a partnership between the two parties, aligns incentives, clearly communicates expectations, and better positions the business for financial success.

When you’re deciding next time between a lease and management agreement, keep these points in mind. If you, as a garage owner, value control, flexibility, financial upside, and having your operator as a well-informed partner, strongly consider a management agreement. If you’d like to learn more or see how JDF can help in a lease vs. management agreement decision, please contact us.

Welcome to the JDF Management Consulting Blog! In this blog we’ll explore a variety of topics related to residential real estate amenities, alternative assets (parking garages, self-storage, laundry facilities), underutilized spaces, and non-rent revenue.

Our goal in this blog is to provide a new perspective for how owners, managers, and developers can think about amenities, resident retention, and non-rent revenue, while also showing what an important role these services and businesses can play in the well-rounded financial health of any property. We will also provide insights for amenities and alternative asset providers on how to improve their operations and client service. If there are any topics in particular you would like us to weigh in on, please contact us.

In this first entry I wanted to briefly outline just a few common themes I have encountered as a professional amenity and alternative asset manager. As I’ve discovered, optics and conventional wisdom can be deceiving.

1. Amenities Can Be Every-Day Functional

A big misperception about amenities, especially in a market such as New York City, is that it’s a race to the top for eye-popping amenities that can one-up your competitors. Such amenities certainly have a place in our market and do provide valuable services and value propositions to owners. But the universe of amenities is much broader and more functional. Services that address basic needs and desires such as transportation, wellness, and convenience often have little visual footprint inside a property but can play an enormous role in resident satisfaction and retention. A few big-splash amenities can’t hurt but don’t forget to look deeper into what residents really want and will really use.

2. Amenities Can Be No-Cost To Property

When I’m explaining possible amenities to my owner and manager clients, I often get questions about how much it will cost them. In many cases, the answer is nothing. Sure, if you want that state-of-the-art golf simulation room, that’s quite an investment (and one that your residents will love). But the creative offerings coming out of amenities providers these days will often be implemented at no cost to the property and sometimes will even cut in the property in a revenue share. Usually it takes a bit of negotiation to get that right deal for both sides, but the no-cost options are aplenty.

3. Contract Structure Matters – A Lot

This point is mostly related to revenue-producing alternative assets, although it’s relevant for amenities as well. When it comes to management of your parking garage, self-storage operation, or laundry facilities, typically owners and managers opt for what appears to be the low-hassle option. For parking this usually means a lease, for self-storage it means the storage company owns the units, and for laundry it means a route agreement. I’m going to write a lot more about this in future posts because I think it’s so misunderstood, but the conventional contract structures I listed above are almost never optimal for the owner or the operator. Furthermore, these kinds of third-party contracts are often seen as zero-sum: either the operator gets the additional dollar, or the owner does. Other kinds of contracts can provide a better relationship between the owner and operator and can expand the pie of income for both parties.

4. Listen To Your Residents, Build For Flexibility

The desires and needs of today’s renters seem to change every week and it’s easy to implement amenities and services that miss the mark. If you have space in an existing property, consider distributing a survey to your residents about what services they want and what services would make them more likely to renew and to recommend the property to a friend. Preferences will shift significantly with demographics, so know your resident base. And because these tastes change so frequently, think about allocating a fair amount of mixed-use flex space that can double as a yoga studio one day and a community gathering area the next. When thinking about connectivity and technology, keep in mind that today’s technology and hardware/software standards will quickly be outdated- so build with excess wiring capacity or go modular for when you want to upgrade your tech features.

5. Rent And Occupancy Are Just The Beginning

Anyone who’s taken a real estate class or worked in real estate knows that rent and occupancy are the primary metrics of residential real estate. In this blog we are going to strive to broaden the horizon into other areas that are equally as important to the health and success of a property. Amenities can lead to renewals and referrals. Alternative assets can provide significant non-rent revenue and much-needed core services for residents. Beyond rents and occupancy there are many levers you can pull as a property owner or manager that will influence your bottom line and set you apart from your competitors.

Thanks for reading our first post and we look forward to expanding on these ideas and more in future posts. If you’d like to learn more or see how JDF can assist you, please contact us.