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2016 Issue Two

Big Picture Issues in Property Management Agreements

By: Kate Glaze and Bri Simpson

Running the day-to-day operations of your real estate entity can bring a host of challenges that you may not have the time, ability or desire to deal with internally. Many owners of multi-family (and other) properties enter into Management Agreements to outsource many functions of owning a multi-family investment. But these agreements require a great deal of forethought if you want them to help you increase efficiency, shift risk and utilize expertise.

A well-thought-out Management Agreement will help you define the roles, responsibilities, and outcomes expected by both parties. This is crucial to ensuring a positive working relationship. While it may be tempting to simply sign whatever agreement the management company hands you, a good bit of thought and consideration will almost always be an excellent return on investment.

In every Management Agreement, there are five primary areas of concern that are addressed by multiple contract provisions: (1) risk-shifting, (2) self-dealing, (3) expertise, (4) money matters, and (5) cooperation with lenders. Discussing each category internally before negotiating a Management Agreement can help generate an agreement that accurately reflects the parties’ expectations.

(1)  Risk-Shifting

Risk-shifting is one of the most important aspects of a Management Agreement. The two most common ways to shift risk  are insurance and indemnity provisions.

The type and extent of insurance required in the Management Agreement should be tailored to the services provided by the management company. For example, the policy limits should be higher for a management company that is undertaking repairs, marketing, and evictions, whereas a smaller policy may be sufficient if the management company is simply handling rent collection and maintenance. It may be necessary for the management company to maintain a policy that covers data privacy if the management company controls or manages an online platform that stores tenant personal data.

An indemnity provision also shifts risk. The management company will generally indemnify the owner for claims made by third parties (like tenants or service providers) that result from the manager’s negligence.  Owners can sometimes negotiate for the manager to indemnity the owner for the owner’s own negligence (which requires certain specific legal language), most commonly when the manager is controlling most aspects of the property.  It is important to recognize that an indemnity provision is only useful to the extent the party bearing the risk has the financial wherewithal to pay for damages incurred.

(2)  Self-Dealing

Often, a management company will want the flexibility to offer other services.  The management company may also have a repair company, or roofing business, or offer janitorial services. Self-dealing is not always bad—the related company could be the best or offer lower prices, and co-ownership can streamline communication.  But if an owner is going to allow self-dealing it should protect itself by requiring a bidding process and written owner consent before the manager can hire a related company to provide services to the property.

Management companies typically manage more than one property, so the owner might also consider including restrictions on where the management company can compete. This can be done with a non-compete agreement. This is particularly important when the management company is responsible for marketing the property. Non-compete agreements will need to be carefully drafted to ensure it is enforceable. It may also be necessary to include confidentiality clauses regarding information such as customer lists, referral sources, etc.

(3)  Expertise

You’re outsourcing because you want to delegate tasks to someone who knows what they’re doing—so it’s important to ensure the Management Agreement specifies what kind of expertise the management company is expected to have. Even more importantly, you want to ensure the management company is acting on the basis of the expertise. This can be accomplished in provisions that address the standard of care, and is particularly essential regarding repairs, representations in marketing materials, eviction policies, and other highly regulated areas.  Ultimately the owner needs to have an enforceable contract with a clear standard of care that it can enforce if the management company is not living up to that standard.

(4)   Money Matters

This is an area where disputes often arise. It’s very important to highlight what financial burden each party will undertake, what financial targets the management company has, and how compensation for the management company will work.

This can include adding a provision for an operating account where the owner keeps a “retainer” of funds available for limited expenses. The owner may want to limit types of repairs or expenses the management company can undertake without prior authorization. Similarly, an owner may want to participate in the negotiation of service contracts or recurring repair contracts that cross certain financial thresholds.

It’s important to ensure there are provisions regarding the method of accounting, the owner’s right to inspect or audit the books, and the location of that information.

Compensation is an area subject to vigorous negotiation. The important thing is to ensure that all parties are clear on the definition of gross receipts. The contract should clearly describe what expenditures are not reimbursable expenses, such as costs attributable to gross negligence or fraud, training expenses, or services the manager has chosen to outsource that the manager could have otherwise undertaken.

(5)  Cooperation with Lenders

The Management Agreement must align and be consistent with any loan documents affecting the property being managed.  If the loan documents require a certain lease form, the Management Agreement must require that same lease form.  If the loan documents require regular reporting, the Management Agreement should mirror those requirements.  If the loan documents permit the lender to request certain estoppel certificates, then the Management Agreement should permit the owner to require the same ones from the manager.

A property owner should therefore talk through the business concerns that arise under each of the following areas of concern with their attorney: (1) risk-shifting, (2) self-dealing, (3) expertise, (4) money matters, and (5) cooperation with lenders.  Once the attorney understands the business priorities and the property, he or she can draft or revise the Management Agreement to address the key concerns and set the parties up for a successful, long-term relationship.