Unit Owners Association of Queensland Inc

Presented at: "Strata and Community Title in Australia for the 21st Century III Conference"
Presented by: Howard Stewart

The subject of this particular paper is “Ensuring correct deployment of management rights”

This morning you have discussed

• the local government issues that significantly determines what sort of property will host the strata title management system;
• planning for effective strata titled tourism accommodation that determines the envelope within which the strata title management systems must operate;

However, before we can discuss “Ensuring correct deployment of management rights” we all need to understand how “management rights” have evolved, who it is that creates “management rights” and what are the constraints that shape or guide the process.

I am sure most of you are familiar with the strata title regulatory framework.

However, just to briefly recap, even though it is different in each State in Australia it is essentially the same. It is the strata title regulatory framework that not only regulates the creation of freehold strata titles for apartments within the Torrens system but also:-

• creates a body corporate to control, manage and maintain the common or community property; and it turn
• regulates the obligation of the body corporate to:-
  • manage itself as a legal entity; and
  • manage the building and the common property.

However, even though we have all of this regulation, it is the developer, within these legal constraints, who decides how the property will be managed.

At the time the developer creates the strata titles and the common property he creates the body corporate.

Because the developer owns all of the strata titled lots the developer becomes the member of the body corporate for each lot. The end result is that the developer has 100% control of the body corporate even though it is a separate legal entity. This unique situation allows the developer to cause the body corporate to enter into agreements and arrangements for the purpose of managing itself and the property.

It is appropriate that he should be allowed to do so.

After all, the developer is the one taking the development risk. The developer has to take his product to the market.

The product I refer to is not just the units on offer but also the community property, the facilities as well as the manner in which the property will be managed and operate.

When the developer sells the “off the plan” apartments or lots in a project he represents to the prospective purchaser just what it is that they are buying, including the manner in which the building will be managed.

The developer must be able to deliver the product he has declared in the “Contract of Sale”.

History

In the 1960/70 era developers saw great benefit to unit owners in having their building managed by someone on site, a person who had a commitment to the building because they owned a unit in the building. Over time it was realised that if that person also managed the letting they could better manage the tenants. There was a secondary benefit in so far as the cost of “onsite” residential management was not only 24 hour, 7 day management, but because it was subsidised by the letting income it was more efficient and cheaper that “off-site” management.

Over all it was a package that had great appeal to unit owners and hence it helped the developer in their primary objective – sell as many units as quickly as possible for as much money as the market will stand.

The result was that the developer wanted this system.

It was a good system. It was a win /win all round.

So, what has changed over the past 25 years or so?

The answer would appear to be complex but is in fact is quite simple.

The agreements that reinforced the position of the manager became known as “Management Rights”.

As can be easily interpreted from the name “management rights”, the managers have sought and have been given:

• a protected position;
• a protected income; and
• an entrepreneurial income from letting units.

Such an “advantageous” arrangement became much sought after by prospective managers. They were prepared to buy, and pay good money, for “Management Rights” that offered these arrangements, all secured by a long term binding agreement.

The friends of business & commerce, the banks, recognised that there was room for them in these “management rights” arrangements, but only if there were agreements with a significant term remaining. In the current offering, the banks now offer finance to the purchasers of “management rights” to the extent of 90% of the value of the designated manager’s unit and 60% of the value of the “management rights” business.

Developers quickly realised they could create a new profit centre in their developments selling “management rights” which in turn reduced their development risk.

Because the principal drivers of the value of “Management Rights” are term and income, what is wrong with developers offering increased guaranteed income to the prospective purchasers of “management rights” and, to go even further, giving them the right to get it forever?

The outcome is that, over time, the term and management income has been pushed to the limit that the market will stand without interfering too much with the rate of sale of units.

The Government thought that these arrangements required regulation. The current regulation, which is common in most States in Australia, is primarily geared towards declaration of these

arrangements by developers in contracts of sale and limiting the term of the management agreements to 10 or twenty years.

For those of you who are not aware, here in Queensland in particular, “Management Rights” are valued at 4.5 to 5 times what they earn. There has been an increase over the past few years. It has increased from 3.5 to 4 times their earning capacity. This recent increase in the multiple has been fuelled by falling interest rights.

It is not uncommon for a purchaser to pay $M2 to $M3 for the “management rights” in a reasonably sized accommodation building.

These purchasers borrow $M1.5 or more to assist with the purchase.

These same purchasers pay $130,000 or more, each year in interest. The interest payment is sometimes more than the body corporate fee for caretaking, cleaning and gardening.

“Management rights” have not been restricted to larger buildings.

The current scenario is that one size fits all as many developers rush to the crock of gold created by introducing “management rights”.

The outcome is that developers are increasingly using long term contracts for Community Title Schemes where they are inappropriate. There are currently thousands of management rights, particularly in Queensland.

Where has the deployment of “management rights” been inappropriate?

It has been the general rule that buildings with 25 units or more can support “management rights”.

It has not mattered whether the building is primarily for use as a residential building or as a short term rental or holiday building. The only criteria have been whether or not the cost of “management rights” can be supported within “affordable levies” for the lot owners.

This is failed logic.

If the services are not tailored to suit the scheme and the occupants, then serious discontent will be common amongst lot owners that will ultimately bring change, but only after a lot of unhappiness, anger, sorrow and loss.

The number of lots is not the only issue that drives discontent with “management rights” within schemes.

Consideration of the following will illustrate where “management rights” are destined to falter:-

• Identity and design of the building and the scheme
• Appropriate description of the role of management
• Match of management responsibilities to the needs of the scheme
• Definition and classification of duties
• Appropriate letting management arrangements

Identity and design of the building and scheme

There are many schemes where there is poor definition of the purpose of the scheme. The regulation prohibits bodies corporate from interfering with a lot owner’s right to devolve their lot. Therefore the body corporate cannot designate a scheme as a “Permanent” or “Resort Rental” scheme.

Mixed permanent and holiday accommodation

Many of these schemes exist particularly on the Gold Coast. Resident lot owners contest with letting lot owners. They contest over building security and use of facilities. Resident lot owners do not like holiday renters who want to play and party.

Managers make more money from holiday rentals and therefore the role and economic imperative of the manager is seen to be opposed to the interests of permanent residents.

Conversion of “use” of apartments within schemes

Several major city schemes are sold and settled for permanent occupation of lots, however, the manager has induced many letting lot owners to purposely convert their apartments into short term rental accommodation.

It is a simplistic solution to change the regulations to limit use of apartments to a maximum of three months. Be assured that this will not work!

In some parts of Queensland and New South Wales, Local Authorities have introduced three month use restrictions within defined areas. The outcome is mass discontent. The valuation profession has dropped property valuations by as much as 30% because of these restrictions and banks have curtailed their lending on the properties with these restrictions.

A strata title scheme that is conducive to “management rights” is one that is well defined in its purpose where the defined use is overtly supported by the facilities, services, scheme regulations and management obligations and duties.

Layered Schemes designed to satisfy development in priority to management

Many layered schemes have multiple bodies corporate that fit into a layer within the scheme that have been introduced into the scheme design for staging purposes. These schemes are difficult and inefficient to manage because different bodies corporate within the scheme can be small in lot numbers yet similar in building design and use. These inefficiencies are compounded when the bodies corporate appoint different managers.

It is also common to impose generic management arrangements on to the various bodies corporate when they are different building types with different uses. This is often inappropriate.

These layered structures with multiple bodies corporate can encourage disharmony between member bodies corporate. E.g. “We V’s they”

A layered strata title scheme that is conducive to “management rights” is one that has been designed to minimise the number of schemes into practical management enclaves that are grouped with complimentary management needs.

Appropriate description of the role of management

Very few schemes, if any, set down appropriate objectives for the scheme in the Community Management Statement nor do the schemes describe the role the manager is expected to play to satisfy the objectives of the community scheme.

This is a great pity because such a mechanism would be a very worthwhile opportunity for the developer to communicate to the prospective members of the body corporate just what they could expect from the product that the development process is expected to deliver.

An objective statement and role description for the manager would also help form the basis for an ongoing scheme management plan.

In the absence of these type of statements there are many and different perceptions in the minds of the stakeholders. This in turn leads to confusion and disappointment.

There have been many instances of occupants in buildings having the perception that managers are there to cater to their needs and difficulties. They often expect the manager to respond to their needs in the same way as the manager does to a tenant that he is managing on behalf of a lot owner.

A strata title scheme that is conducive to “management rights” is one where there is an appropriate description of the objectives of the scheme and a role description for the manager.

Match the manager’s responsibilities to the needs of the building

One of the obvious weaknesses in the “management rights’ system as it has developed is the way the value of the “management rights” is driven by the income secured pursuant to the management contract.

In the more complex schemes is much more appropriate that the manager supervise and administer the operation of the building and the work of cleaners, gardeners and other trades within the building.

However, because the value of “management rights” is determined by a multiple of contracted earnings, there is a temptation on the part of the developer to disregard the good sense for proceeding in this direction. Developers usually attempt to gross up the income and introduce agreements that oblige the manager to not only supervise the duties but to perform them as well.

Besides the “conflict of interest” issues it is almost impossible to predict accurately a just recompense for a broad spectrum of duties as in this case.

It also deprives both the body corporate and the manager from effectively varying the duties on an as need basis.

A strata title scheme that is conducive to “management rights” is one where the manager’s responsibilities are designed to match the most appropriate way to manage the building.

Definition and clarification of duties

Many of the thousands of “management rights” agreements that are in place are generic and have not been drafted specific to the building.

They often refer to the servicing of equipment that does not exist in the building and to duties that are un-necessary.

Many of the duties described in the agreements are vague, unclear and non-specific.

In many of these cases the manager will interpret the duties in a way that is “at odds” with the interpretation of the body corporate. In turn a new manager or a new body corporate committee will interpret the duties differently.

A strata title scheme that is conducive to “management rights” is one where the duties of the manager are building specific and one where clear descriptive schedules of duties are included in the management arrangements and documentation.

Appropriate letting management arrangements

The arrangement for the management and letting of apartments for and on behalf of lot owners is rarely understood by lot owners and other stakeholders in community title schemes.

These agreements simply give the owner of the “management rights” the exclusive right to conduct a “letting business” within the scheme.

It does not mean that others cannot let apartments within the scheme. What it does mean, however, is that they cannot establish a business that provides “letting services” within the building.

Again these agreements do not set down the objectives of the letting management to be provided.

Further, these letting agreements no not provide for the manager to be accountable to the body corporate to provide an ethical, diligent, competitive, lawful and honest service to the letting lot owners that want to avail themselves of that service.

Managers refuse to be accountable to bodies corporate for the services they provide.

Managers provide and / or impose a variety of schemes onto their letting lot owners. A significant number of lot owners are dubious about the letting management operations but feel powerless or too intimidated to do anything about it.

Cases like the “Phoenician” have convinced many lot owners that complaints to the Auctioneers and Agents Committee takes an enormous amount of effort but is of no value.

The corporatisation of “management rights” has also demonstrated that bodies corporate have no control over who will be their manager or what style of operation they will be offered.

From my own experience I know these deficiencies are the cause of seething discontent. Many of these agreements will not be renewed when they expire.

A strata title scheme that is conducive to “management rights” is one where the letting agreements provide for the manager to be accountable to the body corporate to provide an ethical, diligent, competitive, lawful and honest service to the letting lot owners that want to avail themselves of that service.

What steps should be taken to prevent the establishment of long term “management agreements” in schemes where they are not likely to be functional and result in protracted and unhealthy tension between owners and the manager?

Consideration has to be given to the value that is now attributed to “management rights” as a business.

Not only is it the case that bodies corporate despise the large sums of money that are derived from the lot owners, that these moneys are in turn paid to the lending institutions as interest, instead of being spent on their building, it is now also the case that so few good potential managers can afford to purchase “management rights”.

The corporatisation of “management rights” has left lot owners with no affinity or empathy for their corporate building manager. Where the “management rights” have been corporatised the lot owners do not think they are taking away the manager’s superannuation if they refuse to extend or terminate the “management rights”. They did think that way when their managers were a “mum & dad” show but not when it is a corporation.

Those consequences will be felt over time, but it will be some time.

The management industry will see that coming as time goes on and it will affect values.

Developers do contribute considerable value to the management of the building under these “management rights” schemes and are recompensed for it through the manager purchasing the “manager’s unit”.

Thought should be given as to how the developer can be compensated for the bricks and hardware that is provided for the better management of the building.

If the market dictates that he cannot re-coup by increasing the sale price of all apartments in the building then there has to be another way, otherwise it will not be viable to develop these buildings.

Introducing a Tourism Module

This does warrant research, but not to restrict the use of apartments.

The impact of the adoption of this strategy by the Redland Council and its impact at North Stradbroke has already sent dire warnings on the impact this strategy can have on values.

The better approach would be to seriously consider what design features, services and operation issues reinforce a building as a tourism accommodation building. Call these things ‘tourism infrastructure’. The tourism module would be an opportunity to provide that the tourism infrastructure could be fixed into these buildings.

I believe an approach would have many advantages and few disadvantages. Buildings with tourism infrastructure:

• Would have a higher level of appeal to tourists
• Would achieve higher rental returns on units for lot owners
• Would attract named “Hotel operators”
• Would have less appeal to permanent residents

What would be the differences in a building with tourism infrastructure?

• Compact apartments
• Titled apartments without kitchens and laundries
• Built in services for the provision of in room entertainment services and computer services
• Provision for food and beverage services
• Higher levels of facilities such as pools and spa
• Dispense with individual apartment metering for power, water etc.
• Common provision of Furniture and fitout
• Fewer Car Spaces.

In summary, the focus of this presentation has been to recognise that there are multiple defects in the “management rights” system that are a consequence of historical evolution.

There is advice as to how some of these inherent defects can be managed.

“Management rights” are not going to disappear. They will continue to evolve as they have done since the 1970’s.

There is no doubt in that we should encourage the appropriate use of “management rights”. We should encourage the introduction of regulation that will encourage a more appropriate use of “management rights” in these buildings.