What is the true value of a management agreement?
Having recently concluded three consultancy projects involving management agreements (MAs) with operators in situ, I am compelled to share my insights into their genuine worth. Well-crafted MAs offer significant benefits, and my recent experiences have solidified my views on how their value can be accurately assessed. Below, I explore this versatile tool’s merits and suggest a framework for its valuation.
The value of management agreements
To illustrate the practical value of MAs, consider three distinct projects I’ve recently completed:
A lease that evolved into an MA
An MA that transitioned into a lease
An MA that was refined into a stronger MA
Notably, two of these cases involved a smooth operator transition, ensuring uninterrupted business operations – a testament to the adaptability of MAs.
Case 1: from lease to MA
The first example involved a 15-year lease nearing its end. Both the property owner and operator opted for a five-year MA instead of renewal. This short-term arrangement ensured continued income and occupancy for a building requiring substantial upgrades – works neither party was eager to undertake immediately. The MA proved ideal, aligning their interests in maintaining the property’s revenue stream without long-term commitment.
Case 2: from MA to lease
The second case centred on a landmark city-centre property, five years into a 10-year MA. The arrangement was underperforming, delivering suboptimal net returns to the owner. Upon review, we confirmed the business was profitable and sustainable, yet the MA’s structure unfairly favoured the operator, who enjoyed excessive returns. After failed renegotiations, the MA was terminated. A new lease was granted to a national operator eager to enter the market, and the business was seamlessly transferred as a going concern. This shift maximised returns for the owner while leveraging the operation’s underlying strength.
Case 3: from MA to enhanced MA
The final example involved an outdated MA that failed to motivate the operator to boost income or control costs. While it delivered a market-level return, it had stagnated. We replaced it with a new, market-driven MA with a national operator incentivised to enhance profitability. In exchange for a fair profit share, the operator quickly improved performance. The transition was smooth, with no loss of income, and returns soon aligned with market expectations.
What ties these examples together?
These cases underscore the flexibility MAs provide. Unlike traditional leases, MAs allow owners to avoid being locked into underperforming arrangements. They enable swift repositioning with new operators under better terms, opening opportunities for high-performing operators to access properties previously unavailable due to significant capital expenditure barriers. Moreover, as seen in the MA-to-lease transition, MAs allow owners to explore market alternatives, securing higher rental returns and long-term income when the business is robust and well-controlled.
Valuing management agreements
Despite their advantages, valuing MAs remains a contentious issue. Originating in the hotel and trading sectors, these valuation principles have yet to gain widespread acceptance in the office and flexible workspace markets. However, the MA-to-lease case offers a compelling foundation for a reliable valuation method.
The key lies in balancing the owner’s control over the business with the operator’s autonomy to manage it effectively. Essential to this are two elements:
Ownership of the licensees (managed by the operator as the owner’s agent).
Ultimate ownership of Category B fit-outs and furniture, fixtures and equipment (FFE).
With these in place, the business can either be transferred to a leased operator – as demonstrated – or valued hypothetically. The valuation process begins by calculating the net EBITDA of the operation, excluding the operator’s management fees and profit share. This figure is then adjusted to allow the operator a market-standard profit margin (reflecting their risk and reward) after paying rent.
The rent itself can be calibrated – either increased or decreased – to reflect the level of security an operator would need to commit to a fixed lease. This “reverse-engineered” rent line is then capitalised using a market yield, adjusted for covenant strength and typical market factors. Ongoing capital expenditure can be accounted for either as a minor yield adjustment or an amortised cost in the profit-and-loss statement.
This approach, grounded in a real-world transaction, moves beyond theory. As operators increasingly repurpose flexible workspaces, I anticipate more deals adopting this valuation framework.
Conclusion
Management agreements are powerful tools, offering unmatched flexibility and control. Their true value lies in enabling owners to adapt swiftly to changing circumstances while maximising returns. Moreover, with a clear and tested valuation method, MAs can be appraised with the same confidence as traditional leases. As the market evolves, their prominence – and proper valuation – will only grow.
