Key Aspects of Commercial Property Management Contracts
What is a Commercial Property Management Contract?
A commercial property management contract is a legally binding agreement between a property owner and a property management company that stipulates the terms of their working relationship. It essentially provides the framework for how everyday matters will be handled, along with larger issues, such as lease agreements, property maintenance, and tenant management.
A commercial property management contract usually includes the following aspects: By having their roles, responsibilities, and consequences for failing to carry them out clearly outlined, both the owner and the manager can feel confident that their interests are protected . This is important, because a property manager who breaches his duties (or a property owner who fires his manager while there are still several months remaining in the contract) could find themselves getting taken to court.
In spite of the likelihood of this type of contract having to be enforced in court, however, it should probably be thought of more as a roadmap than anything else, should this road be followed. The goal should always be to have a mutually beneficial relationship between the owner and the manager, so that both of you can focus on keeping the property in the best possible condition and addressing the ever-changing needs of the tenants who reside there.
Essentials of a Commercial Property Management Agreement
When engaging the services of a commercial property manager, there are a host of terms to which you and your manager must agree. These terms can fall under a number of heads, such as definitions of the responsibilities and powers of the property manager, fees and other remuneration, the duration of the contract, and termination of the contract. We discuss these below:
1. Responsibilities and Powers of the Manager
These typically include administrative and financial responsibilities, safety and security, maintenance, repair and upkeep of the property, leasing and marketing vacant units, tenant relations, rent collection, managing vendors and service providers, management and accounting for the funds, insurance, budgeting and reporting; landlord/tenant relationships; complaints and repairs; dealer leasing; and maintaining good employee relations.
2. Fees and Other Remuneration
Two typical types of compensation are a management fee based on gross rental revenue or a flat fee. The management fee can be calculated on gross collected rents, gross and pass-through rent, or some combination of both. The property manager may be entitled to reimbursement for out-of-pocket expenses (e.g., mileage, staff meals, long-distance phone calls) or to compensation for incidental expenses (e.g., postage, copying, printing). Determining whether reimbursement for out-of-pocket expenses is appropriate may depend on the amount of the expenses, the type of expenses, and the structure of the pay arrangement.
3. Term
Although not common, a fixed-term may be desirable in circumstances where two or more of the following are present: (1) the manager’s experience will be required for a finite time to address key challenges with the property (e.g., leasing up a newly-acquired property or a property that has been subject to management neglect or poor marketing efforts), (2) the market is recovering from a depressed state and the effects that a recovering market has on the market value (and, thereby, the value of the property), (3) the manager requires a degree of creativity, advisory ability, and flexibility to amend the management plan, and (4) the interests of potential third parties may be adversely affected by a change in the ownership of the property (e.g., a grocery store anchor that has leased space for decades and is concerned about a new lease agreement with a property manager that it does not know).
4. Termination
Termination provisions are often governed by the contract law of the parties’ jurisdiction. A contract lifespan is inherently limited by the duration of the manager’s license to operate the property (i.e., length of license to operate the commercial enterprise).
Duties and Obligations under a Commercial Property Management Agreement
A commercial property management contract outlines all duties and obligations that the property manager must fulfill. The property manager is then responsible for performing these acts, whether personally or through the use of a third party. A property manager has a legal obligation to act in good faith and is liable for its management acts. Managers should consult an attorney to draft the agreement and discuss their regulatory obligations to avoid conflicts of interest and other pitfalls.
The most often required property management tasks include:
Tenant Management
The duties related to tenant management under the contract include:
- screening tenants
- preparing lease proposals
- shaping the rental terms
- enforcing the rules and regulations
- collecting rents
- paying the bills
Maintenance
The contract will define how and when maintenance is performed, and will typically include:
- routine maintenance inspections
- preventative maintenance schedules and protocols
- maintenance procedures, including who performs what
- emergency repairs procedures
- water and sewer management
- elevator management
- roof maintenance and cleaning
- HVAC protocols
- landscaping
Financial Management
The property manager’s financial duties may be defined under the contract, including:
- rental payments
- other requirements
- budgets
- managing the accounting records
- recordkeeping, and
- the specific financial reports the manager is required to prepare for review.
Strategies for a Negotiated Property Management Agreement
The goal of negotiating a commercial property management contract is to ensure that the contract not only provides the property owner with the right protection in several important areas, but also creates enough incentive for the property manager to do a good job. Unfortunately, many commercial property management contracts that I see are very one-sided, and favor the property manager entirely.
First, if you are hiring a partner to manage your property, and that partner is also an owner, then it is generally not a problem that the contract is one-sided—because you want your partner to make money and do well on the property. The two of you will share in the reward (and risk) of working together. On the other hand, if you hire a third-party property management company (which is the majority of the cases that I see), it is crucial that the contract provides adequate protection for the owner, without creating disincentives for the property manager to do a good job.
An area in the contract that is of major importance is whether the management company is compensated based on equity and carried interest—meaning, if the property is sold or refinanced, the manager gets a certain percent of the sale price or refinance price. If the answer to that is "yes," then there is generally not a problem with providing the manager a straight, flat percentage of the gross rents collected as a monthly fee. This is because the manager will also have an incentive to increase the value of the property (in order to cash in their carried interest at the time of sale). However, if the answer to that question is "no," then it is important to work with your attorney to ensure that the monthly management fee is sufficient to incentivize the manager to properly manage the property.
Legal and Compliance Aspects of Commercial Property Management Contracts
One of the most important aspects of commercial property management contracts is compliance with applicable laws and regulations. Both landlords and property managers must be aware of the regulatory requirements that govern their relationship and the properties they manage.
• Common Lawlisbon: Many issues fall under common law — like the duty to make repairs in common areas — and are not necessarily expressed in detail in contracts. However, a manager that fails to uphold its obligations under common law can face breach of contract lawsuits. Common law rules can vary by state and locality, so you must know and understand the common law obligations that apply.
• Materiality of Breach:Materiality refers to the extent to which a breach of contract, if proven, would deprive a party of its contractual benefit. The common law imposes far less onerous standards of performance on a breach of contract than a tort. A trivial breach that instead might constitute a tort probably won’t rise to the level of a material breach of contract . The failure to perform a contractual duty is a material breach of the contract when a party has rendered substantially or completely inadequate performance or has failed to live up to the common law standard of good faith and fair dealing. When a material breach occurs, a party may sue the other for damages. The other party to the contract will not be able to recover damages from the first party for his breach of the contract.
• Local Laws: Local laws add even more complexity to commercial property management contracts. For example, a property manager must sign contracts with service providers in accordance with local ordinances and must have a valid license to engage in management activities for compensation. A landlord who fails to comply with local laws can be found liable for statutory damages. Local laws impact not only the terms and conditions that can be included in a commercial property management contract, but also the manner in which both parties perform their obligations.
Common Issues with Commercial Property Management Agreements
Common challenges in property management contracts are not always obvious but must be anticipated. Sometimes property managers and property owners are not particularly well-matched and the result is a bumpy relationship. Other times, it is simply not possible to foresee the issues that may arise. Regardless of the circumstances, some of the likely causes of disagreement should be addressed in any contract for property management services.
One issue likely to cause disagreement is the level of service. It is a good idea to identify in the contract how obligations are to be handled. For example, if the management company will be providing janitorial services during its normal working hours, the extent of those services should be specified. "Reasonable" or "decent" is not a description that is likely to be helpful.
With respect to supervisory or technical services, these should be similarly defined. For example, if the management company is providing engineering services or once or twice daily visits to monitor operation of co-generation equipment, it should be specified. The problem often arises when the manager has no familiarity with the equipment, especially if there are older buildings with unusual equipment or systems. Management should not be responsible for supervision of equipment that it does not know how to deal with on a daily basis. And, it should not be responsible for making decisions on such systems unless it has some comfort level of the operations. If, for example, the engineer who is responsible for the building is to be backed up by the management company, the comfort level should be identified. Will the engineer have a back up?
Disputes will also likely emerge with respect to what is a "reasonable" cost. For example, what if the manager has been suffering through twenty percent vacancy for three months when the landlord wants a foundation crack repaired that may not be the most important job at the time? Similarly, the management company is entitled to payment for its services. What if the landlord is going through a cash crunch? In that case, there should be a mutual right to terminate on some stated period of notice.
In any event, if it is clear that the parties are not gelling, it may be best to proceed by termination rather than expecting conflict to subside and communication difficulties to magically end.
Emerging Trends in Commercial Property Management Agreements
As the commercial real estate sector evolves, the expectations around property management contracts are also on a transformative path. Digital transformations are reshaping how, when, and why properties are managed, and as innovative technologies make their mark on the industry, the components of a solid property management contract now often include provisions that accommodate future advancements. Some aspects that are receiving more attention in the context of evolving contracts include a focus on sustainability efforts, which not only can have a positive impact on the environment but can also offer significant cost savings. Energy benchmarking is one of the most crucial components of sustainability and is emerging as a top property management consideration, as building owners and tenants expect short and long-term energy efficiency goals to be a mainstay of their property management contracts. The 2019 Energy Benchmarking Guide for Commercial, Industrial, and Institutional Buildings outlines energy benchmarking requirements of the Toronto Environment and Energy Division and City of Toronto proposed mandatory energy benchmarking and reporting framework for buildings over 10,000 square feet. Energy benchmarking is expected to take the following forms:
Similarly, green building certifications continue to gain traction in the property management space and have become an integral aspect of many transactions. As ESG (environmental , social, and governance) factors are becoming more prevalent in the property leasing industry, the adoption and recognition of green buildings and certifications is an indispensable part of the landscape. Among others, the BOMA BEST (Building, Owners and Managers Association) and LEED (Leadership in Energy and Environmental Design) certifications are gaining traction, with developers and institutional investors increasingly focusing on net operating income from green-certified assets. Like other certifications, these green certification approvals require continuous performance monitoring to ensure compliance and so they can be renewed over time. The reflection of changing tenant expectations, including preferences for wellness elements and high-performance building design, within a property management contract will not only satisfy the present requirements of tenants and building managers but will also position the asset for long-term growth. Lastly, as the cultural yearning to reduce paper and waste continues, the property management contract will inevitably set forth an increased mandate for both lease and contract management to become smarter and more efficient via digital capabilities. Although some companies have already made this digital transformation, in the coming years, we expect to see this become a requirement, in particular for commercial landlords and their prospective tenants.