Management Rights extension request

The true cost to the owners

• Gravy train for one is a train wreck for the other • 3% annual guaranteed increase will set owners up for financial ruin • 5 year top up, no worries I’ll be dead by then – where are the Chairman’s fiduciary duties? • Financial analysis and projection show the true cost of granting “top up” requests.

The Extension Request The extension request (known also as a ‘top-up motion’) comes to body corporate either from a caretaker who is an owner in the scheme, or through another owner in the scheme as an owner’s motion. Sometimes, the caretaker requests the extension motion to be submitted to the AGM Agenda by the committee. There is no obligation for the committee to do so, but we have heard of such cases where the (part of a) committee, sometimes without resolution, automatically obliges. The explanatory note accompanying such motion varies: but frequently it is noted that the extension represents no cost to the body corporate, this is just “standard” practice, and the benefits are manyfold. Whilst in past these requests were passed by the body corporate without much ado almost automatically (as a standard practice in the industry), they are increasingly becoming a more contentious issue, due to bodies corporate becoming more aware of the due diligence process and true impact on the owners. What to do when you receive a request for extension? The answer is actually quite simple - a committee needs to follow the standard practice of due diligence. Unfortunately, this is where many committees have failed lacking either the experience or know-how. Instead, they rely on their caretaker or their body corporate manager, who may have a vested interest, or even turn to the caretaker’s solicitor for advice! This article discusses two important focal points of due diligence for extension requests – legal and financial consequences.

The Legal Opinion As noted, we have come across the committees that are satisfied talking to the solicitor of the caretaker submitting the motion. A solicitor should not represent both parties of the same transaction for obvious reasons. Therefore, any ‘advice’ body corporate thinks it is getting is not a legal advice – just communication from a solicitor representing their client (caretaker) in the transaction. First thing – engage a solicitor that takes instructions from you as a client. Legal advice is only as good as the questions you ask. BugdenAllen Legal has issued a very handy tool kit for body corporate committees to use, which is freely available. Click here and we will send you a copy. In its guidance for committees, it states: “approach top up requests cautiously”. Two questions that a committee should always ask are: • What are the benefits of approving the top up? • What are the financial implications of approving the top up? In the tool kit it also states: “Consideration should be given to obtaining the following advice: Financial advice (assessing the long term financial implications of the extension and the value for money proposition when compared to using market based services from independent contractors.” Financial analysis To understand the financial implications the decision to extend would have on the future body corporate expenditure is not difficult at all. Just project the cost out to the new expiry date. For example, if the contract has 20 years left and a 5-year extension request is granted then it means the contract will now extend to 2045. Using a real agreement that has recently been extended with approved top up of 5 years we will discuss the financial consequences below. Noteworthy is the comment of the chairman at the AGM who said: ‘by 2045 I would likely be dead ‘ To interpret this blaze statement – the chairman was really not too concerned about the consequences for future owners Case study There are 132 lots in the scheme. The body corporate levies for this year are just over $1 million consisting of $240,000 manager’s salary, $210,000 security contract (payable to the manager) and $550,000 admin fund. Insurance and sinking fund combined for a further $100,000. The manager’s income therefore is $450,000. The security contract is in sync with the caretaking agreement and letting agreement ie it is a 20 year contract and an extension for it was also requested and approved. Total levies are $1.1 million or $8,333 per lot. Council rates $2,000 per year per lot. R&M $2,500 per year per lot. The complex is 100% investment – no owneroccupiers. Maximum weekly rental income is $800 per lot, after fees and charges it is $575 per lot. Long term average occupancy is 75% therefore weekly net rent is only $431. You also need to allow for eight weeks vacancy so annual income is approx. $19,000 net. Subtract your levies and rates and you still have a net return of about $6,000. At present due to COVID19 occupancy is 50% and next year it is expected to drop to 25%. In the year 2045 In the management and security agreement is a clause that every year it will go up by CPI or 3% whichever is the higher. Let’s assume the remainder of the levies and others increase by 2.5%. Rent has not increased since 2012 and in the short term is very unlikely to go up but let’s allow for an annual increase of 0.5% for calculation purposes. In 2045 the outgoings will be as follows: Management and Security: $ 942,000 Admin fund other $1,020,000 Sinking fund and Insurance $ 185,000 Total annual cost $2,147,000 :132 = $16,265 per lot Rates: $ 3,708 R&M: $ 4,635 Total outgoings per lot $24,608 Net Income per lot $21,523 And that is based on 75% occupancy, if the occupancy is lower then the individual lot owner will be even worse off, in the meantime though the manger is enjoying an income of close to $1,000,000 whilst you the owner will have to put in your own money to break even. Outcome of the financial analysis Note that the figures assume that you do not have a bank loan on the property, if you have a bank loan then you will be even more negative. Try now with those figures in 2045 to sell your property, see what you will get for it. What will happen in five years when they again ask for another extension and your chairman in his smug way says that he does not care as he will not be alive by then. Projecting the figures out to the end date will show the dire situation the complex is heading towards. For the owners it is a freight train very hard to stop once started, for the managers it is a gravy train – it keeps on giving. Remember the other question: What are the benefits for the body corporate approving the top up? We can see that MR holder benefits from the extension, but there are few benefits for you, the owner, so why approve it? Or, in other words: it is always prudent to say no to top-ups, unless there are compelling reasons to say yes. Ask for those reasons the submitter of the motion or the caretaker. There are sufficient case studies now that prove that going to open market can save bodies corporate anywhere up to 50% off the caretaking salary. In another article we will take a closer look at security contracts and show how the above scheme could have saved $200,000 on security alone, reducing the total cost to owners from $450,000 to $130,000. Where to next When asked for and extension, do your due diligence as a committee, and consider seeking proper legal advice from a solicitor. The UOAQ has developed extensive knowledge in this area, and we can help you with information, articles, and strategies – we have done so for many of our members. The experience we accumulate is here to be shared with other owners in the same situation, so do not hesitate to contact us www.uoaq.org.au