Shared ownership reversionary portfolio transactions: The management dimension – ignore it at your peril
Shared ownership reversionary portfolio transactions (SORPs) have become a hot topic in the affordable housing market – for registered providers (RPs) and institutional investors alike.
Typically involving the sale of a portfolio of the reversionary interest in shared ownership homes by a not for profit RP to an investor backed for profit RP (FPRP), the model conventionally sees management of the portfolio being retained by the RP under a management agreement (MA). Such arrangements are often seen as providing comfort to residents, ongoing work for housing management staff and, importantly for the investor, a skilled resource familiar with the portfolio.
Whilst a lot of attention is necessarily focussed on the sale, it is vital that the management arrangements are not overlooked. When the initial euphoria of transaction close has passed, it is the MA that underpins the relationship between investor and RP. Typically lasting between five and 10 years, the management agreement can make the difference between a strong relationship based on clearly understood principles and risk allocation and one which is not. The former is good, the latter to be shuddered at.
So, what are the things to think about? There is a long list, but some headline points are:
Counterparty – who is the manager going to be? The selling RP or a member of its group? This will influence matters such as where liabilities sit, the vires analysis if the RP is a charity, the extent to which group insurances cover the arrangements and, to the extent that the management vehicle is an SPV, how it is going to discharge its duties under the MA (are internal service agreements required?) and the level of comfort the FPRP will require as to its financial covenant.
Timing – the MA needs to go live on the same day as the sale closes. This means that it will have to be negotiated in parallel. It is important that you have sufficient internal resource allocated to that exercise and that the negotiation team is joined up with the team negotiating the main transaction. There will be points of crossover, particularly in leasehold structures where the manager's actions have the capacity to impact on the FPRP's obligations to its superior landlord.
Section 20 – the MA (if not properly dealt with) has the capacity to be treated as a Qualifying Long Term Agreement for the purposes of section 20 of the Landlord and Tenant Act 1985, giving rise to a risk of service charge recoverability if the MA exceeds 12 months in duration. To ensure those risks are mitigated, careful thought needs to go into what assets and services the management agreement is going to cover (dwellings and/or wider estate) and the manner in which costs arising are going to be recharged to leaseholders.
The analysis will vary depending on the nature of what is being acquired – the FPRP's obligations (and the service charge position) will be different across freehold or leasehold blocks or houses subject to shared ownership leases. If, as is common, the SORP is accompanied by a pipeline deal, consideration also needs to be given to the future management treatment of those pipeline dwellings.
Pricing – insofar as views have been taken by the RP seller as to the value of the long term income deriving from the MA and the basis of remuneration, thought needs to be given to matters such as which services are within the fee and which outside, what happens if the FPRP wants to change the services or add or divest properties. Is there a floor below which running the MA becomes uneconomic and how should remuneration for subsequent pipeline properties be addressed? Is a mobilisation fee required or compensation on early termination appropriate if the FPRP sells the portfolio on?
Investor relations – information security; financial crime; system adequacy and good data are important issues for any investor backed FPRP and will result in significantly wider "asks" under the MA than many RPs will be used to. In many cases, those requirements will need to be discussed with internal teams to ensure that they can be delivered on. Experience shows that those discussions can significantly add to the timescales in getting the MA agreed and need to be addressed early in the process.
Contract – the MA is a commercial contract with real obligations on the manager and a very commercial counterparty with high expectations on delivery and an important brand to protect. It is vital that the manager is clear about what its obligations are and what it is being paid to do. It is equally important that it is clear about what it is not being paid to do – "obligation creep" is something to watch in these types of agreement. The RP is no longer the landlord, it is a contractor and the extent of its obligations start and finish with the MA. That can be difficult conceptually and practically and – particularly if the new landlord's policy or approach differs from that of the seller in respect of its retained portfolio –needs to be recognised and reconciled early.
Corporate buy-in is key – the MA will require involvement from almost every team in the RP – finance, legal, HR, asset management, sales, IT, corporate services to name but a few. That involvement will be needed as part of the negotiation process and during the agreement's life – building understanding of the MA's requirements; ensuring those requirements can be met and what the consequences of non-performance are (financial, legal and reputational) takes time and needs to be committed to at the start of the SORP process.
Risk – as in any contract, there needs to be a clear allocation of risk across the MA. All the normal risks in this type of arrangement need to be dealt with – underperformance, breach, force majeure, indemnities, change of law etc – but attention also needs to be paid to a matter peculiar to affordable housing – regulatory risk. How are new consumer standards to be dealt with in the MA; who is responsible for TSM reporting; what if there is divergence between the FPRP's approach to a rent cap and that of the seller; who bears the cost of professionalisation; what obligations have to sit with the FPRP and what can legitimately be delegated to the manager?
The MA is very far from a simple document – it sits at the heart of the long term relationship with the FPRP, is key to its relationship with its leaseholders and carries reputational risk for both parties. It needs to have the same degree of focus as the SORP transaction itself and absolutely, definitely and incontrovertibly should not be left to the last minute to deal with.