One of the most overlooked areas of managing commercial real estate is contract management. Commercial real estate assets typically have a lot of contracts for the various services required to run the business. Some of these contracts are shorter term and flexible, whereas others are long term contracts that could have significant financial impacts if not managed properly.
In this article, we will cover the different types of contracts involved in multifamily and how the management of such contracts is an important part of the asset management function.
Basic Service Contracts
Similar to any real estate, there are basic services to operate the property such as water, gas, landscaping, pest control, trash pickup, telephone, etc. Most of these contracts are generally flexible and can be amended/cancelled with short notice. Many asset managers rely on their 3rd party management companies to source these services and contracts, which makes sense as the management companies should have the scale to source the most advantageous services. However, it’s very important to keep a good pulse on these contracts as they are easily overlooked by management and can result in increased costs. For example, there can be various overages on trash pickups that are added on weekly, landscaping contracts are often just kept the same at takeover and not bid out, etc. Savvy asset managers can drill down into the P&L and identify services/contracts that may need to be reevaluated and renegotiated to save costs at the property level.
There are certain contracts that are often long-term and very inflexible. Some of these contracts have auto-renewal clauses that, if missed, could extend the contracts for another 10 years! Some examples of such contracts included:
- Laundry – Laundry contracts are notorious for having auto-renew clauses that renew contracts for the initial term which is often 10 years. Owners and asset managers who do not manage these contracts, can end up with surprises as the contract renews and they are stuck with old equipment, which likely results in increased downtime and less revenue.
- Electricity – Electricity contracts usually have to be assumed by a new owner. The term of energy contracts varies depending on the energy market, the intended hold period, climate, geopolitical situations, etc. and they can be fixed rate or variable. In some states, like Texas, sales tax isn’t supposed to be charged on multifamily properties, but often are and owners can be owed thousands of dollars. Given the complexity, it’s highly recommended to consult with an experienced energy broker who can walk you through the various options and develop sounds strategies.
- Cable/Internet – These vary in shape and form but generally these contracts must be assumed by a new owner. Many cable contracts have large “door” fees, which are upfront bonuses paid to the original owner and then have a smaller profit split based on penetration. Before getting into one of these contracts, the asset managers must understand the short and long term costs/benefits.
Systems to Manage Contracts:
As can be seen, the management complexities increase as the size of the asset manager’s portfolio increases. Thus, it’s imperative that a system exists to manage the various contracts. Newer owners are often reliant on management companies to lead in this role and often learn the hard way through experience. Seasoned asset managers have systems and tools that track the various contract expirations, renewal dates, etc. and prepare themselves to elicit and negotiate future bids. If systems are not in place, the assets are at risk of losing hundreds of thousands of dollars in income that will impact valuations.
Contract management is not a glamorous topic, but it’s a critical one that can impact the bottom line. We’ve seen a number of properties for sale that poorly managed contracts that must be inherited by the new buyer and can often impact valuations negatively. On the other hand, there are often opportunities that come to new buyers who have the systems in place to identify and seize the opportunities left on the table.