Enhancing Value through Ongoing Management Chapter 21: Enhancing Value through Ongoing Management Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Why is Management So Important? Making good property acquisition & development decisions is important because they cannot be undone easily or costlessly But what about after a property is acquired? Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Why is Management so Important? Ownership of RE puts investors in business of providing rental services—which is extremely management intensive Owners-or their agents-must repeatedly make management decisions that affect the value of property & investors’ return on equity Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Compare to Public Stock & Bond Markets Unlike many publicly traded stock & bond investments, the going-in & going-out transaction costs of commercial RE investments are high Thus, investor IRRs are usually maximized by holding assets for longer periods Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Compare to Public Stock & Bond Markets Also, the majority of RE return come from periodic net rental income, not from price appreciation Thus…… commercial RE returns are significantly affected by how well the ongoing asset managment function is performed Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Two Categories of Management Decisions Those that deal with day-to-day rental operations i.e. “property” management Those that deal with the physical, financial, or ownership structure i.e. “asset” management Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Functions of a Property Manager Marketing the property Leases are perishable assets that must be replenished Who should market/lease available space Apartment properties? Office buildings & shopping centers? Independent broker In-house leasing agent Property manager Independent licensed sales associates (working for a licensed broker) usually paid on a commission basis Commissions typically equal a % of the face amount of lease Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Functions of a Property Manager Selecting tenants Importance of “willingness & ability to pay” “Credit” tenants Tenants (corporations) with an investment grade rating Vast majority of potential tenants are not credit tenants Tenant mix Signing leases Collecting rent Property expenses paid out of rental income Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Functions of a Property Manager Repairing & maintaining property Objective? Maximization of market value Comprehensive maintenance program Importance of being proactive Aids tenant relations Maintenance as an investment decision PV of benefits versus cost Qualitative vs. quantitative decisions Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Functions of a Property Manager Communicating with owners Maintaining tenant relations Complying with landlord-tenant laws Designed primarily to protect households renting apartments & other residential properties Governed by state law Attempt to level the playing field between owners & renters Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

All States Have Landlord/Tenant Laws Designed to Protect Tenants Establishes a more equitable relationship between residential landlords and tenants Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Landlord & Tenant Relations Landlord’s obligation to make repairs Tenant’s obligation to preserve the premises Landlord’s right to inspect Landlord’s right of entry Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Landlord’s Access to Unit Landlords may enter a premises to: Reasonable notice Make repairs Inspect Show the unit 12-hour lead time 7:30am– 8:00pm Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Notice is not required for emergencies Emergency Access Notice is not required for emergencies Smoke/fire Water leak Security system Storm damage Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Property Management Agreements Exhibit 21-2 Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Agency Relationship Management contract creates an agency relationship owner (principal) & manager (agent) Empowers manager/agent to serve as owner’s fiduciary in matters related to mgmt. of property words & actions of manager are binding on owner Agent has a legal obligation to exercise care in managing both money & property for owner Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Property Management Fees Typical property management fee? 3-8% of gross rental income What about incentive compatibility? Does manager have an incentive to control/minimize operating expenses? What about basing management fee on net rental income instead of gross? Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Who Hires Property Managers? Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Professional Associations & Designations Many professional & trade organizations exist Institute of Real Estate Management (IREM) Building Owners & Managers Association International (BOMA) National Association of Residential Property Managers International Facilities Management Association Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Professional Associations & Designations Provide professional education & work to enhance status of professional property managers by promoting conduct & performance standards offering professional designations Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Professional Associations & Designations IREM Certified property manager (CPM) Accredited resident manager (ARM)—for those specializing in apartment buildings Accredited management organization (AMO)—awarded to management companies Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Professional Associations & Designations BOMA Programs aimed primarily at owners & managers of office buildings Real property administrator (RPA) Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Property Management: Just One Aspect of Asset Management Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Asset Management Functions After property is acquired, asset manager must: Monitor & control operating performance Site visits, CAPX budgets, property tax assessments Report value-enhancing opportunities for rehabilitation, historic preservation, modernization, & conversion Suggest strategies for lowering owner’s cost of capital Be aware of opportunities to restructure equity ownership Continually reassess buy vs. hold decision for owner Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Performance Evaluation and Compensation During 1970s & 1980s, investment/asset managers’ compensation typically based on % of assets under management (AUM) 0.50 to 1.50% This produces clear agency problem Managers have incentive to acquire & hold assets for principal as sales reduce fee But investors’ returns may not be maximized by continuing to hold Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Recent Trends in Compensation? Industry is moving to including performance-based compensation for asset managers Fee tied directly to portfolio performance Owner & manager must agree on the performance benchmark actual performance of agent typically evaluated over period of management contract (typically 3-5 years) Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Managing Corporate RE Assets Non real estate corporations own trillions of dollars of RE Storage facilities, retail outlets, warehouses, office buildings, etc. These assets often account for 25-40% of total assets of large industrial firms. Historically, little effort has been expended to manage these assets Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Managing Corporate RE Assets Corporations beginning to pay more attention In-house real estate management personal Asset management consultants Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Managing Corporate RE Assets Issues/required work: Site analysis Buy vs. lease decisions Acquisitions and dispositions Portfolio refinancing Facility management Property tax appeals Sale and leaseback arrangements Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

End of Chapter 21 Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.