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228 Part IV:Day-to-Day Ownership and Operations
You’re in denial regarding problems
Say, for example, that your significant other stops calling and replying to your e-mails. And then your birthday passes without even a word or gift. Is the writing on the wall? It sure is! You must have messed up somewhere and now he or she is trying to get rid of you! In situations like these, you can’t be in denial; you have to face the truth.
The same goes for real estate. When you start having problems with a prop-erty, something has to be done. Simply ignoring the problems or denying that they’re there won’t make them go away. Even your authors have fallen prey to denial. Just remember that the denial of property problems is a major cause of property failures. Here are some of the most commonly denied symptoms:
U Poor curb appeal: The most important part of keeping your property occupied with paying tenants is to keep it looking nice, clean, and attrac-tive. Imagine looking for an apartment to rent for yourself and having a choice between a bright, shiny, and nicely manicured apartment build-ing and one with an overgrown lawn, missing screens, and loose shingles. Which one would you walk into? A property that resembles the latter is showing symptoms of financial distress. Being in denial in your property’s appearance goes straight to the bottom line.
U Missed monthly mortgage payments: This symptom of distress is a pretty obvious one. Consider those who have had trouble paying the mortgage on their homes. The reason they had trouble was because they had money problems. They had too much month at the end of the money! The same trouble applies to owners of a commercial property — they can have money problems too. Just remember that missed mort-gage payments serve as the writing on the wall. Something’s obviously amiss if the owner can’t come through with the payments.
U High vacancy levels: When a property has experienced higher vacancy levels than its comparable neighbors for months on end, don’t be in denial, and consider yourself forewarned. A high vacancy level generally means that the owner doesn’t have the money to prepare the vacant space for a tenant, let alone market it efficiently. In this case, tenant turnover is likely to be higher as well.
U A struggling market: Even if your property is in good physical shape, there’s no guarantee that the leasing market will be strong. The problem with a struggling market is that you can’t place paying tenants into your property if the tenants or their businesses don’t exist. We have been in this situation before and we were forced to deeply lower our lease rates and offer huge incentives to attract tenants. When this happens, supply simply outweighs the demand, and then you run into greater competi-tion for a smaller number of tenants. Face the truth sooner, by getting aggressive in your leasing strategies by deciding whether to have zero rent in a soft market or a little rent in soft market.
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A way to spot high vacancy levels and struggling markets is to research market concessions. Concessions are incentives given out by the prop-erty to entice people to lease from you. An example of a concession would be one month free rent or a reduced move-in security deposit.
If you see a lot of concessions in a market, you know that quite a few vacancies need to be filled. A market that’s full of vacancies is called a soft market. If you invest in a soft market, be prepared to operate a prop-erty with a larger vacancy factor than usual.
U Lack of lease renewals: Because leases are the lifeblood of the commer-cial real estate business, tracking lease expirations and renewing them becomes crucial to your survival. If the property’s leases are expiring and not being renewed or extended frequently, you’re headed for trouble.
Managing your lease expirations is as critical as the leasing itself. So make sure to stagger your lease expiration dates across the property. Avoid having a bunch of leases expire in the same month. Consider what the consequences would be if 10 of your 12 tenants’ leases expired all in the same month. Instead, stagger the dates to spread out your risk.
U Inability to pay normal bills: When bills such as landscaping, phone, elevator service, security, and advertising go unpaid, you’ve come across a danger sign. And when your leasing manager is handling more bill col-lector calls than leasing calls, trouble has arrived. Instead of living in denial, strategize on a new cash-flow management system that includes working with vendors by making partial payments for a while.
There is no shortcut on avoiding denial, even in real life. It comes down to taking ownership and responsibility of what you’re in charge of. Facing cold hard facts of the matter is what makes truly successful people successful.
How Management Can Cause a Property to Fail
Most people can recall or know of a once-prosperous company that either made major management changes or brought in new management and the result was a disaster. The company had everything going for it — great staff, great product, great operations, great brand, and the list goes on and on. But, unfortunately, the management made mistakes and ruined the company’s success.
The number one reason that investors fail is because they poorly manage their property or hire incapable property managers (and don’t forget that this failure can happen to both inexperienced and experienced investors!). No matter who fills the position, the property manager must be an effective leader. An effective leader does the following:
230 Part IV:Day-to-Day Ownership and Operations
U Works from a business plan
U Sets goals and takes responsibility for the results
U Defines the roles of the staff under him or her
U Confronts operational problems head-on and finds workable solutions
U Encourages the staff
U Provides direction when needed
U Knows his or her capabilities and knows when to ask for help
We highly recommended that when beginning your quest for acquiring a property you “lead” with a professional property management company. What we mean is that you find reputable property management for the type of asset that you’re pursuing in that city before you even make offers to pur-chase. If you can’t find experienced and trustworthy property management in that city, don’t buy the property. It’s that simple.
If you spot any of the following management warning signals, take action immediately:
U Your management is failing to manage. This warning sign is dangerous and sets a precedent. If your management is failing to act, you may notice that it isn’t holding the onsite property manager accountable to the expected promises and actions, it isn’t calling and meeting with the managers consistently, and it isn’t reading the property reports regu-larly. The performance of a property like this one is headed for a crash and burn. You, as the owner, can take action by starting at the top of the food chain. Get the property management company’s management in conference immediately. Be very specific going over your concerns. Don’t depart until action items have been agreed on and delegated.
U Your management seems to be clueless at times and is always ineffec-tive at operating the property efficiently. With ineffective management, you’ll have higher than market vacancies, higher expenses, late property reports, poor communication, and arguments. In the end, you won’t have a chance to be profitable. So what do you do? Start interviewing other companies for hire and cut your ties with the current company as quickly as possible.
When hiring professional property management, make sure that the can-didate has extensive experience in managing the type of property that you’re acquiring. For example, if you’re acquiring a 100-unit apartment building, don’t hire a company that only has experience in managing retail strip centers. Managing, marketing, and operational strategies are different as night and day.
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U Your property manager is ripping you off. Yes, your property manager can rip you off. It’s unfortunate, but true: They can steal from you, lie to you, and hide things from you. The consequences of this disrespect can be devastating — it can set you back financially for months or years. It can even send you into foreclosure. How do you spot a thief? First of all, have your finances audited at least once per year. You can also monitor the cash like a hawk by verifying bank deposits and receipts to checks. It’s also smart to visually verify completed work and physically verify rented space or units.
To avoid getting ripped off, consider getting some of your employees or your property management’s employees bonded. Bonding is an insur-ance contract in which an insurance agency guarantees payment to an employer in the event of unforeseen financial loss because of the actions of an employee. You don’t have to get every employee bonded, but it’s smart to at least bond the ones who have access to money or accounts. Luckily, bonding isn’t very costly.
U You’re being managed by your own property. If you’re managing a piece of property yourself, it’s easy to start losing perspective of who you are. You’re the owner and you’re in charge. When your property begins to run you instead of you running it, you’ll start making business decisions based on your current circumstances rather than from your set business plan and financial goals. You’ll easily get off track, and that’s when things can start to unravel and fall apart. To avoid having your property run you ragged, set appropriate boundaries. Don’t take work or your work attitude home. Have a phone dedicated for work and shut it off at quit-ting time. Have an after-hours service set up or have others on-call for after-hour service calls or for other non-emergencies.
U Your property doesn’t have a business plan. A business plan guides you and your property in the right direction when it comes to making business decisions. It can help you determine when to study the compe-tition, it can help figure out your property’s strengths and weaknesses, and it can set performance benchmarks that keep other management members on track. If your property doesn’t have a business plan, from what basis are you making business decisions? Every property goes in a certain direction, but it may not be going in a profitable and sustaining one. A business plan can be your compass. A good and well-thought-out business plan has a property summary, a market analysis, a sales and marketing plan, a management summary, and a financial plan.
Property management is a favorite topic when commercial investors get together. We like to collect horror stories and then brainstorm ways to sys-tematically remove the possibility of having the same issue come up again. To get mentoring help with your property management challenges or to read some of the recent solutions, go to www.commercialmentoring.com.
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How the Market Can Cause Failure
Owning commercial real estate can be more dynamic than you ever thought it would be. For instance, you may not have ever imagined that you would have to concern yourself with levels of inflation, interest rates, job growth, and population growth as an investor of an apartment complex or a down-town office building. And you may not have realized why it’s important to know where your market is headed if you plan to develop a strip mall on a 10-acre site. But deal making and daily business decisions need to be made and carried out. And if you don’t take these market issues into consideration, you might choose investments that miss their financial targets.
The behavior of your market can cause your property to fail. So, you need to know what influences your market and how to spot and identify these influ-ences. The next two sections break things down simply.
The ups and downs of real estate cycles
As you’re probably well aware, our nation’s economy is cyclical. For a few years, we’re going like gangbusters, and then for a few years after that, we slow down to a snail’s pace. Luckily, for the most part, economists can tell us when the economy is growing, stagnating, or shrinking. Real estate undergoes the same type of cyclical pattern. At times your market may grow and at other times it doesn’t. In fact, it may even shrink back a bit sometimes.
Just don’t forget that it’s possible to misunderstand your market’s real estate cycle, and this misunderstanding can cause your property to fail. For exam-ple, if you buy property at the following times, you’re likely setting yourself up for failure:
U Buying at the end of a boom: Buying at the end of a boom (or at the top of the real estate cycle) sets you up for failure in more ways than one. At this point, the market is saturated. Rent prices level off and drop a little. The supply of new buildings outweighs the demand and then vacancies increase. After vacancies increase, you have to drop your rent prices and offer incentives. This starts the downward financial spiral because as your income decreases, your expenses stay the same (or get even higher). And as your income decreases, you obviously have less money available to keep the property in tiptop shape.
U Buying during a recession: It pays to know if your market is in a reces-sion or if it’s headed for that part of the cycle. In a recession, you can expect new supply on the market (more competition) and demand for rentals and space to decline. You can also expect rent prices to fall and vacancies to reach all-time highs. Your typical investor flees from this market, which means that property values will plummet and foreclo-sures become more apparent. Not a pretty picture for most.
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