A&P 2017 Meeting Report: Is Doing it Right…Enough?

Posted on August 30, 2017 in Viewpoints by admin

_L2A8989“ Management is doing things right; Leadership is doing the right things.”
– Peter F. Drucker

(for a print version, click here)

Asset Management is more important than ever before. “Every commercial property is a business unto itself and every asset manager is essentially the CEO of that business,” said Gunnar Branson in his introduction. How to make that business weather a compression and come out in tact is one of the most essential elements in CRE, without it, every portfolio would crumble once a decade. “Everything from the technology that we use to the demands of tenants and inventors have never been faster. The onus is on the asset manager to do the right thing.” We cannot take the path of least resistance at this point. We cannot simply keep the noise down. We have to do the right thing, the hard thing, to be ready to lead through the next few years of rapid change and uncertainty. “Those acquisitions guys are good at shopping, we are good at cleaning up.”

NAREIM members gathered at the ART hotel in Denver, CO to discuss just how to do that.

How is the new government shaping CRE?

_L2A9467“Think about what happened last November. The expectation of a Clinton presidency was status quo. We were shocked, I was shocked by the result,” recounted Suzanne Mulvee, Director of Research and Senior Real Estate Strategist at CoStar. “What did that mean? Status quo would have meant 2.2% growth for four more years.” Clinton in fact ran on that very platform. “But with the election of Trump markets began to see a path toward higher growth.” There is a very low unemployment rate at the moment, coupled with increasing but still relatively low interest rates. “This might slow hiring a bit but it will probably mean wage increases for those that are already in the door.” Considering Trump’s proposed policies, “every single one points to inflation which goes right back to real estate.”

Looking at the 10-year treasury and the forward yield curve in 2014 suggested that “by now we should be around 3-3.5%. We have steadily marched down from that,” explained Mulvee. “Now we are looking at a forward yield curve that is 100 basis points higher.” This started a race between rising NOI and rising interest rates. “Before the election this was like watching a high school track race but now we have entered the Olympics.” It’s a lot faster and the stakes are a lot higher. If the current administration is trying to push more growth into the economy will they be successful? “There are structural headwinds that suggest that interest rates should stay lower for longer.”

With regard to job growth Mulvee pointed out that, “We are seeing a slowing from a 270 thousand average in 2014 to a current average of 175 thousand a month.” That number would be a negative if not for immigration. When the Great Financial Crisis hit, “most of the losses were first in first out.” Which tended to affect the younger employees. The jobs that have come back have overwhelmingly been that same demographic. “There is a large group of people known as the ‘structurally unemployed’ that exist in the middle ground.” They are those who were aged 34+ when the GFC hit and lost their jobs but haven’t been rehired and “there is not a lot of hope that they are going to.” If we saw the 20-34 year-old demographic revert back to pre-GFC levels “that would mean another 1.8 million people would enter the workforce.” So, there is still a lot of room to grow. “We could very well grow faster than our projections suggest.”

On the topic of earnings, “We are seeing wage growth today but it is targeted.” The bottom 25% of earners are getting next to nothing, while top 25% are getting an average 13% per year. The top 25% earners tend to be the top 25% of the age bracket as well. “So, there is income coming into the economy.” However, there is an impending problem here: What happens when all those high wage earners leave the workforce? “Now you’re taking money out of the economy,” and growth goes to near zero. People do get raises, and the last shall be first, but if their net gains are not commensurate with the retiree’s net losses, it could pose a problem.

“There will be a recession, sometime in the next 5 years,” says Mulvee. So, what will cause us to overheat? The tech sector? Over exuberance in the markets? The Fed’s tightening cycle? “The dispassionate view, or logic model, that takes into account implied yield curve, intensity of investment, S&P 500 ratio, and time shows that there is a 50% chance of a recession in the next 3 years.”

How will tech influence how we do our jobs?

Tech is disruptive and it’s just sinking its teeth into CRE. Goldman Sachs used to employ 600 traders and now, through the use of software automation, employs only two. They have however had to hire 200 computer engineers to maintain and run that software. No one is disputing the fact that we are a bit behind the times. Many of the new and splashy startups are tech based platforms designed to streamline the business practices of existing behemoths.

_L2A9543Diane Vrkic, Founder and CEO of Waypoint (not to be confused with Waypoint Residential), recounted a recent REIT client of hers that wanted to standardize their information across their portfolio. “We on-boarded 250 of their assets to our platform, we brought in information from 4 different accounting systems, and we started looking at their controllable expenses.” It turns out that it really does pay to compare stats across your portfolio. They noticed a $.27PSF difference in cleaning costs between two regions served by the same vendor. “They were able to renegotiate the contract and save $200k of operating costs.”

Rentlytics was a company started by Justin Alanis to help multifamily owners and operators optimize their portfolios with better data. “If you like money you need to like data. It’s a currency just like cash.” He found that much of the data he was using in his former life as an asset manager was siloed, inaccessible, and messy. “If you have disconnected workflows you simply lose control of your business.” TruAmerica, a Los Angeles-based investment firm, partnered with Rentlytics to regain that control. Before becoming a client, TruAmerica had analysts spending a huge amount of time aggregating data across their portfolio, and even then, they couldn’t do it with the frequency required by their business. “Rentlytics provided dashboards that automatically connected all the data from all their operators and delivered it in real time.”

Keith Dunkin, SVP of Asset Operation for Real Page, shared with us how his company allows clients to maximize the profitability of an asset. “We have a large data science team that focuses on how to most effectively benchmark, how to most effectively do true comparable analysis, and what metrics really move the needle. It isn’t just about rent.” They introduced the concept of “lease transaction based performance benchmarking.” Wayne Gretzky famously said, when asked what made him so good at hockey, that “he skates to where the puck is going to be.” We cannot focus on where we were six months ago or even where we are today. We must instead look to the future. “What if you had the ability to get an alert on your phone that told you that a portion of your portfolio would underperform its benchmark by 2% in two years because of system and practices you are engaging in today?” That’s the next step.

Can wellness and air quality increase value?

“Sustainability is moving into that area where it’s touching on health and wellness of our tenants and the residents of our buildings,” according to Ed Novy, Senior Associate of Asset Management for American Realty Advisors. There are many new products coming to the market that allow managers to offer higher air quality and or healthful living spaces. “Whether we like it or not, our tenants are proving that they are keeping track of these elements in our buildings better than we are.” For instance, people can simply download the Breeze-o-meter app and it will tell them what the air quality is where they’re standing at that moment. It has gotten that easy.

_L2A0009“Health is the new sustainability,” declared Joanna Frank, Executive Director at The Center for Active Design. “More importantly, it is the new opportunity. It is an important way of differentiating your property from someone else’s.” 10 years ago if you were going attempt the implementation of health-related systems you had to prove, by citing very recent and slightly experimental studies, that it was even worth doing. “We are now at a point where this is beyond being an opinion.” Millennials are famously equating the quality of their surroundings with their very compensation. They are equally as important to the young generation. The Center for Active Design has been chosen as the operator for a new health benchmark called “Fitwel.” It is designed to be highly effective while also being highly cost effective. Much like GRESB, “It takes a portfolio approach and is very much optimized for existing buildings. It takes a holistic approach that looks at community, vulnerable populations, physical activity, and mental health all of which correlate to higher productivity.” This new benchmark should be an easy sell to those concerned with the bottom line.

Chris PykeChris Pyke, formerly of USGBC and GRESB, is now the Chief Strategy Officer at Aclima Incorporated. They are making great strides in the testing of indoor air quality which can contribute to cognitive ability, drowsiness, and, of course, productivity. “In the constant effort to differentiate our properties, being “green”, in the sense of LEED certified, is no longer enough. Those are table stakes.” So what is next? What can we do to differentiate our properties today? Proof of good air quality is a very good option. Aclima provides indoor air sensors to monitor and graphically track the quality of that vital stuff we breathe. If presented with the choice between two office spaces, the one which can demonstrate superior air quality will undoubtedly command a higher price per square foot. But it doesn’t stop there, “We found that not only could you put these devices in a room, you could also put them in a car and drive them around.” Aclima is now providing mapping services that can show you what street corner in a given area has the best air-quality. “The air quality challenge that a building faces on block X might be five times higher than one just a couple blocks away.” This is invaluable information for knowing how much capital to devote to air handlers on a per building basis, but it could also affect the potential value of one building site versus another.

How can internal operations affect asset management?

To put it simplistically: There are those who are managers and leaders of asset management teams, there are front-line people who we think of when we say “asset manager,” and then there are the support teams. “Sometimes the leaders are coaches, sometimes they are player/coaches depending on the size of the business,” says Tim Kessler, Principal at FPL Consulting. “I get asked all the time, “how many analysts should we have?”” The current number is usually around .5 to 1 analyst per manager. “The answer lies rather in how you use the analysts you have; some are pooled, some are dedicated.” The optimal arrangement depends on your operating structure. For instance, the chain of command, “there are firms that require approval for asset managers to spend a dollar or sign off on a lease even if it meets the business plan. Then there are those that are much more relaxed and allow managers a fair amount of independence to make decisions they don’t necessarily meet the business plan.” On the subject of leadership training, many NAREIM hours have been devoted to the subject of allowing employees to have autonomy, and the benefits thereof. “The nature of your ownership structure affects this a lot. If you’re part of the massive financial institution more checks and balances will be present and are probably necessary, than say, a family office that might require no approval at all and doesn’t really need it.”

“We do a lot of compensation studies at FPL and we have found that, by and large, compensation is not the reason people quit their jobs. More than likely it is because they hate their boss,” admitted Kessler. Understandably, if a boss gives no room to breathe, no room to make decisions, and doesn’t trust his or her employee enough to allow them to possibly make a mistake, that could engender some distaste. “We are generally not good people managers in this business.” The people that get promoted ascend because they are good at managing property. “They have never been trained, they have never been taught, and in some cases, they don’t even care weather people on their team are motivated or not. This is why people lose their talented individuals.”

Our industry values shopping more than it values creating value. It is easier to count after all. “Maybe our challenge is even more data centric than we all think it is?” mused Branson in his conclusion. “Maybe the reason asset managers aren’t valued as highly as acquisitions people is that we haven’t been able to capture the data that would determine that value.” But it is out there. The data exists. Once again, the answer to our problems lies in finding it and using it effectively.

We are doing things right. We are spending a lot of time making sure of that. Though it is what will get us the bonus, it’s not what will get us the win. Doing it right is no longer enough.