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Standardizing pension advisor reporting.

An Interview with Roger Franz

During Roger Franz's six-year tenure as the Mortgage Investment Officer, Real Estate Asset Management, for the powerful California Public Employees' Retirement System, CALPERS has emerged as a leading force in real estate.

The fund has approximately 80 investments valued at nearly $5 billion, which accounts for part of this influence. But equally important is Franz's work in standardizing and centralizing a broad range of asset management functions with such thoroughness that CALPERS reporting criteria and formats are fast becoming the industry standard.

In an interview with JPM, Franz discusses his ideas on standardization and what it can and cannot achieve.

JPM: What initially convinced you that CALPERS needed to standardize its reporting requirements?

Franz: We oversee a portfolio of $5 billion in assets with approximately 80 investments using an internal staff of three managers and eight employees. To handle that portfolio, we need concise, yet comprehensive, reports that follow the same format.

While we always received quarterly reports from our real estate advisors, they were very limited in nature and did not contain useful information. Several years ago a typical quarterly report was less than one page per investment, per quarter. We felt we needed to know more about many aspects of the property.

We looked at reporting for other pension fund clients and other real estate investors, and then began to consider what the reports from our advisors should contain.

JPM: What are some of the areas in which CALPERS has been active in standardization of reporting from its real estate advisors?

Franz: Several years ago, we began working with the management consulting group of Coopers and Lybrand to develop a four-part quarterly report from our advisors. The reports cover both property- and portfolio-level information, including: a narrative description of property activities during the period; comprehensive, standardized financial statements; activity statements such as leasing activity, delinquency, bad-debt, and capital expenditure; and performance measurement reports.

To achieve these standardized quarterly reports, we first adopted an accounting procedures manual which defined the specific treatment of certain interpretive areas of GAAP. We then developed standardized performance measurements which allowed for more accurate comparison between our properties.

As part of our portfolio-level reports, we have developed a Risk and Performance Assessment System. It is a qualitative and quantitative assessment of the property's performance.

JPM: In addition to standardizing reports, haven't you also centralized certain management functions directly under CALPERS control?

Franz: Yes. For example, we elected to use outside MAI appraisers to do required annual appraisals of our properties rather than relying on appraisals prepared by our advisors. We have also developed a standardized appraisal report and appraisal specifications so these appraisers will use the same format in preparing reports and documenting their opinions.

Cash management is another area where we have standardized our approach. Each property's bank account is maintained at the First National Bank of Chicago where we have lock-box collection accounts and zero-balance-controlled disbursement accounts. Daily, our rents are deposited, checks are paid, and net funds are transferred to CALPERS at State Street Bank and Trust, our master custodian.

The system is highly automated so float is minimized. With annual portfolio net income of over $300 million, the amount of interest realized can be very substantial.

At the portfolio level, we have developed a comprehensive risk and insurance program, an environmental management plan, and a compliance auditing program.

JPM: To what degree does CALPERS directly supervise its property managers?

Franz: At our request, property managers seldom communicate directly with us but instead report to our real estate advisors.

CALPERS does sign the property management agreement and the exclusive authorization to lease. We also make the ultimate decision on hiring and firing with input from our advisors.

However, we recognize that quality property management is an important aspect of our portfolio's success. We have asked our advisors to set up their own detailed evaluation forms for property management firms and their personnel. While these evaluation forms are not standardized, we did give our advisors some samples of what might be included.

We ask advisors and property managers to develop detailed annual performance objectives and then evaluate performance against those objectives in the same way that any business gives regular performance appraisals. We require that these evaluations be done in person and in writing on at least an annual basis.

CALPERS believes that it is a good personnel practice in any industry to evaluate performance and provide feedback where improvement is needed. We can also see whether problems are major or minor and what is needed to bring performance up to an acceptable level.

JPM: What else does CALPERS do to monitor advisor and property performance?

Franz: Working with Kenneth Leventhal and Company, we just completed a property manager and advisor compliance auditing program to ensure that there is some ongoing evaluation of property managers and advisors.

The system is designed to analyze many business practices of our property managers--not just leasing, collecting the rent, and paying the bills, but in aspects of business and property management. We evaluate areas such as accounting procedures and financial matters, reporting and budgeting, leasing and tenant relationships, and operations and maintenance.

CALPERS looks at the compliance audit as a form of performance appraisal--to point out weaknesses in basically good management operations and to bring every company's performance up to the highest level possible. Without this specific feedback, property managers may not recognize that there are areas that need improvement.

Last year we did several test compliance audits, and the system worked well. We plan to audit approximately one-third of the portfolio annually using the auditing department of our state controller's office and an outside CPA firm, Conrad and Associates of Irvine, California.

Once a property audit is completed, we ask the advisor and property manager to tell us how they intend to improve performance and to report back on their results. Again, we want this audit to be a personnel tool; a report to be acted upon, not one to be filed.

Another method we use to evaluate advisor performance is Revised Projection Reports. A year ago, we developed a format for doing revised projections on a property. Typically, you begin an investment with a 10-year pro forma, but after that you may only receive a yearly budget. Now we have updated return projections, which contain a hold/sale recommendation, for 3, 5, 7, and 10 years.

These reports were prepared for the entire separate account portfolio and will be updated every three or four years. They are intended to be short-term plans against which actual performance can be compared. The advisors identified immediate, near, intermediate, and long-term sales candidates and provided justifications for their hold/sale recommendations.

JPM: Do you find much resistance to this standardization?

Franz: Actually, we find that most of our advisors welcome the structure we provide. In that way, they know what is expected and what we do and don't want. We don't attempt to micro-manage our advisors; we still expect them to make decisions on day-to-day management. For example, our advisors develop standardized leasing guidelines for virtually every tenant space in a building as part of their annual property budget. But using those guidelines, our advisors have substantial discretion to approve almost any lease within defined parameters.

Similarly, we have not given our advisors a single contracting procedure for tenant improvements and capital expenditures. Contractors may be employed in a variety of ways.

We did conduct a survey of properties to gain an awareness of some of the contracting procedures being used, but we have not dictated one standard method. At the same time, we hope the survey has increased advisors' awareness of contracting methods and the advisor's and property manager's responsibilities.

JPM: Many people feel that the comprehensiveness of the CALPERS system will become a benchmark in the industry. Can you comment?

Franz: We have evaluated our information needs and feel our systems and procedures now meet those requirements. When asked, we have shared our system of quarterly performance reports, performance measurement, and risk/performance assessment with other pension funds and advisors.

Over the last four or five years, pension funds, both public and corporate, have determined that in many cases the property- or portfolio-level information they receive has been inadequate, so many are working to increase their reporting requirements. It used to be just "here are the actual results," rather than comparing performance to the budget, explaining the variances, and determining what management objectives have or have not been achieved.

Some advisors feel that clients are demanding too much information, but too much is better than not enough. Hopefully, all the funds are using this information wisely to understand their investments and hold their advisors and property managers more accountable.

JPM: Do you think that pension advisors will eventually adopt standardized reporting industry wide?

Franz: There has been talk, but there is also the desire by consultants and advisors to answer any information request. It is difficult to have one reporting format address every client's needs.

JPM: Having began with standardized reporting, what did you tackle next?

Franz: Our latest effort has been working with our real estate consultant to make further improvements to our Annual Investment Plan, which describes our near-term investment goals by property type, geographic region, and investment structure. The plan is a short-term, "tactical" plan that complements our long-term, strategic real estate plan.

Our Investment Committee adopts the investment plan, and it is shared with our advisors. With a plan, investment decisions are made more systematically and are in keeping with an overall strategy.

This year for the first time we have included asset management accomplishments in the plan, comparing actual performance to last year's objectives. One of our 1992 goals, for example, was to bring properties into compliance with the Americans with Disabilities Act.

Development of an annual investment plan is an interactive process with our advisors and real estate consultant. We use their suggestions on attractive property types and regions and develop target ranges for each. New areas for research and investment are also discussed.

JPM: What do you see as the ultimate goal of CALPERS' more involved style of asset management?

Franz: We look at our standardization as a way to better understand our portfolio, to produce better returns for the fund, and to achieve greater accountability from the advisors and property management firms who work for us.

Hopefully, what we bring to the process is overall good management techniques. If more thought is given to an area, more of the right questions will be asked. Pension plans, in general, are asking many of the appropriate questions today.

Until recently, there has not been a great deal of accountability among real estate advisors. Even in cycles of six or seven years, when there is sufficient time to assess performance, very few separate-account portfolios have terminated managers or moved properties among their real estate managers. In contrast, stocks and bonds have a history of moving funds from one manager to another.

But real estate investment is changing now, and the plan sponsors are more willing to take action, if necessary. Improved information systems have also contributed to new levels of accountability.

Roger C. Franz is mortgage investment officer for the State of California Public Employees' Retirement System and the manager of the fund's Real Estate Equity Asset Management Unit. His unit is responsible for asset management at the fund level of over 80 real estate equity investments representing more than $5.7 billion in invested capital.

Mr. Franz joined the fund after 13 years of experience in banking and the commercial mortgage industry for companies such as Bank of America and L.J. Melody and Company. He holds an M.S. in management from Northwestern University and a B.A. from the University of Oregon. He is a member of the Mortgage Bankers Association, the Pension Real Estate Association, and the Urban Land Institute.
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Title Annotation:Asset Management; interview with Roger Franz of the California Public Employees' Retirement System
Publication:Journal of Property Management
Article Type:Interview
Date:May 1, 1993
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