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Boosting net operating income.

Today, more than ever, real estate is a bottom line business. Owners and managers alike realize that the money to be made today will come from consistent cash flow, not ballooning increases in value. For this reason, improving NOI performance - always an essential part of the property manager's role-has become even more vital.

While expanding net operating income (NOI) through higher rents and greater occupancy is, course, desirable, controlling costs can contribute just as much to profits. Yet, lowering expenses does not have to be synonymous with cutting staff and services. Reduced outlays at the property can be achieved through careful, consistent cash management strategies.

Managing receivables aggressively

Occupancy is worth little if rents are not paid promptly and in full. Our firm requires rent to be paid by the first; by the tenth or the fifteenth, it is overdue.

If rents are not received by the fifth of the month, we begin calling tenants to determine if there's a reason that the rent has not been paid. Of course, this first conversation is a pleasant one because tenants don't typically think that rents are due until the tenth. Letting them know that you are aware of the fact that they have not paid reinforces the fact that your tracking and record. keeping are accurate.

In a way, these reminders serve to train the tenant that if rent is due on the first, it should be paid on the first. Because if one tenant is allowed to slide, others will soon follow. You don't want your slow-pay tenants bragging about what they got away with. We have taken over the management of properties where late payments have become a way of life, and spent the first six to nine months just getting the good tenants to pay promptly.

If on the tenth, we have not received the money, we send out a form delinquency letter and a bill for the late penalty. Then, we call again in a day or two and make a more intense effort to discover if there really is a problem. Perhaps the computer is down, or the check has been delayed at the main office. It is often worthwhile to make this call a face-to-face one with a top-ranking person in the company.

A face-to-face visit may also give you the chance to get more of the inside story from other staff members; the receptionist or some worker in the back room may give you a hint as to the depth of the problem. A personal call also gives you a chance to check out the premises, to look for packed boxes stacked in a corner or other signs of departure.

Tenants that are constantly in arrears present a more difficult problem. Of course, you must use your judgement, but a good general rule for repeating late payers is to serve a notice of unlawful detainer at the end of the first month and move to evict.

If this process does not produce the rent, move ahead with the eviction. We do not believe in tenant workouts of past-due rents. If a tenant cannot give you at least part of the payment when it is due, it is unlikely that they will be in a better financial condition two months from now. It has been our experience that only about one in ten workouts ever pays in full.

In our firm, we made our on-site managers responsible for all rent collection, as long as the tenant is in the space. In fact, managers' bonuses are calculated in part on their receivables totals, so they are motivated to either get the money or get the tenant out of the space.

After eviction, we turn over receivables to an outside collection agency, which works strictly on a percentage of what it collects. At one time, we had in-house collection people, but we found that because you have to be so nasty, employees often get burned out.

Using the outside agency and paying 30 percent of what its employees collect, we usually recoup about 20 cents on the dollar of our bad debts. However, because the collection agency bears the direct costs of attorneys' fees and judgements, we have no out-of-pocket expenses with these collections. We don't spend money chasing tenants, but it is also important to maintain a reputation as a company that will not permit non-payments.

Our aggressive receivables policy has reduced our bad debt write-offs to about 0.75 percent annually. In an effort to reduce this figure even more, we analyze past bad debts by property, by geographic area, and by tenant profile. In this way we can determine if there are any patterns that can be prevented in the future.

Managing expense recoveries

Pass-through and overage revenues from commercial tenants are other sources of improved NOI if managed effectively. Rewrite the leases to permit you to collect estimated amounts of these charges on a monthly basis rather than waiting until the end of the year. The differences between the estimated and actual costs can be reconciled at year end.

This type of plan benefits both the owner and the tenant. The owner is able to collect monies literally as they are spent, instead of waiting up to 14 months. If a lease expires mid-year, it is often difficult to collect the partial pass throughs once the tenant vacates. With monthly collections, if a tenant defaults on a payment, you at least have a portion of your operating expenses.

In addition, more frequent payments allow you to manage cash flow more efficiently, realizing interest on banked monies and paying bills promptly without dipping into reserves.

From the tenant's perspective, spreading costs out makes it easier to budget. In addition, most tenants prefer to pay for rent-related costs during the operating year they are used. Even if it is anticipated, it is disconcerting to get one large bill for costs in March or April. Instead, we try to estimate costs in such a way that tenants receive a small refund at the reconciliation. This has a very positive effect.

While some sophisticated tenants may be concerned about the time value of money loss, the amount of interest accrued for a single tenant is usually fairly small. It only matters to us because we have a large number of tenants.

Another aspect of managing expense recoveries is reclassifying your capital expenses as much as possible to operating expenses that can be passed through. For example, if you replace an entire roof, it is obviously a capital expense, but if you only repair and replace parts of it, the cost may be an operating expense.

Most tenants will not question these types of redefinitions, although some major tenants may. The difficulty may arise when you want to classify these same costs as capital expenses for income tax purposes. This is a gray area, but it is seldom an issue except with large tenants.

A third consideration in managing expense recovery is working to eliminate base deductions for management fees. This issue can be very sensitive, especially when you are assuming management of a property with existing leases. It is certainly desirable to eliminate base deductions.

Challenging vendor pricing

Most vendors are aware of the economic pressures real estate is under now and are open to negotiation. Even in cases where you have a multi-year contract with a vendor at a fixed price, it is possible to revise your payments.

Challenging pricing is not just taking bids and changing contractors. We have found that in at least 50 percent of the cases, it is talking frankly with your current vendor about the needs of the property. Often a property may have particular cash flow requirements or short-term problems that could be alleviated if expenses were temporarily reduced.

Share your strategy with your vendors and make them part of the solution. Let vendors know that if they cooperate they will gain your long-term loyalty. And don't negotiate so hard that the vendor cannot make a profit or that the quality of service is seriously compromised.

We generally ask vendors to make voluntary proposals for cutting costs by a certain percentage. They know more about their businesses than we do. They may come back with some suggestions for cutting services, but we also expect some actual concessions in their profit margins.

If a vendor does not cooperate, we look for a new vendor. Often you can get the best prices and service from long-term contractors, but vendors get tired like everyone else. Management can change or other situations can affect service. Nor do we hesitate to get prices from new vendors and use it as leverage to get lower prices from our current contractors, although we don't just bid shop.

In comparing bids and negotiating prices, find out what the competition is paying for services such as landscaping and window washing. We don't find that sharing information with competitors is a threat; all of us gain when prices are lower.

Appealing properly taxes

This method of reducing expenses has received a great deal of attention recently, and with good reason. Declining values have created an opportunity to lower this sizable expense.

Typically, we use contract people to appeal property taxes, on a flat fee or incentive basis. Specialists in tax appeals have more experience in cultivating assessors and a greater understanding of what will and will not work.

Another consideration in an appeal is not to win the battle, but to lose the war. If you score a coup by pointing out some oversight, the assessor will still be there next time. By all means, take the reversal, but be discreet about it.

Involving your staff

Getting your staff at every level to support efforts at cost savings is the most important technique for improving NOI performance. Talk to your people face to face and explain why reducing expenses is essential. Do not just write a memo or add to the policy guidelines.

Line up bonus and promotion incentives with NOI performance. Work with staff to set very specific standards for each property. In some cases, a realistic goal is not improving NOI, but keeping it from falling further. Negotiate these standards with your on-site managers, sign them as you would a contract, and expect all parties to live up to it. This means following up on these goals every month, rather than waiting until too much time has passed to make the goals reachable.

Another means of involving your staff is soliciting them for ideas on ways to improve NOI. Often, because they are closer to the properties, they will think of things you overlooked. If they fail to mention things you want to emphasize, try to steer the conversation to these points, rather than just interjecting them yourself. In this way, the ideas become joint goals, rather than imposed ones.

You also need to train your staff to reach the NOI improvement goals you have set. For example, you are not likely to be the one negotiating contract reductions with vendors. If goals are to be achieved, you must give your people the tools to accomplish them.

Making it all happen

In the final analysis, the keys to improving NOI performance are not mysterious. To make improved NOI performance a reality, you must initiate a top-down effort throughout the entire company. Every staff member, from onsite engineer to senior management, must enroll in the improvement program and make a commitment.

Most importantly, you must actively demonstrate that you personally care about achieving this objective by walking the buildings, talking to staff, and rewarding accomplishment. That is the effective way to improve NOI.

Ray Wirta is president and COO of the Koll Company, Newport Beach, California. He previously served as president of Koll's Management Service Group, directing management of Koll-owned properties and fee management of outside properties, and as executive vice president of company asset management operations. Under his supervision, the asset management portfolio grew from 9 million to more than 40 million square feet and from a value of $800 million to $4.2 billion. Mr Wirta holds a master's degree in international management from Golden Gate University.
COPYRIGHT 1991 National Association of Realtors
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Author:Wirta, Ray
Publication:Journal of Property Management
Date:Sep 1, 1991
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