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Computing management fees.

Commercial properties, whether the net operating income (NOI) is $1 million or $50 million, require management by highly skilled professionals who can reduce overhead, maintain a high level of tenant services, and protect the value of the asset. In fact, owners are demanding more and more services from property managers.

At the same time, increased competition from the swollen ranks of property managers is exerting downward pressures on fees. Property managers need to understand and monitor their cost of doing business as never before.

Yet, it is amazing how many firms that offer management services have never determined how much it actually costs to manage the buildings in their portfolios.

Calculating fees

The methods used to develop a management fee are no different than those used to develop a charge for any service or product. The most important thing is to determine cost for overhead and profit. However, several models are widely used today to set fees:

Income-based. The manager bases his or her fees on a fixed percentage of the rental income. Unfortunately, the income of a building is in no way related to the cost of management, especially during periods of high vacancy. However, some owners prefer giving the manager a percentage because they believe "they'll do a better job."

In addition, because the time required for different types of buildings varies so greatly, fees may not be in alignment with the difficulty of the job. Clearly, the income approach is not really in keeping with the competitive realities of today's market.

Loss leader. A full-service company may offer a low fee to get the leasing work, with lucrative leasing commissions subsidizing management. Often companies save money on low fees by hiring lower paid, less experienced personnel.

While lower fees may initially seem attractive to owners, the cost of management fees is minuscule when compared to the operating savings that can be achieved by a skilled management company.

Per square foot. The cost of managing a large building in good condition with a few large tenants can be far less than managing a smaller building catering to many small-business tenants with poor payment records. Thus, the notion of budgeting fees by the square foot is unscientific and potentially unprofitable.

Flat fee. If calculated properly, a flat fee actually takes into account the complexity of building operation; cost of time spent performing management functions; building condition; and in the case of new buildings, the extra effort in hiring and training staff to get the building running.

Costing out fees

Factors to consider in determining how much it costs to manage a particular building include:

* Examining the tenant roll for the number and type of tenants.

* Examining the collection records to determine if a full-time collections person is needed (especially important in smaller buildings with fewer credit tenants).

* Examining the building to determine its physical condition.

* Determining whether operating, emergency procedures, and other manuals must be created.

* Reviewing the owners' financial reporting requirements.

* Reviewing the cost of personnel and calculating the amount of time necessary to operate the building.

* Reviewing what improvements should be made to increase NOI.

Because of the extra start-up time required for new buildings, initial cost should be amortized over a long-term management contract. For budgeting purposes, assume that the first year will not be profitable, but ensure that the initial higher cost will be recouped over a three-year contract.

Determining the staff required to manage a building is a vital aspect of the fee calculation. A third-party manager's portfolio normally ranges from institutionally owned and occupied buildings to multi-tenant buildings owned by private owners. This mix of goals results m a variety of demands for operations, leasing, and financial reporting that only experienced personnel can meet.

The managing agent must ensure the best results not only by having a staff of qualified personnel, but also by developing the proper systems that can be utilized in the economic management and leasing of the property.

The increasing sophistication of building operations--computerized elevators and accounting systems, security surveillance, water treatment technology, and compliance with government regulations-has raised the demands on managers' technical skills and time commitments to the property.

Given the current state of the rents, NOI can only be augmented by improving the efficiency of the building operating systems. And this improvement can be accomplished only with proper staffing and close day-to-day supervision of building operations.

It is virtually impossible to find any one person who is qualified in the disciplines of engineering, building management, financial management, and leasing. Therefore, a property manager must assemble a team of professionals who have this expertise and whose cost is distributed over a portfolio of buildings.

Analyzing the RFP

In part, the factors used to determine fees will be dictated by the owner's demands, as spelled out in the request for proposal (RFP). When an RFP is received, it should be read carefully to determine exactly what is required. Frequently, the RFP is verbal or just consists of a letter containing no details other than a request for a price.

Question the owner for more specifics, if at all possible, before submitting a bid. To bid effectively, a determination must be made of exactly what is required and exactly what these requirements will cost.

From an operational point of view, calculate how much time must be spent supervising the day-to-day operations of the portfolio. If no on-site building manager is used because of the size of the building, then a greater workload (translated to time requirement) will be imposed on the supervising property manager.

If a site manager is used, will the building manager or other labor be a reimbursable expense, or is it to be included in the management fee?

The building must be thoroughly inspected to determine its condition and whether an operating manual or preventive maintenance system has been developed.

The entire method of operating must be reviewed. The building's energy consumption must be evaluated to determine the effort required to optimize its operations. All of the contracts for services must be written, priced, evaluated, and awarded.

Has a management plan been previously developed or must a new one be created from scratch? Have emergency procedure manuals been developed for such things as fire, hurricanes, tornadoes, flood, power loss, etc.?

When taking over management, the managing agent must abstract all leases and not depend on previous abstracts. The tenant roll must be examined to determine what the billing workload will be. Also the receivables must be reviewed to compile an historic record of tenant payment patterns.

Tenant information kits must be prepared, and tenant improvements must be coordinated in a timely fashion. In a new building, the manager must also participate in the owner's "acceptance team," which does the testing, punchlisting, and startup of the building.

The type of financial reporting employed by the building must be examined to determine how many reports must be generated and at what frequency. Does the owner's chart of accounts conform with existing systems? Will the financial reports be done on a cash or accrual basis? Are special cutoff dates for accounts payable required?

Current leasing strategies and tenant retention efforts must be reviewed and analyzed for their success. If necessary, a new leasing plan must be developed, with promotions to support it.

All of the above items will require an evaluation of time involvement. When all the time to perform the management services is added up, a monthly or annual time requirement is determined. Travel time requirements should be included. The overhead percentage can then be determined by dividing total department cost by total department labor cost.

The hourly cost of each person involved should be multiplied by one plus this overhead cost. This result is the hourly cost to perform the labor portion of the contract. Any material costs should be treated the same way and added to the total labor cost.

To this total is added a mark-up for profit. If ownership wants a management fee presented in another form, this total may be divided by square footage or rent roll.

However the fee is expressed, it must be calculated on the actual cost of doing business. In some instances, it may be necessary to make concessions on fees. But without an understanding of management cost, it is very easy to set fees so low that the business cannot cover cost. If this happens, you can manage yourself right out of business.

Kenneth A. Shearer is executive director of corporate management services for Cushman & Wakefield in New York City. He is the editor of The Investors' and Owners' Guide to Office Building Management, published by Business One/Irwin, and is a member of the Board of Directors of the New York Chapter of BOMA.
COPYRIGHT 1993 National Association of Realtors
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993 Gale, Cengage Learning. All rights reserved.

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Author:Shearer, Kenneth A.
Publication:Journal of Property Management
Date:Sep 1, 1993
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