Why you should prioritize Value Building in Real Estate
"Real estate allows you to park your money, create passive income and make your money grow by itself" is what is often told to showcase the benefits of real estate. While this has some sense in comparison to operating a business, it is far from the truth.
See, in every business for it to be successful it has to create and add value which can come under different forms either by facilitating a struggle, offering a needed product/service…real estate is no different, real estate is here to offer a solution to an existing problem (people need a place to live, a place to travel, companies need a place to sell and or store their products…).
Sure, there is ways to invest in a complete passive manner like investing as a limited partner but for the sake of this article we are going to focus on direct investors and operators.
Commercial real estate is a very broad industry composed of many different sectors which all have their own specific value building opportunities, building value in the hospitality sector is going to be intrinsically different than building value in the net lease sector as an example.
One has got to dive deep on analyzing what creates value in each sector, as an example in the net lease sector, the lease and credibility of the tenant are often seen as being the major drivers influencing the asset valuation.
A lease with favorable terms and a tenant having a strong business model that has proven itself to be successful while knowing to adapt to an ever changing economy and customer requirements will inevitably positively impact the asset value over for example having a tenant with an outdated concept.
Today, our wish is to focus on 3 main areas that will tremendously impact the valuation of any commercial real estate
01st- Management optimization
Management can be split into two subcategories, the first one being property management which is here to insure the day to day management, tenant arrivals, administrative paperwork, payment processing…
The second one is referred to as the asset management, which can be referred to as the value-building management. Asset management, often underrated, plays a primary role in the value creation and development.
Its purpose is to look at the broader picture while analyzing each metrics of the operations by for example identifying the key areas that are eating up the operating profit, staying on top of the market trends by analyzing the competitors, finding ways to raise overall revenues while controlling the expenses and most importantly putting a plan to action.
Asset managers should identify and act quickly always in coordination with the property management team.
Owners should always closely monitor both the property and asset management whether they decide to do it themselves or hire a third party by conducting monthly or quarterly meetings, reports, inside auditing, making notes on what needs to be acted on with a specific timeline for completion.
Incentives also play a major role in the value building path, all members of the team should have the same goals to aim for, if not chosen carefully incentives can sometimes turn themselves in goal-breakers.
The goal of every business should be to maximize revenues while also controlling expenses, however incentives in property and asset management often only reflect one part of the equation: the revenues.
Fees are often charged solely based on a percentage of the revenues when in fact the incentive models should also focus on other key operating metrics such as ebidta performances in addition to revenues, only focusing on the revenues can possibly create a divergence of interest between the managers which are incentivized to grow the revenues while the owners who are looking for a growing net profit.
For example, growing revenues by 20% is great but if the expense ratios are not optimized, it can quickly turn into costly and useless efforts.
02nd- Niche analysis
Yes, real estate is the same than operating a business. Not defining a niche is a room for disasters.
In order to determine your niche, one has got to understand and conduct market studies. Nobody wants to install high end counters in workforce multifamily, yet a lack of market analysis and not determining your niche can have this impact. Mistakes like this can have a tremendous negative effect such as impacting IRR.
Another example would be to install several amenities to create a ``vacation like hotel`` for the sake of creating value in a “airport hotel” where your clientele is only going to be there for one night and is simply looking for a place to sleep and recuperate their energy from long hours flights.
Identifying your niche by using metrics such as income, needs, age, competition analysis are key to add the right value, no one size fits all.
03rd Customer satisfaction
You heard that right, clients should also be treated as the kings in real estate. It would only make sense, since at the end of the day if there is no clients, no revenues. Putting in place the right elements to guarantee satisfactions is the key to success.
As an example often times when tenants are not paying their rents, an email is sent often accompanied by penalty fees or a threat of eviction instead of understanding the real issue such as understanding why is the tenant not paying the rent: did he forget, maybe he is a little short in treasury…
An owner that thrives to understand the issue and directly talks with the tenant in order to find the right solution instead of engaging in never ending conflicts will most definitely have for once the respect of the tenant and studies have shown that tenants are more likely to do the best of their abilities to resolve the issue.
At the end of the day, owners should thrive to have happy tenants that will do everything in their power to act in a timely manner, talk positively to others about their housing experience, leave the apartments in better condition.
Low turnovers will positively impact the value of the asset, high turnover often being seen as a sign of miscontent from the tenants and the more the turnover the higher the expenses and vacancy rates.
Another critical value building tool to be implemented is customer surveys, let me tell you an anecdote as I am writing this article I am in the lobby of the hotel where I stayed last night.
The host asked me how my room was and I had no hesitation in saying terrible because of the mattress that was completely outdated and wouldn’t let me sleep. Surprised and confused, he mentions I am the first person to report this issue.
It is in our human nature to make concessions, often times negative comments makes us look rude which is why so few people will ever tell you truth if negative and some people will just want get over it, checkout and never come back.
Those clients will most likely never come back... One solution is to create a customer experience online survey with an anonymous option while including an incentive such as receiving a coupon, a discount on a local attraction…This would have most likely resulted in being able to identify the issue faster and be able to act on it.
Finally to summarize, thinking investing in real estate will allow for your money to grow by itself is a false and incorrect statement. Value building should always remain the core focus of all real estate investors.
Commercial real estate should be treated as an investment while applying business principles.
Written by Tugdual Chitrit
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