Management & Value

Distressed real estate is often characterized by incompetent or undercapitalized management. Investors need to be aware of the significant impact management can have on a property's value. Appraisers particularly struggle to value distressed real estate that is adversely impacted by incompetent management. In an era where property values

in many markets have declined by more than 40%, key concerns prevail about how to fund property operations and equip management to operate a property. A review of many failed real estate projects reveals both incompetent management and undercapitalized operations.

Management expense is considered to be variable based on the theory that management fees will change based on collected revenue. In general, variable expenses are those operating costs that vary with the level of occupancy or with the extent of services provided. Utilities, janitorial, repairs and maintenance are examples of typical variable expenses. Competent management is critical.

How do appraisers address this issue? Various appraisals include statements referring to competent management in the Assumptions and Limiting Conditions section of the appraisal.

Some sample statements include:

"Property ownership and management are in competent and responsible hands", "It is assumed that the property is owned in accordance with lawful uses, competent and informed ownership and management unless noted", "The property is analyzed as though under responsible ownership and competent management." Quantifying and reporting on existing management cost and effectiveness is often a sensitive issue. The question becomes, what responsibility does an appraiser have to quantify what represents competent management, or better yet, what responsibility does the appraiser have if existing management does not seem competent to manage that property?

A management checklist, like the one below, will significantly benefit the appraiser/analyst in analyzing the effectiveness of existing management:

• Is existing management a third party or is it owner-management? If third party, what local, regional or national territory does this company serve? If owner-managed, what experience does the owner have with the property type and the market?
• Is existing management on-site or off-site? If on-site, how many days of the week is the office open, and what are its hours of operation? If off-site, how often does management visit the site?
• How long has the current management been in place? If not since project completion, what prompted the change? (Turnover of management personnel may result in loss of continuity in operating a property efficiently as well as impacting tenant relations. High turnover rates may be a reflection that existing management does not have the resources to manage the property.)
• What other area properties are managed by this same firm? Are these properties comparable?
• Does management have a competitive market survey?
• Are tenants satisfied with management? (Generally best to ask this question away from current management.)

On distressed real estate, a fixed monthly management fee may be paid rather than an expense paid as a percentage of effective gross income. Convincing someone to manage a vacant property based on a percentage of collected revenue will not generate many takers. On the other hand, in certain cases, the management fee can be excessive if the owner is trying to use this expense component as a profit center. I encourage a review of the total dollar amount of the management fee as much as a pure percentage. If owner-managed, has an appropriate management fee consideration been made? Two notes on owner-managed properties: (1) An owner may understate or omit the management expense to obtain a higher net operating income and correspondingly higher potential value, and (2) Management is an essential expense on income-producing property. As such, when owners or developers dispute the allocation of a separate fee, an appraiser must be prepared to explain that management services are essential to determine market value and must be forecast based on market norms on a going- forward basis. Quantifying effective management is always a challenge, but with an appropriate study, market-based results are achievable.

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