Apartment Management: Goals of Ownership

When you undertake the management of a real estate investment for either yourself or others, the first order of business is to understand exactly what you expect to accomplish. If you are being hired by the owner of an apartment complex, what does he or she want? ‘To make as much money as possible” is not a very precise answer and it’s one that will not help you very much in preparing a management plan. Some owners need regular monthly income while others would rather reinvest surplus money into the property in hopes of dramatically increasing the ultimate resale value some time in the future. Let’s explore some of the more important goals of ownership and discuss their differences.

Periodic Income

This means a steady return in the form of cash. An owner risks equity by investing in real estate. In return, he or she expects to receive monthly, quarterly, or annual cash dividends that represent the profits or surplus revenue derived from the property’s operation. In addition to real estate, there are many competing types of investments such as bonds, stocks, in vestment trusts, and even bank accounts that yield regular income. Many of these are insured, guaranteed, or backed by years and years of payment patterns. Real estate, on the other hand, is very unpredictable and most sensitive to market “winds” and the impact of management skills. Those seeking regular and predictable returns often opt for buildings with long-term commercial or industrial leases rather than risking the more frequent turnover experienced with rental apartments or small offices. The rate of return is generally dictated by the probability of predictable and sustained periodic returns. In other words, an investor will usually seek a much higher return if there is a degree of uncertainty about either the rate of earnings or the return of the original equity invested. Real estate investments, including rental apartments, have those risks; such investments must be structured to deliver a higher rate of return.

As we enter the 1990s, investors are searching for cash generators. They are looking for apartments and other forms of rental real estate that will produce a steady flow of cash as a return or reward for invested capital. The problem is that there are few properties that qualify as continuous moneymakers and many investors are in search of them. Whenever there are too many bidders, the price goes up and an increased price lessens the Property’s ability to deliver the desired return. The alternative is to look for properties that have been poorly managed, or ones that have been so loaded down with debt in the past that they have a dismal record of returning periodic cash. A great many properties fall into this category, and most experienced real estate buyers spend their days searching for the properties offering the opportunity of periodic cash returns.

Appreciation In Value

When investors search for real estate investments that will, with reason able probability, grow in value at a faster rate than inflation, the process is commonly called “playing long ball.” As a group, these investors are typically successful in their primary career and they look to real estate investment as a way of building equity and staying ahead of or at least even with inflation. Most people who invest in land are looking for appreciation in value because that is the only promise land speculation offers. Others wait for an economic upturn after purchasing buildings in up-and-coming locations or properties that need an infusion of new money and imagination. Some investors pay too much to capture a trophy building in a prime neighborhood and are forced to wait for rents and eventual values to catch up. The goal of appreciation is present in each of these examples.

Think about the difference between the management techniques employed to satisfy the goals of an owner who is more interested in the ultimate property appreciation and those employed to satisfy the owner who is only concerned with the monthly generation of cash return. Usually, the management techniques employed for an owner looking solely for periodic return are far more conservative than they are for the investor speculating and building for the future.

Control of Investment

An investment in real estate probably offers the investor more control than any other form of investment short of a passbook savings account. When you purchase stocks or bonds, you are clearly at the mercy of a great many influences over which you have absolutely no control. When a particular stock plummets or panic selling begins in the market, investors may not see the warning until it is much too late to avoid losses. Bonds, gold, and collectibles often follow patterns that are difficult to predict and impossible to control. With real estate, however, the investor can exercise some degree of control. If there is a surplus of unfurnished apartments in the market, the answer may he to offer some units as furnished or corporate units. If two-bedroom apartments with one bathroom are slow to rent, perhaps the second bedroom can be modified into a den or an extension of the living room. The owner or agent can attract more customers by adding some punch to the entranceway landscaping. An apartment operator can always exercise control over occupancy levels—and some times influence profits—by adjusting rent rates.

Some aspects of real estate are beyond the investor’s control. Real estate markets, mortgage rates, and availability are a few examples. Tax laws, environmental issues, and neighborhood influences all change; they too are usually beyond the immediate control of the real estate investor. Nevertheless, real estate offers a far greater degree of control than most other forms of investment and you, as a manager, will be called upon to participate in that control.

Pride of Ownership

For many people, being able to demonstrate success and a high level of achievement is a common desire. Over the centuries, real estate has been used by many successful people to display wealth and power within a community. While considering this concept, several names probably come to mind—people who have named towers, developments, or even entire communities after themselves. On a less grand scale, there are many real estate owners who are more motivated by the pride they have in their properties than by the dollars they can earn. As a manager, you will probably come in contact with the type of owner who regularly sacrifices maxi mum profits while making a property more and more of a showcase. To such an owner, decisions regarding an effect on the property’s appearance always seem to outweigh the immediate effect on the bottom line. All the same, it can be said that pride of ownership is another form of appreciation in value; meticulously maintained properties almost always command premium prices at resale.

For Use by Owner

This ownership goal is not nearly as prevalent in rental apartments as it is with office, commercial, or industrial real estate; but it does occur. There are owners who prefer living in a multifamily building and do not want to trust their lifestyle to the typical landlord. These owners may have friends who also choose apartments that can be modified or customized to their liking. Usually, properties that are owned and used in part by their owners enjoy better locations. Also, a much more strict set of criteria is used to screen prospects who wish to rent in these properties. One of the most difficult assignments a property manager can undertake is handling the affairs of a rental apartment property in which the owner or owners reside. This arrangement usually involves two sets of rules—one set for the owners and a distinctly different one for the rent-paying residents.

Financing Leverage

One of the attributes of real estate ownership is that an investor can lever age a considerably larger investment through borrowing. In its heyday, mortgage financing of 90 and even 100 percent was not uncommon. An investor who made a relatively small cash down payment could control real estate worth much more. Any cash return was substantial when compared to the actual cash at risk. Many books, web sites, and even television shows have been created to show the world how to become rich through the use of other people’s money. Leverage or mortgage borrowing is fine when the cost of the money (the interest rate) is close to the earning rate of the property. The problems begin to escalate quickly, however, when a property can only earn, say, 7 percent and borrowing the money costs 10 per cent or more. Another sure indicator of trouble is when the mortgage payments are so high that they begin to “steal” money away from needed operating revenues. During inflationary times, many owners choose to burden their properties with additional debt in order to gain the advantage of acquiring cash today; this allows them to pay back the debt with cheaper, inflation-diluted dollars. Managing investment real estate that has been the subject of such financing schemes and extremes is a most difficult undertaking. After the debt service has been paid, there is often little left to properly operate the investment.

Income Tax Shelter

For a period of some forty years, investment real estate enjoyed a unique advantage over almost all other ventures. Owners were allowed to recover the cost of their investment—often at an accelerated rate—and offset any resulting losses against their other income including salaries and the like. Tax laws allowed investors to be creative and aggressive in their interpretation of these regulations. Property values regularly exceeded the properties’ ability to earn a return because investors sought the advantages granted by the favorable tax climate. The tax-saving aspects of real estate ownership negated a consideration of the basics of location and the particular property’s ability to generate any return. Many managers were pushed past the point of reason when investors insisted that tax-driven in vestments continue operating in an effort to avoid the negative consequences of recapture should the property fail and fall into receivership. After the shock of a new set of tax laws, it took some time to convince investment property owners that the tax-shelter advantage had been neutralized and real estate must again stand on its own merits.

Hedge on Inflation

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