2002 A Year of Transition
The party's over and we know it. The last five years have been a special time for income-producing properties. The dot.com meltdown, economic uncertainty and the events of September 11 have changed our industry and the economy. Most economists agree that we are in a recession. Commercial office vacancies are on the rise. Concessions, unheard of 18 months ago are becoming commonplace. San Francisco, Dallas and Atlanta are overbuilt. The sublet market is breaking records. Making the bottom line grow will become increasingly difficult.
Compounding the problems of an economy heading south are operating costs climbing north. Insurance rates are going through the roof. If you have not received your insurance premium renewal for the coming year, prepare for sticker shock. Some insurance experts believe that insurers are looking to recover the $70 billion they lost as a result of the September 11 terrorist attacks. If you are lucky, your property and liability insurance premiums will increase by as little as 20%. Some owners have been quoted premium increases of several hundred percent for less coverage in many cases. You can almost bet on the fact that acts of terrorism will be excluded from future insurance policies. This exclusion puts owners in an extremely difficult position. One, it may prevent an owner from selling a property or refinancing one. Few, if any, lenders will want to assume terrorism risk, especially in light of today's international climate. The taller and/or higher profile the property, the harder it will be to obtain insurance that is affordable and adequately protects the asset. Some insurers are offering terrorism endorsements or special terrorism policies. These types of policies have been commonplace in Europe and in England.
Property managers can take proactive steps to help address insurance issues by looking for alternatives well in advance of renewal time. You may be able to reduce the impact of premium hikes by aggregating buildings and asking for quotes on a portfolio instead of individual buildings. Additionally, contact underwriters to ask them the criteria that insurers use to evaluate risk and then investigation actions that can reduce exposure and thereby reduce the impact of premium hikes. This insurance crisis represents another opportunity for managers to shine. The decline in the stock market's performance also is fueling the rate increase fire. The combined effect also has insurers reducing the types of coverages offered and the amount and types of risk they are willing to insure.
Increasing property and casualty rates are not the only insurance premiums that are contributing to rising operating costs. Health insurance, workers compensation and business insurance all are experiencing painful increases of 15 to 150% or more. For many properties and property management companies, these are expenses that are very difficult, if not impossible, to control. Some of the increase can be passed on to commercial tenants, and employees. However, the apartment community will find it very difficult to raise rents to cover these costs.
Insurance rates are only the tip of the iceberg. Utility cost control continues to challenge even the most seasoned of property management professionals. And its not just deregulated gas or electricity that is pushing expenses higher. Water and sewer rates have ballooned in many parts of the country.
Another cause for operating cost concern is deregulation. Buying utilities in an open market has not resulted in the economic windfall that some real estate owners had expected. In fact, in many cases the opposite has occurred. The cost of providing power for every owner of real estate has either resulted in additional expenses for commodity or labor to manage utility buying. In separately metered properties, deregulation has increased residents' costs, thereby affecting owners' ability to raise rents.
Given the uncertainty surrounding the purchasing of commodity, the most control managers can exercise over energy costs is the management of energy once it has been purchased. Energy management and conservation are back in vogue. These measures also require owners and managers to conduct risk and reward evaluations. Simply increasing the thermostat a degree or two during the summer or lowering it during the winter can add significant savings across a portfolio. More complicated tasks involve managing peak demand. Peak demand determines pricing. Phasing in the start up of HVAC equipment at different times without compromising thermal comfort can add to the bottom line. Managers could have a significant positive effect on NOI by exploring new technology that can help reduce peak usage. These may include lighting retrofits, installation of motion detectors, variable speed drives on electric motors, pumps, air handlers and chillers. These measures are relatively easy and can provide paybacks that are no-brainers.
More complex measures that may include equipment upgrades and energy retrofits become increasingly difficult to justify in an economy where vacancies are risking and rent levels are dropping. Managers should be conducting energy audits on a regular basis to better determine load characteristics and to help identify savings opportunities. Usage should be monitored daily. CarrAmerica has outsourced this function to Duke Energy Corporation. According to Rich Greninger, managing director of CarrAmerica Realty Corp., Duke's monitoring provides data on the amount of energy used every 15 minutes in 280 buildings nationwide. The data enables CarrAmerica to pinpoint its energy buys. Tenant education is another often overlooked component of an effective energy management program. Managers should play a proactive role by explaining to tenants how equipment operates and recruiting their support for conservation efforts. By reducing energy costs or controlling increases, managers can offer tenants and owners lower operating costs, increased revenue and a better bottom line.
The bottom line is that the environment is significantly tougher than it was a year ago. It will be time to watch expenses and look for opportunities to increase revenue streams. Last, but certainly not least, is to capitalize on professional development opportunities that provide mediums to learn from the experiences of peers. Active involvement in organizations such as PMA can provide returns that today's economic environment requires.
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