As an apartment syndicator, your most important team member is your property management company. The property management company's main responsibilities are to manage the day-to-day operations and implement your business plan.
However, what if — due to market conditions or lack of skill on the part of the property management company — your net operating income projections aren’t being met? Occupancy is low. Collections are struggling. Rental premiums aren’t being met.
One strategy to turn operations around, or to avoid operational challenges altogether, is to create a property management incentive program.
An incentive program creates an alignment of interest between you and the property management company. The better they perform, the more money you, your investors, and they make.
An incentive program is an agreement between you and the property management company in which the property management company is given an objective, and if they complete the objective, they are rewarded.
Incentive programs fall into one of two categories.
The most common program is one in which the objective is to effectively manage the property. The reward is a property management fee equal to a percentage of the collected income. Plus, they aren’t fired.
Other objectives can include investing their own money in the deal, acting as a loan guarantor, or bringing on their own investors. The reward for all three is more equity or cash flow.
You can also create type 1 incentive programs for key performance indicators, or KPIs. For example, the objective might be to grow total revenue by a certain percentage each year. Or to maintain or exceed a specified occupancy rate.
Just make sure the objective results in alignment of interest. For example, a bad objective is to grow the occupancy by a certain percentage each year, because there is a maximum occupancy rate. Once they achieve a percentage in the high 90s, it will become impossible for them to achieve their objective without first sabotaging occupancy so that they can then increase it again to receive a reward.
Type 2 incentive programs are used when you want to target a specific KPI that is underperforming. For example, if occupancy drops below 90%, you can create an incentive program. The objective is to achieve a specified occupancy rate within a specific time frame (e.g., achieve 95% occupancy within two months).
Once the desired objective is achieved, they receive a reward and the incentive program expires.
Both incentive programs can be beneficial.
The type 1 incentive programs create alignment of interest from the start, whereas the type 2 incentive programs can be used during the business plan to improve a specific lagging KPI.
However, you need to be mindful when creating incentive programs. For example, if you set an occupancy-based type 1 incentive program (e.g., maintain 95% occupancy), the management company can accomplish this goal by offering unnecessary concessions to increase occupancy. Or for a “number of new leases”-based incentive program, the management company can let in unqualified renters to inflate the number of new leases.
Therefore, type 2 incentive programs are the ideal option for KPI-based objectives. If a KPI is lagging, target it with an incentive program. Whereas the type 1 incentive programs are ideal for non-KPI-based objectives, like effectively managing the property, investing in the deal, etc.
The objective of the incentive program needs to be realistic and attainable. For example, an objective to raise occupancy from 85% to 100% in two weeks is too unrealistic. A good strategy to ensure that the incentive program is practical is to plan a brainstorming session with key members of the property management team and discuss objectives and rewards.
Also, be creative with the rewards. They can be financially based, like a gift card or bonus. However, other reward ideas are dinners with you or someone in your company, an extra paid vacation day, a free education or training course, a special trophy or plaque, etc.
Lastly, the best incentive programs do not punish property management companies for failing to achieve the objective. If they miss the mark on an incentive program, don’t reduce their management fee. However, this doesn’t mean that you NEVER punish (i.e., fire) a property management company.
Overall, incentive programs are a great way to create extra alignment of interests with your property management team and can help you target specific KPIs that are lagging.
About the Author:
Joe Fairless is the co-founder of Ashcroft Capital, a fully integrated multifamily investment firm with more than $2.7 billion in assets under management, and the founder of Best Ever CRE. His podcast, the Best Real Estate Investing Advice Ever Show, is the world's longest-running daily real estate podcast with more than 500,000 monthly downloads.
Disclaimer:
The views and opinions expressed in this blog post are provided for informational purposes only and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.