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Theo Hicks: Hello, Best Ever listeners and welcome to another episode of The Syndication School series – a free resource focused on the how-tos of apartment syndication. As always, I’m your host, Theo Hicks. Now we are gonna start airing one syndication school episode every single week in addition to another show we’re starting off with me and Travis. I don’t have a name locked down yet, but it’s gonna be focused mostly on passively investing. So whether you are a passive investor listening to this or an active apartment syndicator listening to this, I think these episodes will be valuable whether, again, from a passive investor perspective learning the tricks and tips for that, as well as the active syndicator, understanding what it is that passive investors are actually looking for. But this is going to be Syndication School to talk about the specific aspect of the apartment syndication investment strategy. We’ll continue to release free documents in syndication school when it makes sense as well.
Today, we’re going to talk about property management incentive programs. So we’re gonna be talking about how to create this program for your management companies. This will be a post closing or I guess, at the earliest, post due diligence phase step, and the reason why you want to do an incentives program is because it will create an additional alignment of interest between you and your property management company, because the better they perform, the more money that they make.
So we’ve talked about other ways to create an alignment of interest, bringing on a team member, an experienced team member creates alignment of interests between you and your investors, and then with that team member, from lowest to highest alignment of interest, you have them getting an equity stake in the deal, which is a little bit lower than the next one, which is them investing their own money in the deal, where they have skin in the game. Above that would be them investing their own money and/or bringing on their own investors, and then above that would be them signing on the actual loan. So this incentive program falls probably in between you just bringing them on and giving them equity in the deal, but this is still a great way to create alignment of interest, because based off of whatever your incentives program is, they achieve that goal, then they get paid more.
So what is an incentive program? Simply put, you give your property management company an objective and if they complete that objective, then they are given a reward. That’s the simplest way to explain what an incentives program is. The incentives programs are going to fall into one of two categories. So for the purpose of this episode, we’re going to call them Type 1 programs and Type 2 programs.
So Type 1 incentive programs are incentive programs that begin at acquisition, and then they end at sale. So these are the types of programs where the objective is not necessarily never fully accomplished, and we’ll give some examples, but this is something that whatever reward they get, the possibility of continuously getting that reward every month, every quarter, every year, or all three. So that’s the Type 1 program – start at acquisition, end at sale. The Type 2 would be the one-off incentive programs that starts and end over a fixed amount of time.
So what are some examples? So for Type 1 incentive programs, the most obvious would be the property management fee, which is technically an incentive. It’s going to be used all the time, but that is considered an incentive. The objective is for them to effectively manage the property, to make sure the property’s occupied, make sure expenses are kept low, and their reward is their property management fee. The reward is also not getting fired if they do a poor job. So that’s the base level incentives program that everyone is going to have.
Other ones are them investing their own money in a deal. So the objective is they invest their money, the reward is they get the compensation given to the limited partners. If you’re getting a loan guarantor – same thing, they’ll get either a chunk of equity or a one time fee. Bringing on their own investors, same thing, they’ll get a chunk of equity. So the reward for all these are more equity or more cash flow. So those are kind of like basic, simple incentive programs.
These next ones are what you would probably consider incentive programs. So you can create these Type 1 incentive programs based off of KPIs, the Key Performance Indicators, and we’ve done an episode in the past on the property management weekly performance reviews, and in that series, we offered a free document which was that KPI tracker. And on that document, you’ll have all of the various KPIs that you will want to track on a weekly basis at your property. Of those KPIs, you can create various Type 1 and Type 2 incentives programs. So for example, the objective for an incentive program could be to grow revenue by a certain percentage each year, or maintaining or exceeding a specific occupancy rate, like 95%. So that could be something that you have an agreement with your property management company from the get-go, that as long as revenue grows by 5% every single year, then you’ll get an extra 1% bonus; or if you are able to maintain a 96% occupancy rate, for every month you exceed that, you’ll get some bonus. So those are examples of Type 1 incentives programs; so the KPI is revenue growth and occupancy rate.
Now make sure that when you are doing these Type 1 incentive programs that the objective actually makes sense and actually results in alignment of interest. So for example, a really bad incentive program with a bad objective would be to grow the occupancy by a certain percentage each year, because there is a limit to the occupancy growth. Once they’ve achieved 95%, 96%, it’s gonna be very, very difficult for them to achieve a 5% growth without, in their mind, sabotaging, reducing occupancy and then bringing it back up again. So just occupancy fluctuating up and down so they get paid more. So that’s why having an occupancy threshold that they need to maintain or exceed is a much better objective when you’re using an occupancy KPI. Same thing for total revenue growth. Setting a total revenue growth goal of 20% is too unrealistic and is not going to accomplish what you set out to accomplish. So those are examples of Type 1 incentive programs.
Type 2, again, are the one-off incentive programs. So these are ones where you can target a specific underperforming KPI. So let’s say, for example, your occupancy rate drops to just below 90%, then you can create an incentives program, and the objective would be to achieve a specific occupancy rate within a specific timeframe… Say, 95% occupancy within two months. And you can apply this to many of the other KPIs too if they fall below whatever your projections are. So if you do the KPI right away in the beginning to maintain the 95%, or you can do this in addition to that already incentives program. If your occupancy or some KPI falls below your projections or it doesn’t necessarily have to be below your projections, it could be non-stabilized or something else, you can set up a just one time Type 2 incentives program to get that number back up. Once they’ve achieved that occupancy rate, then they receive the award and that incentive program expires, and then you’ll do another one or not do another one, depending on how the property performs.
So let’s compare these two. Both can be very beneficial. The Type 1 incentive programs will create that alignment of interest from the get-go, and then the benefit of the Type 2 incentives program is that they can be used during the business plan to target and improve a specific lagging KPI. Of course, you might be saying, “Well, Theo, why don’t I just do all Type 1 incentive programs? That way, I don’t have to worry about a KPI ever lagging.” Well, as I mentioned before, one reason why is because if you set an objective to increase the occupancy rate by percentage, it’s not going to actually create an alignment interest, but the second point is that you need to be very, very careful and mindful when you’re creating these incentives programs, because you have to make sure that it’s actually incentivizing the management company and it’s incentivizing you; that it’s a win-win scenario.
So I already gave the example of the occupancy rate percent increase each year could potentially result in the property management company purposely sabotaging the occupancy, so that they can then be the knight in shining armor, increase the occupancy rate by that 3% they need to increase it by, and then getting that bonus.
Another example would be if you set an occupancy-based Type 1 incentives program. Let’s say, it’s to maintain a 95% occupancy rate. Well, how are they going to accomplish that 95% physical occupancy rate? So that’s just the number of units that are actually occupied. It has nothing to do with the rents demanded for those units, the concessions that were given for those units… So setting a Type 1 physical occupancy goal or even a Type 2 physical occupancy goal is probably not the best incentive program, because the property management company can sacrifice other aspects of the P&L in order to get that number to 95%.
So a much better KPI would be the economic occupancy rate. Another example would be a number of new leases based incentive program; 20 new leases every single month. Well, what’s stopping them if that’s the goal from letting in unqualified renters to inflate those new lease numbers? So you have to be very, very smart when you are creating these incentive programs, because you don’t want to shoot yourself in the foot. So Type 2 incentive programs are gonna be really good for the KPI based objectives. So if a KPI is lagging, then you’ll want to target that with incentives, and then the Type 1 incentive programs are gonna be much better for these non-KPI based objectives, like the property management fee, and then other ways to create alignment of interest like them investing in the deal and things like that… Because again, you don’t want to incentivize the management company to do things that actually hurts you.
So a few other best practices when creating an incentives program – first, you want to make sure that the objective set is realistic and attainable. We’ve already given examples of what would be realistic ones, but an objective to, say, raise the occupancy just below 90% to 85% and you set an incentives program to increase occupancy to 100% in two weeks – that’s unrealistic, very difficult. I mean, obviously, it’s possible, but very difficult to accomplish. So a really good strategy to ensure that the incentive programs are practical is to actually plan a brainstorming session with the key members of your property management team and discuss objectives, metrics for those objectives, and then the actual rewards. What do they want? Which brings me to my second best practice, which is to be creative with your rewards. So maybe, after the brainstorming session, you realize that the property management company just wants money. They just want a cash bonus or a gift card, but other rewards would be dinners with you or someone else in your company. You could offer them an extra paid vacation day. It could be a free education or training course which helps you and them. It could be a special trophy or plaque that gets passed around every single month. Just be creative about your rewards, make it fun. Not only incentivize them to do it for monetary reasons, but also because it’s fun; it’s a competition.
Then lastly – and this is really important – you do not want to create an incentives program that actually punishes the management companies for failing to achieve the objective. So when you set incentive programs, you want it to be, “Here’s the objective. If you achieve the objective, you get rewarded. If you don’t, then you don’t get rewarded,” which, in a sense, could be considered a punishment, but you don’t want it to be, “If you have achieved the objective, then you get a 1% raise in your management fee. If you don’t, then you get a 1% decrease, and if you fail three objectives then you get fired.” That’d be a really bad incentives program, because that’s not creating an alignment of interest, that’s just helping you in a surface level, but also, it’s not necessarily helping you because your management company is not going to achieve that incentive, they might get fired and that is going to affect the operation that’s your property. So don’t reduce management fees, don’t give out any punishment if they don’t achieve the objective. The only time you necessarily want to punish your management company is when you actually fire them, and I believe we did an episode on how to approach firing a property management company. Actually, it was a Follow Along Friday that Joe and I did, where we went over how to fire a property management company. If you go to YouTube and say ‘how to approach firing your property management company’. It was released July 26, 2018. Joe and I went through that process.
So obviously, it’s not that you never want to punish your management company, but you’re not going to fire them for not achieving the objective in an incentives program, you’re gonna fire them for other reasons. So maybe incentive programs would be a good way to give them a chance to not get fired, and then in that sense, you might fire them after an incentives program failure, but overall, you don’t want to punish them over an incentives program.
So overall, these incentive programs are a great way to create that extra alignment of interest with your management company, as well as help you target specific KPIs that start to lag. So right now, amidst the pandemic, right now might be a great time to implement a fun, engaging, realistic, attainable incentives program. Even if they don’t meet that goal, that push up in economic occupancy or revenue or whatever, it could be very helpful.
Anyways, that concludes this episode, that is how to create a compelling property management incentives program. Make sure you check out some of the other syndication school episodes and those free documents at syndicationschool.com Thank you for listening. Have a best ever day and we’ll talk to you tomorrow.
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