July 11, 2023 • 34 mins
Massively Increase Your Net Operating Income™ with The TCO Method™
Andy shifts the conversation away from procurement and discusses capex, cash reserves, and other impacts to your budgetary planning and why it's important to have good data and leverage that for success - while taking into consideration all the potential issues and desired outcomes while establishing the budget for best results.
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Transcript
Episode Transcript
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(00:00):
[Music]
(00:24):
Welcome to the TCO Method, the only show focused on helping you massively increase your net operating income.
I am Andy McQuade and thank you so much for joining me on this beautiful Tuesday morning in the middle of July.
Oh, I guess it's the beginning of July still, right? The 11th.
And I want to finish the episode that we started last week talking about budgets.
(00:51):
Not because I really love budgets. I see it as a necessary evil.
I was being facetious in the last episode when I said it was everyone's favorite topic.
It's actually probably everyone's least favorite topic, but one that needs attention to be done correctly,
(01:12):
because it's part of your planning process and it's going to make or break your success.
The reason I wanted to talk about budgets is because for the last five, seven, eight, ten years,
we've seen a lack of focus on budgets, mostly because money was basically free.
(01:39):
Anything under 4% in my opinion is free money.
So the idea of unlimited uncapped rents over the last two or three years combined with free money made for some very reckless spending habits and really poor planning.
Now you would have thought that the pandemic would have taken care of the poor planning part, but no, not at all.
(02:04):
Actually, maybe it's even worse now.
So there's a disconnect is more and more people get siloed into their jobs and into their focus, right?
So we're back to working in your business instead of on your business.
But as you hire employees to manage functions, their job is to be siloed.
(02:26):
Their job is to be focused on what you hired them to do.
The problem is that in most cases, I won't say all because all is a hard and fast answer that doesn't really cover reality.
In most cases, people are not doing everything they need to be to stay ahead of the business.
(02:55):
Budgeting, hopefully, is being coordinated between multiple different people and multiple different silos in your company to create ideally vertically integrated budget, but it doesn't seem to happen.
Budgets are typically cookie cutter bottom dollar.
How do I get this done for the least amount of money possible?
(03:19):
As quickly as possible. And we'll worry about all of the things that we're going to cause in this process.
All the fallout, all the complications, all the extra maintenance, all of the callbacks, all of the work orders, we'll worry about that when it happens.
(03:41):
It's part of the cost of doing business.
I hate that phrase.
The cost of doing business is another one of those phrases used on the path to the bottom, the race to the bottom.
And why do I say that?
(04:03):
Because it's de fetest by its very nature. It's focused on having you accept what is instead of what could be.
All I need to buy products is just part of doing business. It's just an expense I have to write off.
Yeah, but is it? Is it really?
(04:26):
Are you telling me that it's not possible to make a decision today and have that decision pay for itself in two to three years?
Or to not start costing me extra money in two to three years or to increase my revenue or to like, I don't know something crazy.
(04:51):
Extend the useful life of my unit before I have to gut it and start over. Are you saying that selecting the right tenant isn't actually important to the quality and well-being of your property and the other tenants in that building?
Really? Really?
(05:12):
Because all those things kind of tie together. And you can't just unlimited rent increase for the rest of time.
Yes, rent increases should happen every single year. And they should keep up with inflation. Yes, when you do a full gut and rehab to bring a property back up to market value, there should be a rent increase.
(05:35):
But you need to have a budget now because money is not free anymore.
So in the last episode, we really focused kind of on supply chain stuff, which is my default go to and I apologize if procurement is boring.
I can't help that it's boring.
It's literally probably the most fundamental foundational part of your entire operation.
(06:00):
And it's the one that's just seen as a cost of doing business that either takes you on the race to the bottom or can help make you money.
It depends on how you approach it and what you do with it.
And that's going to determine whether or not whether it's a cost center or a value driver.
(06:22):
So obviously, we're going to be focused on making it into a value driver because I don't think there's any reason to ever be just lighting money on fire because it's just the way we've done things for the last 60 years.
The revelations that information has brought to the modern age for every industry, not just real estate, are stunning because suddenly you can see patterns.
(06:51):
Suddenly you can see with very granular, very exact detail where you're lighting money on fire.
When you're lighting on fire and what decisions lead to that fire being started.
And yet we either don't use the data, we don't collect the right data or when we see some data, we choose to ignore it.
(07:17):
In most cases, we're just not gathering the right data from the right places.
Successful strategy in business operations involves looking for patterns and understanding that decision A, B, and C from here will carry forward for however many years and impact costs EF and G down the road.
(07:49):
When you get enough data and you look at enough numbers, you remove yourself from the situation, you take the emotion out of it, you take the in your business, not being able to see the forest through the trees, and you look at it, you start to see patterns of things that are happening that cost you money that are just a cost of doing business.
(08:17):
Well, are you in business to just do business or are you in business to do business in the best way that you can to really move that needle to really generate more to do more.
Well, how do you do that when you don't even know what's costing you money or why?
(08:47):
Everybody's reasons are different. There are no two operations I have set foot in in the last 25 years that have been identical.
None.
But they all have common threads they all have patterns they all have similar issues and opportunities for improvement.
(09:09):
Some do it better than others.
But I have yet to see someone with all the answers.
I don't have all the answers I walk into operations all the time and see stuff that I think is really cool that I try to learn about so I can take those ideas and help other people with them later.
(09:33):
That's part of the learning process.
But if you've already got all the answers number one, this ain't to show for you.
Number two.
When are you going to give me all the answers because I really want them.
The other thing I'll say before we move back to budgets.
(09:54):
There's no single software in implementation that I've ever seen from any vendor that covers all the basis.
They don't. Some do things better than others.
There's no single solution. I wish there was.
But if there was those people would be billionaires and all the other ones out there would be gone too many variables for blanket answers for every single project for human beings come in to help steer the ship.
(10:25):
You can still be human and be objective.
The problem is that when you're emotionally invested in something.
Objectivity takes a back burner to personal priorities and.
Opinions or systems that you formed based on prior experience.
(10:47):
But here's the thing with data.
If you collect the wrong data or no data.
Your building on a foundation.
Made out of sand.
You need the right data. You need the right information.
Build a foundation out of concrete.
(11:10):
So that your structure doesn't collapse.
Garbage in garbage out.
So what you need to do is start looking at where these decisions are being made in the budgeting and planning process.
When you're building systems when you're setting standards when you're hiring or looking to hire people to run these particular properties projects etc.
(11:40):
What information are you using to help steer that conversation.
Do you know where your biggest opportunities lie as far as long term operational costs.
And I'm not talking about the hot buttons right now with property taxes and insurance.
Because those are hot for everybody because the world's on fire and everything's crazy.
(12:04):
I'm talking about the things you can control directly.
Like you can control your insurance.
I've seen people say that there's nothing you can do about your property taxes and there's nothing you can do about your insurance.
You're wrong on both points.
Is it always going to be what you want?
No.
Can you do better?
Yeah, probably.
(12:25):
But it takes effort and it takes expertise and it takes the right connections and the right people in the right places to make that happen.
It doesn't happen overnight and all the answers aren't going to be perfect.
I know plenty of people with lots of property who went to a captive insurance system because they could have afforded it.
But it was an unpleasant hit to the NOI.
(12:46):
So they went captive instead.
It is what it is. There are things you can do. They might be distasteful.
But there's ways you can impact it.
You can't tell me that less claims isn't going to affect your insurance cost because guess what?
(13:10):
More claims does increase your insurance cost.
So let's do the math on this one. Do things smarter to avoid insurance claims.
I'm hearing risk management cost avoidance compliance.
Do those things.
And at the very least your insurance costs won't escalate.
(13:32):
In the world of opportunity cost, that's a win.
Anyway, budgets timing.
Money's not free anymore.
So let's talk about your CAPEX, which is kind of what we've been talking about.
What we really focused on supply chain in the last episode.
(13:53):
Well, how do you plan for CAPEX?
What do you mean, how do you plan for CAPEX?
I understand that a lot of businesses popped up during free money times.
And that things like reserves for CAPEX, reserves for unforeseen circumstances, reserves for emergencies didn't exist for a lot of them because they never needed them because money was free.
(14:22):
How do you budget for CAPEX?
Well, it's really simple because every single thing you use on your property has a lifespan and it's finite.
Your curb appeal in your units has a lifespan and it's finite.
And if you have the right data and you can see markets trends and patterns, you can calculate out when you're going to need to do XYZ.
(14:49):
Like if you have a roof that's 25 years old.
God bless you at number one, but number two, you think maybe you're going to have to replace that at some point?
And that it might cost more than what's in your reserves if you have reserves?
Hot water tanks, boilers, furnaces, finite life spans.
(15:14):
Easy to know what they are.
If they happen to go over the average lifespan, you make out.
But that doesn't mean you get to get rid of that money that you've set aside to take care of that problem if it happens.
That means that you continue building because your projects, your product, your units, your whatever, everything has a finite lifespan.
(15:40):
And there's more than one component with one lifespan in every single one of those.
Tenant wear and tear, notwithstanding.
You know that you have to account in a lot of ways for tenant wear and tear depending on the class of property.
There's so many things that happen in a macro environment in a societal level that you just can't predict everything.
(16:06):
So you hope for the best and prepare for the worst. Sound familiar?
So part of your budget before you get to what you get to keep.
So below NOI is your debt service and your cash reserves as well as your capital expenditures.
(16:29):
Hopefully you minimize the number of unplanned ones.
But again, there's a lot of moving parts.
So with those moving parts, you always build for failure.
You build for the lowest common denominator. Two benefits to that. One is you're not really surprised when something goes sideways.
(16:53):
Is that a negative outlook on life? No. It's called reality.
When money is involved, idealism has to take a back burner.
You have to approach your product, approach your project, approach your business in a way that accounts for reality.
(17:16):
Now I'm a strategy guy, which means I like to understand where things are coming from so I can kind of get that 10,000 foot look and see where things are going.
You should be doing the same thing with your business.
You cannot just hope things are going to work out based on the outlier of human nature.
You need to assume that things are going to go sideways and make sure that your units are resilient enough to withstand it.
(17:43):
We hear a lot of talk about resilience and building materials when it comes to new construction, surviving.
Forest fires and colder weather and hotter weather and crazy winds and weather uncertainty and all this other stuff. Well, that's cool.
I'm talking about resilient from the people living in the unit, from the tenant, leasing that space.
(18:08):
How do you build for failure? How do you build?
Assuming things are going to get beat up. Hopefully experience teaches you and hopefully it's not your experience necessarily where you're taking it on a chain and lighting your money on fire.
Hopefully you can listen to some of these podcasts and look at some of your counterparts and your peers in the industry and go wow they really have a hard time in this neighborhood with this type of tenant using this product or building something this way or putting some sort of.
(18:40):
XYZ product in that fails after two or three years like hopefully you're smart enough if you're listening to podcasts and trying to increase your.
Market knowledge your business acumen whatever it is hopefully you're doing it in a way and for a reason that is that you want to get better at something.
(19:01):
If you listen to these and you don't take action on anything you hear and you're not learning anything you still have to learn things the hard way.
Why are you listening to podcasts why are you reading books.
It's not entertainment I mean it might be entertainment I try to make my show very entertaining but.
It's pretty dry stuff like if I wasn't a real estate person my show would suck out loud my show probably does suck out loud.
(19:32):
I'm not that good it's just life I'm okay with it.
The rant is over for now the core message is a core idea of this entire conversation is that in addition to your supply chain and your standards near their stuff and being built for failure and.
Whatever is that you have to assume that things are going to happen.
(19:58):
And you have to have a cat X planning process and you have to have sufficient reserves to cover those at their estimated time of failure.
A lot of companies just have a general reserve fund that they pool a whole bunch of stuff from a whole bunch of properties and I've seen 47,000 different formulas to do it I take X percent of rent and I put it in here.
(20:26):
From all of these properties and I take you know why Z and B and I put it all into this cash reserve and then.
I have you know system A and B that helped me track.
Whatever all well and good as long as you're doing something but because it affects your cash flow right the money you keep.
(20:52):
There's a tendency again because of human nature to underestimate what those need to be especially from the long time operators.
Because what we're seeing is long time operators still wanting to pay the same thing that they were paying in 2019 for labor for product for service.
(21:16):
And it's just not life like it'd be cool if we could get back to that but no you can't build your business today.
On the mat from four years ago doesn't work you need to give up some of that cash flow to account for today's numbers now some people have adapted.
(21:45):
A lot of people looking at this at 10,000 feet and looking at multiple sets of books and multiple sets of confidential internal information I can tell you that.
Reserve funds if they were not directly tied to a percentage of gross revenue.
(22:06):
I've not increased but the cost to do the things the reserve was created for have increased by like 30% because people wanted to take home more money and they did.
It is not my business you operate your business how you want to.
(22:27):
But from an outside source the neutral objective consultant knowing that things cost 30% more today than they did in 2019.
But not increasing your reserves assuming you had any in 2019 not increasing your reserves by that same 30% to cover these expenditures is pretty fucking stupid so you can plan you can budget you can hope for the best.
(23:08):
But if you only prepare for the best you're going to get your freaking teeth kicked in now.
There's a positive side to this in that.
You're creating opportunity for the next owner of that property.
But you need a system.
That accounts for today and the problem we see with management companies investment firms and operators family office whatever it is.
(23:40):
The people operating the business similar to the race to the bottom in construction are incentivized and paid to deliver better results.
Better results equate to taking home more money.
Your boss or as an owner looking down at their operation from 10,000 feet you want to see positive growth positive cash flow.
(24:16):
Things being done under budget faster than expected all these numbers but here's the problem.
Instead of working in reality you're incentivizing your employees whether they're 1099s or whether they're W2.
You're incentivizing the people working with you and for you to deliver what you want to see.
(24:44):
Which is great to a point but they need to be grounded in reality record profits record margins record growth.
All really cool.
But what are you sacrificing to get there what are you missing that's going to cost you more later to get there.
(25:09):
You're telling people that you want to see this and this and this delivered and they will find a way to do it because it is their livelihood and their jobs they are not you the owner they are not you the entrepreneur they are not you the builder the driver the owner.
They are somebody who's looking at you as their paycheck and they're going to do everything in their power to minimize what you see in here from problems and maximize the good stuff so they can make more money and become more secure in their careers and their services that they offer.
(25:43):
The best part about consulting with an ethical quality consultant is that they will tell you the bad news they will look you in the eye and say this is messed up and it's going to bite you in the butt and here's why and here's how you fix it.
(26:05):
Employees will not tell you that because they don't want to piss you off.
The ones who are willing to do that are literally one and a million.
Again who's on your team.
It's not just about what you want to hear you need the truth and the truth is if your reserves are the same today as they were in 2019 or 2020 you are doing it wrong.
(26:33):
If you have no reserves you're really doing it wrong and if you don't have a plan to budget out your capex based on real useful life expectations but yeah it's complicated.
It is not easy to take 50 or 60 or 120 different products with different service life.
(27:01):
Combine it with market fundamentals and market dynamics from curb appeal standpoints.
And then to project out functional life and what that's going to cost you but that's part of the tcm method you have to know these things you have to know what's left in the useful life of x y and z.
(27:25):
When you acquire a property.
You should be aware that your windows haven't been changed since 1972 and that that's going to cost a whole crap load of money.
You should be aware that your boilers were installed in the 60s.
(27:46):
And they're super inefficient.
You should be aware that there's no insulation in your attic on your buildings you should be aware that your hot water tanks are all 12 years old.
There's an argument to be made.
For just gutting those things at the beginning at an acquisition because you've got the capital available and you've got the time and the energy.
(28:10):
And then you're resetting that number across the entire property and it's less variables doesn't always work for everybody every property every portfolio every approach is different.
Because of risk management risk tolerance compliance prior experience supply chain market dynamics there's so many things that go into it.
(28:35):
But they can be quantified they can be accounted for and they need to be.
If your budget is actually going to be a budget and not just a hey this would be really cool if this worked out this way that is a recipe for failure and yet especially in some of these older companies with larger portfolios.
They light six figure seven figures on fire.
(28:59):
As opposed to putting systems in place that might cost them to employees in a position to operate that side of the business.
Like if you know that the average savings on a 1950s to early 1990s built development with 700 doors.
(29:27):
Is leaving somewhere between 120 and $190,000 a year on table.
Because of opportunities in process and product and the third maintenance in the past that needs to be addressed and all this other stuff like if you knew.
(29:49):
That you could not raise rents and put an extra 200 grand a year into your NLI do you think that would be a good idea.
Yeah, probably.
But because of all these employees between the leadership ownership driver producer operator whatever.
(30:11):
And that level that money sitting there and it's because of bad decisions being made on top of bad decisions being made on top of bad decisions and it steam rolls.
Doing this will create more maintenance will use more electricity will use more water will create more maintenance will do this in its snowball.
(30:35):
Because you're on a foundation built out of sand. And yes, it's the foundation that we've been using for 60 years. I get it.
We've always done it this way is the fastest path to failure.
The companies who figure it out who see the patterns who make changes who build systems.
(30:57):
They're the ones who scale and become successful. And at some point.
The big company was in that innovation land where they were looking at things and going wow this is a great opportunity.
We should do this in this in this.
But then they stopped innovating because they got big. And they sit back and they look at themselves in the mirror like.
We got this we're good.
(31:19):
And we're making money and everybody's getting paid and it's awesome.
But is it really awesome.
If you know that for every 700 doors you've probably got somewhere between one in two hundred thousand dollars worth of opportunity just collecting dust.
And it's not instant like snap your fingers wow I'm making an extra 200 grand a year now there's work in there it's going to cost you money to make those changes it's going to cost you money for change management it's going to cost you money for product possibly.
(31:48):
It's going to cost you money for hiring people firing people there's a lot involved a lot involved it is not that there's no get rich quick scheme in real estate.
Know your operations vet your people maybe we'll do an episode on vetting things at some point I don't know.
So the end I'll be all of this in addition to having standards having spec having a budgetary plan is to make sure that it's realistic and current.
(32:21):
And to make sure that you understand where the major components of your property are what they are and what they cost today to fix.
Because your budget your cash reserves your plans from four years ago after everything we've been through not just as a country but globally.
(32:44):
If you haven't adapted with the times you're done the rise of AI the rise of big data the like all these tools are available to you as an owner as an operator.
And yet we're still doing things by and large the same way we've been doing in from the last 40 to 60 years.
(33:05):
What's the definition of insanity again.
So if you got any value at all from this podcast please subscribe.
Leave a review please leave a comment if you can comment on an episode spotify does that now if you can review and comment per episode give me feedback.
Send me an email at podcast TCO method dot com.
(33:28):
Let me know what you think give me your opinions.
More cool stuff on the way.
We'll have some announcements in a couple of weeks I know I said that last week but no seriously in a couple of weeks we'll have some announcements.
And I hope everybody has a great rest of your week get out do real estate make some deals make some friends shake hands kiss babies do what you need to do.
(33:52):
Be honest be ethical be moral be upstanding.
But be outstanding don't settle go watch the video on YouTube subscribe on YouTube you don't have to watch me you can just put me in another window.
I appreciate you listening much to have a great rest of the day.
(34:15):
[Music]
[Music]
[Music]
(00:24):
Welcome to the TCO Method, the only show focused on helping you massively increase your net operating income.
I am Andy McQuade and thank you so much for joining me on this beautiful Tuesday morning in the middle of July.
Oh, I guess it's the beginning of July still, right? The 11th.
And I want to finish the episode that we started last week talking about budgets.
(00:51):
Not because I really love budgets. I see it as a necessary evil.
I was being facetious in the last episode when I said it was everyone's favorite topic.
It's actually probably everyone's least favorite topic, but one that needs attention to be done correctly,
(01:12):
because it's part of your planning process and it's going to make or break your success.
The reason I wanted to talk about budgets is because for the last five, seven, eight, ten years,
we've seen a lack of focus on budgets, mostly because money was basically free.
(01:39):
Anything under 4% in my opinion is free money.
So the idea of unlimited uncapped rents over the last two or three years combined with free money made for some very reckless spending habits and really poor planning.
Now you would have thought that the pandemic would have taken care of the poor planning part, but no, not at all.
(02:04):
Actually, maybe it's even worse now.
So there's a disconnect is more and more people get siloed into their jobs and into their focus, right?
So we're back to working in your business instead of on your business.
But as you hire employees to manage functions, their job is to be siloed.
(02:26):
Their job is to be focused on what you hired them to do.
The problem is that in most cases, I won't say all because all is a hard and fast answer that doesn't really cover reality.
In most cases, people are not doing everything they need to be to stay ahead of the business.
(02:55):
Budgeting, hopefully, is being coordinated between multiple different people and multiple different silos in your company to create ideally vertically integrated budget, but it doesn't seem to happen.
Budgets are typically cookie cutter bottom dollar.
How do I get this done for the least amount of money possible?
(03:19):
As quickly as possible. And we'll worry about all of the things that we're going to cause in this process.
All the fallout, all the complications, all the extra maintenance, all of the callbacks, all of the work orders, we'll worry about that when it happens.
(03:41):
It's part of the cost of doing business.
I hate that phrase.
The cost of doing business is another one of those phrases used on the path to the bottom, the race to the bottom.
And why do I say that?
(04:03):
Because it's de fetest by its very nature. It's focused on having you accept what is instead of what could be.
All I need to buy products is just part of doing business. It's just an expense I have to write off.
Yeah, but is it? Is it really?
(04:26):
Are you telling me that it's not possible to make a decision today and have that decision pay for itself in two to three years?
Or to not start costing me extra money in two to three years or to increase my revenue or to like, I don't know something crazy.
(04:51):
Extend the useful life of my unit before I have to gut it and start over. Are you saying that selecting the right tenant isn't actually important to the quality and well-being of your property and the other tenants in that building?
Really? Really?
(05:12):
Because all those things kind of tie together. And you can't just unlimited rent increase for the rest of time.
Yes, rent increases should happen every single year. And they should keep up with inflation. Yes, when you do a full gut and rehab to bring a property back up to market value, there should be a rent increase.
(05:35):
But you need to have a budget now because money is not free anymore.
So in the last episode, we really focused kind of on supply chain stuff, which is my default go to and I apologize if procurement is boring.
I can't help that it's boring.
It's literally probably the most fundamental foundational part of your entire operation.
(06:00):
And it's the one that's just seen as a cost of doing business that either takes you on the race to the bottom or can help make you money.
It depends on how you approach it and what you do with it.
And that's going to determine whether or not whether it's a cost center or a value driver.
(06:22):
So obviously, we're going to be focused on making it into a value driver because I don't think there's any reason to ever be just lighting money on fire because it's just the way we've done things for the last 60 years.
The revelations that information has brought to the modern age for every industry, not just real estate, are stunning because suddenly you can see patterns.
(06:51):
Suddenly you can see with very granular, very exact detail where you're lighting money on fire.
When you're lighting on fire and what decisions lead to that fire being started.
And yet we either don't use the data, we don't collect the right data or when we see some data, we choose to ignore it.
(07:17):
In most cases, we're just not gathering the right data from the right places.
Successful strategy in business operations involves looking for patterns and understanding that decision A, B, and C from here will carry forward for however many years and impact costs EF and G down the road.
(07:49):
When you get enough data and you look at enough numbers, you remove yourself from the situation, you take the emotion out of it, you take the in your business, not being able to see the forest through the trees, and you look at it, you start to see patterns of things that are happening that cost you money that are just a cost of doing business.
(08:17):
Well, are you in business to just do business or are you in business to do business in the best way that you can to really move that needle to really generate more to do more.
Well, how do you do that when you don't even know what's costing you money or why?
(08:47):
Everybody's reasons are different. There are no two operations I have set foot in in the last 25 years that have been identical.
None.
But they all have common threads they all have patterns they all have similar issues and opportunities for improvement.
(09:09):
Some do it better than others.
But I have yet to see someone with all the answers.
I don't have all the answers I walk into operations all the time and see stuff that I think is really cool that I try to learn about so I can take those ideas and help other people with them later.
(09:33):
That's part of the learning process.
But if you've already got all the answers number one, this ain't to show for you.
Number two.
When are you going to give me all the answers because I really want them.
The other thing I'll say before we move back to budgets.
(09:54):
There's no single software in implementation that I've ever seen from any vendor that covers all the basis.
They don't. Some do things better than others.
There's no single solution. I wish there was.
But if there was those people would be billionaires and all the other ones out there would be gone too many variables for blanket answers for every single project for human beings come in to help steer the ship.
(10:25):
You can still be human and be objective.
The problem is that when you're emotionally invested in something.
Objectivity takes a back burner to personal priorities and.
Opinions or systems that you formed based on prior experience.
(10:47):
But here's the thing with data.
If you collect the wrong data or no data.
Your building on a foundation.
Made out of sand.
You need the right data. You need the right information.
Build a foundation out of concrete.
(11:10):
So that your structure doesn't collapse.
Garbage in garbage out.
So what you need to do is start looking at where these decisions are being made in the budgeting and planning process.
When you're building systems when you're setting standards when you're hiring or looking to hire people to run these particular properties projects etc.
(11:40):
What information are you using to help steer that conversation.
Do you know where your biggest opportunities lie as far as long term operational costs.
And I'm not talking about the hot buttons right now with property taxes and insurance.
Because those are hot for everybody because the world's on fire and everything's crazy.
(12:04):
I'm talking about the things you can control directly.
Like you can control your insurance.
I've seen people say that there's nothing you can do about your property taxes and there's nothing you can do about your insurance.
You're wrong on both points.
Is it always going to be what you want?
No.
Can you do better?
Yeah, probably.
(12:25):
But it takes effort and it takes expertise and it takes the right connections and the right people in the right places to make that happen.
It doesn't happen overnight and all the answers aren't going to be perfect.
I know plenty of people with lots of property who went to a captive insurance system because they could have afforded it.
But it was an unpleasant hit to the NOI.
(12:46):
So they went captive instead.
It is what it is. There are things you can do. They might be distasteful.
But there's ways you can impact it.
You can't tell me that less claims isn't going to affect your insurance cost because guess what?
(13:10):
More claims does increase your insurance cost.
So let's do the math on this one. Do things smarter to avoid insurance claims.
I'm hearing risk management cost avoidance compliance.
Do those things.
And at the very least your insurance costs won't escalate.
(13:32):
In the world of opportunity cost, that's a win.
Anyway, budgets timing.
Money's not free anymore.
So let's talk about your CAPEX, which is kind of what we've been talking about.
What we really focused on supply chain in the last episode.
(13:53):
Well, how do you plan for CAPEX?
What do you mean, how do you plan for CAPEX?
I understand that a lot of businesses popped up during free money times.
And that things like reserves for CAPEX, reserves for unforeseen circumstances, reserves for emergencies didn't exist for a lot of them because they never needed them because money was free.
(14:22):
How do you budget for CAPEX?
Well, it's really simple because every single thing you use on your property has a lifespan and it's finite.
Your curb appeal in your units has a lifespan and it's finite.
And if you have the right data and you can see markets trends and patterns, you can calculate out when you're going to need to do XYZ.
(14:49):
Like if you have a roof that's 25 years old.
God bless you at number one, but number two, you think maybe you're going to have to replace that at some point?
And that it might cost more than what's in your reserves if you have reserves?
Hot water tanks, boilers, furnaces, finite life spans.
(15:14):
Easy to know what they are.
If they happen to go over the average lifespan, you make out.
But that doesn't mean you get to get rid of that money that you've set aside to take care of that problem if it happens.
That means that you continue building because your projects, your product, your units, your whatever, everything has a finite lifespan.
(15:40):
And there's more than one component with one lifespan in every single one of those.
Tenant wear and tear, notwithstanding.
You know that you have to account in a lot of ways for tenant wear and tear depending on the class of property.
There's so many things that happen in a macro environment in a societal level that you just can't predict everything.
(16:06):
So you hope for the best and prepare for the worst. Sound familiar?
So part of your budget before you get to what you get to keep.
So below NOI is your debt service and your cash reserves as well as your capital expenditures.
(16:29):
Hopefully you minimize the number of unplanned ones.
But again, there's a lot of moving parts.
So with those moving parts, you always build for failure.
You build for the lowest common denominator. Two benefits to that. One is you're not really surprised when something goes sideways.
(16:53):
Is that a negative outlook on life? No. It's called reality.
When money is involved, idealism has to take a back burner.
You have to approach your product, approach your project, approach your business in a way that accounts for reality.
(17:16):
Now I'm a strategy guy, which means I like to understand where things are coming from so I can kind of get that 10,000 foot look and see where things are going.
You should be doing the same thing with your business.
You cannot just hope things are going to work out based on the outlier of human nature.
You need to assume that things are going to go sideways and make sure that your units are resilient enough to withstand it.
(17:43):
We hear a lot of talk about resilience and building materials when it comes to new construction, surviving.
Forest fires and colder weather and hotter weather and crazy winds and weather uncertainty and all this other stuff. Well, that's cool.
I'm talking about resilient from the people living in the unit, from the tenant, leasing that space.
(18:08):
How do you build for failure? How do you build?
Assuming things are going to get beat up. Hopefully experience teaches you and hopefully it's not your experience necessarily where you're taking it on a chain and lighting your money on fire.
Hopefully you can listen to some of these podcasts and look at some of your counterparts and your peers in the industry and go wow they really have a hard time in this neighborhood with this type of tenant using this product or building something this way or putting some sort of.
(18:40):
XYZ product in that fails after two or three years like hopefully you're smart enough if you're listening to podcasts and trying to increase your.
Market knowledge your business acumen whatever it is hopefully you're doing it in a way and for a reason that is that you want to get better at something.
(19:01):
If you listen to these and you don't take action on anything you hear and you're not learning anything you still have to learn things the hard way.
Why are you listening to podcasts why are you reading books.
It's not entertainment I mean it might be entertainment I try to make my show very entertaining but.
It's pretty dry stuff like if I wasn't a real estate person my show would suck out loud my show probably does suck out loud.
(19:32):
I'm not that good it's just life I'm okay with it.
The rant is over for now the core message is a core idea of this entire conversation is that in addition to your supply chain and your standards near their stuff and being built for failure and.
Whatever is that you have to assume that things are going to happen.
(19:58):
And you have to have a cat X planning process and you have to have sufficient reserves to cover those at their estimated time of failure.
A lot of companies just have a general reserve fund that they pool a whole bunch of stuff from a whole bunch of properties and I've seen 47,000 different formulas to do it I take X percent of rent and I put it in here.
(20:26):
From all of these properties and I take you know why Z and B and I put it all into this cash reserve and then.
I have you know system A and B that helped me track.
Whatever all well and good as long as you're doing something but because it affects your cash flow right the money you keep.
(20:52):
There's a tendency again because of human nature to underestimate what those need to be especially from the long time operators.
Because what we're seeing is long time operators still wanting to pay the same thing that they were paying in 2019 for labor for product for service.
(21:16):
And it's just not life like it'd be cool if we could get back to that but no you can't build your business today.
On the mat from four years ago doesn't work you need to give up some of that cash flow to account for today's numbers now some people have adapted.
(21:45):
A lot of people looking at this at 10,000 feet and looking at multiple sets of books and multiple sets of confidential internal information I can tell you that.
Reserve funds if they were not directly tied to a percentage of gross revenue.
(22:06):
I've not increased but the cost to do the things the reserve was created for have increased by like 30% because people wanted to take home more money and they did.
It is not my business you operate your business how you want to.
(22:27):
But from an outside source the neutral objective consultant knowing that things cost 30% more today than they did in 2019.
But not increasing your reserves assuming you had any in 2019 not increasing your reserves by that same 30% to cover these expenditures is pretty fucking stupid so you can plan you can budget you can hope for the best.
(23:08):
But if you only prepare for the best you're going to get your freaking teeth kicked in now.
There's a positive side to this in that.
You're creating opportunity for the next owner of that property.
But you need a system.
That accounts for today and the problem we see with management companies investment firms and operators family office whatever it is.
(23:40):
The people operating the business similar to the race to the bottom in construction are incentivized and paid to deliver better results.
Better results equate to taking home more money.
Your boss or as an owner looking down at their operation from 10,000 feet you want to see positive growth positive cash flow.
(24:16):
Things being done under budget faster than expected all these numbers but here's the problem.
Instead of working in reality you're incentivizing your employees whether they're 1099s or whether they're W2.
You're incentivizing the people working with you and for you to deliver what you want to see.
(24:44):
Which is great to a point but they need to be grounded in reality record profits record margins record growth.
All really cool.
But what are you sacrificing to get there what are you missing that's going to cost you more later to get there.
(25:09):
You're telling people that you want to see this and this and this delivered and they will find a way to do it because it is their livelihood and their jobs they are not you the owner they are not you the entrepreneur they are not you the builder the driver the owner.
They are somebody who's looking at you as their paycheck and they're going to do everything in their power to minimize what you see in here from problems and maximize the good stuff so they can make more money and become more secure in their careers and their services that they offer.
(25:43):
The best part about consulting with an ethical quality consultant is that they will tell you the bad news they will look you in the eye and say this is messed up and it's going to bite you in the butt and here's why and here's how you fix it.
(26:05):
Employees will not tell you that because they don't want to piss you off.
The ones who are willing to do that are literally one and a million.
Again who's on your team.
It's not just about what you want to hear you need the truth and the truth is if your reserves are the same today as they were in 2019 or 2020 you are doing it wrong.
(26:33):
If you have no reserves you're really doing it wrong and if you don't have a plan to budget out your capex based on real useful life expectations but yeah it's complicated.
It is not easy to take 50 or 60 or 120 different products with different service life.
(27:01):
Combine it with market fundamentals and market dynamics from curb appeal standpoints.
And then to project out functional life and what that's going to cost you but that's part of the tcm method you have to know these things you have to know what's left in the useful life of x y and z.
(27:25):
When you acquire a property.
You should be aware that your windows haven't been changed since 1972 and that that's going to cost a whole crap load of money.
You should be aware that your boilers were installed in the 60s.
(27:46):
And they're super inefficient.
You should be aware that there's no insulation in your attic on your buildings you should be aware that your hot water tanks are all 12 years old.
There's an argument to be made.
For just gutting those things at the beginning at an acquisition because you've got the capital available and you've got the time and the energy.
(28:10):
And then you're resetting that number across the entire property and it's less variables doesn't always work for everybody every property every portfolio every approach is different.
Because of risk management risk tolerance compliance prior experience supply chain market dynamics there's so many things that go into it.
(28:35):
But they can be quantified they can be accounted for and they need to be.
If your budget is actually going to be a budget and not just a hey this would be really cool if this worked out this way that is a recipe for failure and yet especially in some of these older companies with larger portfolios.
They light six figure seven figures on fire.
(28:59):
As opposed to putting systems in place that might cost them to employees in a position to operate that side of the business.
Like if you know that the average savings on a 1950s to early 1990s built development with 700 doors.
(29:27):
Is leaving somewhere between 120 and $190,000 a year on table.
Because of opportunities in process and product and the third maintenance in the past that needs to be addressed and all this other stuff like if you knew.
(29:49):
That you could not raise rents and put an extra 200 grand a year into your NLI do you think that would be a good idea.
Yeah, probably.
But because of all these employees between the leadership ownership driver producer operator whatever.
(30:11):
And that level that money sitting there and it's because of bad decisions being made on top of bad decisions being made on top of bad decisions and it steam rolls.
Doing this will create more maintenance will use more electricity will use more water will create more maintenance will do this in its snowball.
(30:35):
Because you're on a foundation built out of sand. And yes, it's the foundation that we've been using for 60 years. I get it.
We've always done it this way is the fastest path to failure.
The companies who figure it out who see the patterns who make changes who build systems.
(30:57):
They're the ones who scale and become successful. And at some point.
The big company was in that innovation land where they were looking at things and going wow this is a great opportunity.
We should do this in this in this.
But then they stopped innovating because they got big. And they sit back and they look at themselves in the mirror like.
We got this we're good.
(31:19):
And we're making money and everybody's getting paid and it's awesome.
But is it really awesome.
If you know that for every 700 doors you've probably got somewhere between one in two hundred thousand dollars worth of opportunity just collecting dust.
And it's not instant like snap your fingers wow I'm making an extra 200 grand a year now there's work in there it's going to cost you money to make those changes it's going to cost you money for change management it's going to cost you money for product possibly.
(31:48):
It's going to cost you money for hiring people firing people there's a lot involved a lot involved it is not that there's no get rich quick scheme in real estate.
Know your operations vet your people maybe we'll do an episode on vetting things at some point I don't know.
So the end I'll be all of this in addition to having standards having spec having a budgetary plan is to make sure that it's realistic and current.
(32:21):
And to make sure that you understand where the major components of your property are what they are and what they cost today to fix.
Because your budget your cash reserves your plans from four years ago after everything we've been through not just as a country but globally.
(32:44):
If you haven't adapted with the times you're done the rise of AI the rise of big data the like all these tools are available to you as an owner as an operator.
And yet we're still doing things by and large the same way we've been doing in from the last 40 to 60 years.
(33:05):
What's the definition of insanity again.
So if you got any value at all from this podcast please subscribe.
Leave a review please leave a comment if you can comment on an episode spotify does that now if you can review and comment per episode give me feedback.
Send me an email at podcast TCO method dot com.
(33:28):
Let me know what you think give me your opinions.
More cool stuff on the way.
We'll have some announcements in a couple of weeks I know I said that last week but no seriously in a couple of weeks we'll have some announcements.
And I hope everybody has a great rest of your week get out do real estate make some deals make some friends shake hands kiss babies do what you need to do.
(33:52):
Be honest be ethical be moral be upstanding.
But be outstanding don't settle go watch the video on YouTube subscribe on YouTube you don't have to watch me you can just put me in another window.
I appreciate you listening much to have a great rest of the day.
(34:15):
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