When I put on my fractional CFO hat to examine the inner workings of a real estate business, I am not looking for mistakes. I’m looking for missed opportunities. After roughly 30 years in this industry, I have noticed that real estate CEOs often grapple with the same issues. They experience a period of rapid growth and rise to the occasion. Meanwhile, inefficient practices develop and go largely unnoticed until a snag occurs.
Below, I share my insights into how this happens and what you can do about it.
How Inefficiencies Develop
The real estate industry is highly susceptible to the whims of the economy in that we experience cycles of significant growth and expansion followed by a contraction. We saw this happen in the timeframe surrounding the Great Depression, the dot-com era, and then again during the COVID-19 pandemic. These economic changes also occur on a smaller scale during times of relative calm.
When growth occurs, real estate CEOs set up companies, establish an organizational structure, hire quickly, and expect everyone to do what they hired them to do. Unfortunately, that’s not how it sometimes plays out in real life, especially when the market is hot and people are busy. Instead of staying in their lanes, employees do what they think they must do to succeed. That can lead to roles and responsibilities becoming entwined, murky reporting, and uncontrolled spending.
Yet, firms can continue to operate in this fashion for some time, especially when they are doing well and other issues seem more urgent. However, when left unaddressed, minor problems can evolve into costly handicaps that become painfully evident when you start losing people, or your Net Operating Income (NOI) gets negatively impacted, and everything comes crashing down.
To understand why this is such a crisis in our space, here is a brief real estate finance lesson for anyone who needs it.
Real Estate Investing 101
Operationally, real estate investment businesses are pretty straightforward. The company acquires property using investor money and then manages cashflows through capital improvements, leasing, and, sometimes, expense reduction. Then, the company sells or recapitalizes the asset after creating value and achieving returns.
In most cases, real estate investment requires debt, which the firm repays over the life of the investment. So, cash flows in from tenants and out for property operations, maintenance, management, and investor compensation. Therefore, in real estate, Net Operating Income (NOI), the difference between your income and expenses, is your primary Key Performance Indicator (KPI).
A positive NOI means your property generated enough cash to service your debt, provide a return to investors, and, ideally, reinvest in the property. However, if the property is mismanaged or expected market conditions take a turn for the worse, your NOI could turn negative (imbalanced), and there may not be enough cash left to service your debt.
If you can’t pay your debts, you certainly can’t provide your investors a return. That matters a lot in real estate investment. Investors can lose faith in your company, leading to diminished funding opportunities. Yet, everyone involved understands that there is risk. Economic change like rising interest rates or reduced demand is not within your control. To manage this risk, you must keep costs contained and plan for the inevitable hiccups.
To illustrate, let’s look at a real-life example.
A Real-Estate Investment Firm with Crippling Bottlenecks
The Problem:
I have been the CFO for more than one company that has experienced the highs of success and the lows triggered by negative changes in the market. Each had acquired about a billion dollars in property and significant equity. This stability made them an appealing investment partner, and business was booming. Then, a change occurred. In one case, the dot-com bubble burst, and in the other, interest rates spiked after COVID-19. The companies’ portfolios suffered, and they weren’t making their numbers.
That experience was very helpful when I engaged as a CFO consultant for a company that had recently parted ways with its full-time CFO.
The CEO had already started downsizing. I performed my assessment, and we realized that through all the growth, the past CFO had retained a key role in the expense approval process that they should have delegated to asset managers and other positions. That behavior created tremendous inefficiencies, and communication broke down as the company grew.
Asset managers in well-run real estate investment firms play a vital role in overseeing and managing portfolios. They represent the investors when making day-to-day operational decisions and execute the business plan each investor agreed to when making the investment. For instance, suppose the metrics start to stray away from the plan. In that case, the Asset Manager communicates the issue to the investment committee and presents a plan to right the ship. However, that only works when Asset Managers are empowered to make sound business decisions and held accountable.
That realization was enough to get us started, so we got to work.
The Solution:
The CFO role is partly about managing your accounting team, setting budgets, and establishing best practices. And, as importantly, it’s highly strategic. CFOs analyze financial information and combine it with other insights to identify issues the team must address to achieve its goals. In other words, it’s about giving your staff the right tools to do their jobs, monitoring the big picture, and managing the process while watching for red flags.
Since we knew we had a problem with efficiency, I reviewed the company’s org chart with the CEO. I asked questions like “Is everyone doing their job?” and “Do you know what they are doing?” Then, we asked each employee to respond to a questionnaire with similar questions for comparison, such as the following.
- What is your job title, and who is your manager?
- What are your primary responsibilities, and what do you do day-to-day?
- What resources can we offer, or what tools can we provide to help you succeed?
The answers to the questionnaire provided additional insight into the company’s hidden issues. Here’s what we learned.
- Roles and responsibilities were unclear, so everyone was doing their own thing, and there was a lot of overlap.
- No one had a budget. When the company was doing well, the CFO swiftly approved spending requests, and employees acquired what they needed to do their jobs.
- That spending pattern resulted in disparate technologies, inconsistencies, and no economies of scale.
- The team had adopted the mindset of doing everything itself – finding property, securing funding, and managing every detail of running each property. Therefore, it kept adding headcount to keep up with its growing inventory.
The company’s staff wasn’t doing anything wrong; they were doing what they thought management expected. They didn’t know there was a problem until spending approvals ceased, but many reported frustrations.
This project is ongoing, and we are implementing a plan to continue downsizing staff while outsourcing property management and other responsibilities to specialized firms. We are working to clarify or define roles and responsibilities, set budgets, and establish reporting mechanisms to communicate project status. We also plan to review our technology stack and standardize where possible to take advantage of economies of scale and make reporting and communication easier.
We expect these activities to reduce costs and return us to a positive cash flow position, preserving our reputation as a trusted investor partner.
What are the Signs You Have a Problem?
The abovementioned situation is common in our industry because rapid growth can lead to problems. A self-imposed bottleneck developed in the case above, and I have seen plenty of situations where inefficiencies arose due to other factors. Therefore, it can help to know the signs that trouble is brewing at your firm so you can resolve issues before they become a crisis. These signs include the following.
- Inefficient communication throughout the organization
- Lack of transparency
- Micromanaging behavior
- Unhappy employees or employee attrition
- Cash flow issues
How Can You Minimize Inefficiencies?
So, what can you do to avoid, reduce, and prevent inefficiencies? Follow these steps to return to the basics.
- Clarify what you do best as a company.
The real estate investors above knew they were great at finding, buying, and managing properties from a high level. But, hiring and training staff to execute the day-to-day operations of each property (filling vacancies, performing maintenance, etc.) wasn’t cost-effective for them. Reducing staff and outsourcing that activity is already proving much more effective. - Define individual roles and responsibilities.
Refine your documentation about each position. Clarify the title, reporting structure, what the responsibilities are (and are not), and what success looks like. Be as specific as possible – define the role scope, the decisions they can make, who they will interact with, and when they should pass responsibilities to someone else. Then, set the expectation that people stay in their lane.
Although this may sound constraining, it has the opposite effect. Clear expectations empower people to do the right job correctly, freeing managers from feeling like they must micromanage. - Prioritize transparency and communication.
Support your work in step two with tools to streamline reporting, then explain what it means to be a clear communicator in your environment.
For example, we now expect Asset Managers in the firm from our example to produce reports for their leadership team and investors. These reports shouldn’t only contain history or exist in a vacuum. Instead, they must explain what happened, why it happened, what it means for the future, and include recommendations for what the team can do about it.
Then, once they send the report, the management team and investors must acknowledge receipt somehow. It could be a simple thank you or, if there is a problem, a communication about how they can help resolve the issue. That makes the recipient of the report accountable, too. Only then is the communication considered complete.
Given the volatility of this industry, sometimes these communications result in the Asset Manager asking for more money to weather tough times. Investors are much more receptive to such requests when kept abreast of the situation.
- Hold people accountable.
Of course, none of this will help if you don’t hold your entire team (including yourself) accountable for establishing budgets, setting goals, and adhering to them. That can be as simple as tying employee compensation to success metrics and troubleshooting causes and solutions when things go wrong.
Issues might be due to human error, or people might lack the right tools, resources, or backing to be effective at their jobs. It happens, but you must get to the bottom of it when things go sideways. You will occasionally outgrow the systems you put in place and need to return to step one.
The Bottom Line
Coming from a CFO, the advice above may sound strange because many consider this work part of the human resources function. However, your people are often your biggest asset and most significant expense, so inefficiencies among your staff will affect the bottom line and your ability to reach your goals.
Although the actions above won’t immediately produce cash, they will relieve bottlenecks. They will also make it easier for your executive team to pinpoint the problem the next time you run into an issue so they can quickly get money flowing again.
