John Maxwell's 21 Laws of Leadership: Part 4

#17 The law of Priorities – Leaders understand that activity is not necessarily accomplishment

No matter the size of your organization or past success, leaders must continue to prioritize what is important to achieve their goals. The goal is to satisfy multiple priorities with each activity which increases focus while reducing activity. Therefore, you achieve more with fewer actions. John Wooden, the former head basketball coach of UCLA, was an expert at focusing on priorities through his thoroughly planned practices. He studied the economy of motions and meticulously planned every moment of practice Wooden’s planning allowed him to improve multiple priorities with each exercise. Because of this, he never scouted opposing teams. His focus remained solely on maximizing his players potential. Wooden’s career included four undefeated seasons and ten NCAA championships.  So why is it difficult to prioritize? First, we mistake being busy with achieving. Second, leaders must continually think ahead, consistently focusing on the overall vision. Third, prioritizing requires difficult decisions, sacrifice, and discomfort. Maxwell says that each year he takes two weeks in December to “look at the big picture of what I’m doing to make sure the way I’m living aligns with my values and priorities.” A guiding principle Maxwell uses during this evaluation is the Pareto Principle which is the idea that “if you focus your attention on the activities that rank in the top 20 percent in terms of importance, you will have an 80 percent return on your effort.”

He also uses the Three R’s to evaluate his priorities: Requirement, Return, and Reward.

Leaders must order their lives according to these:
1.     What is required of me? – meaning activities that must be done by me alone and cannot be delegated.
2.     What gives the greatest return? – you get your greatest return from efforts when they are within areas of your greatest strengths and natural gifts. Maxwell notes, “because you can do something does not mean that you should do i.t”
3.     What brings the greatest reward?  - focusing your attention on the areas of greatest satisfaction, on what you love to do, should be a priority.

#18 The Law of Sacrifice – a Leader must give up to go up

No success can be achieved without significant sacrifice by oneself. The future benefit of this sacrifice may not be seen by the leader. Martin Luther King, Jr. made significant sacrifices as the leader of a movement, including the ultimate sacrifice of his life for the cause of gaining civil rights for African Americans in the 1960s. The more he succeeded on this mission, the “greater the price he paid,” including being stoned, stabbed, and attacked. Along the way, his vision & influence grew. He was ultimately assassinated for this cause, sacrificing everything. Yet as he pursued.

While many believe that leadership is about power, position, and perks, the true essence of good leadership is sacrifice, not personal gain. For good leadership, you must understand the following about the Law of Sacrifice:

1.     There is no success without sacrifice – whether attending graduate school, working 10,000 hours on a craft, or parents sacrificing for their children, a significant amount of sacrifice is evident in achieving greatness.

2.     Leaders are often asked to give up more than others – Opportunities are passed over, hobbies are neglected, and in MLK Jr.’s instance, a life was lost.

3.     You must keep giving up to stay up – leadership requires continued sacrifice, and what gets you to the top is not what keeps you there. Maxwell notes, “Leadership success requires continual change, constant improvement, and ongoing sacrifice.”

4.     The higher the level of leadership, the greater the sacrifice – a leader’s sacrifice is magnified as the position is elevated.

Time is a commodity, and it must be used wisely as you make trade-offs to pursue your goals.

#19 The Law of Timing – when to lead is as important as what to do and where to go

The common adage of ‘Timing is Everything’ cannot be understated because the consequences are often dramatic and immediate. An example of poor timing can be seen at most steps during the natural disaster of Hurricane Katrina. From Mayor Nagin to President George W. Bush, the law of timing was violated continually. It was not declared an “Incident of National  Significance” early enough, and the mayor enacted a mandatory evacuation of New Orleans with less than 24 hours before landfall. Maxwell summarizes stating, “if the leaders had paid greater attention not only to what needed to be done but also to when it needed to be done, many more lives would have been saved.”

Timing is often the difference between success and failure. When action is taken there can be 4 outcomes:
1.     The wrong action at the wrong time leads to disaster – Followers will suffer the failure when this occurs, and if this happens more than once, they will soon doubt the leaders ability.
2.     The right action at the wrong time brings resistance – this resistance may result in the action being unsuccessful. Good timing requires understanding, maturity, confidence, decisiveness, experience, intuition, and preparation.
3.     The wrong action at the right time is a mistake – because of this, leaders must know when to cut losses and change course.
4.     The right action at the right time results in success – when this happens, success can become almost inevitable, causing an organization to achieve its goals and grow momentum.

#20 The Law of Explosive Growth – to add Growth, Lead followers – To multiply, lead leaders

Being able to recruit & train followers is essential to any organization, but developing leaders within your team is the way to obtain exponential growth. It has a multiplication effect on your success. Maxwell summarizes with the following comparisons:

Leaders who attract followers… need to be needed
Leaders who develop Leaders… want to be succeeded

Leaders who attract Followers… develop the bottom 20%
Leaders who develop Leaders… develop the top 20%

Leaders who attract Followers… focus on weaknesses
Leaders who develop Leaders… focus on strengths

Leaders who attract Followers… treat everyone the same
Leaders who develop leaders… treat individuals differently

 Leaders who attract Followers… spend time with others
Leaders who develop leaders… invest time in others

 Leaders who attract followers… Grow by addition
Leaders who develop Leaders… Grow by multiplication

Leaders who attract Followers… Impact only people they touch
Leaders who develop leaders… Impact people beyond their reach

It is difficult to develop leaders, requiring time, energy, and resources. The reasons include:
1.     Leaders are Hard to Find
2.     Leaders are Hard to Gather
3.     Leaders are Hard to Keep

#21 The Law of Legacy – a Leader’s Lasting Value is Measured by Succession

Though the last of the 21 laws, it may be the most important to constantly consider. What do you want to leave behind in this world after you’re gone? Things do not carry on our work, but people do, so training those to continue the work leaders have begun is how a legacy is left.

This is how to do it:
1.     Know the Legacy you Want to Leave – you need to live proactively, seeking your goal & bestowing it in others as leaders as well. Maxwell summarizes by pointing out that “Someday people will summarize your life in a single sentence. My advice: pick it now!”

2.     Live the Legacy you want to leave – even to become a leader, but even more so, hope to leave a lasting legacy; you must gain & sustain credibility by practicing what you believe.

3.     Choose who will carry on your legacy – People are the conduit of a legacy, not things. Max De Pree, author of Leadership is an Art, states, “ Succession is one of the key responsibilities of leadership.”

4.     Make sure you pass the baton – in a relay race, the exchange zone where runners pass the baton is the most critical part of the race. Speed can become inconsequential with a blundered exchange. And this is true with a legacy. If the succession plan is not well planned and administered, the legacy will die.

In any endeavor, true success depends solely on the team’s leadership abilities. As you build your organization, remember this:
Personnel determines the potential
Relationships determine the morale
Structure determines the size
Vision determines the direction
Leadership determines the success

John Maxwell's 21 Laws of Leadership: Part 3

Law of Empowerment – only secure leaders give power to others.

To lead well, we must help others achieve their potential. Contrary to the common belief that empowering subordinates makes yourself dispensable, continually growing the leadership of others makes you more indispensable. Empowerment is about developing leadership in others, encouraging others, providing resources, imparting responsibility, and granting authority to act. Henry Ford and, subsequently, Henry Ford II are examples of undermining employees' leadership abilities, thus causing Ford Motor Company to languish with subpar growth for decades, continually losing its high-level executives. President Theodore Roosevelt noted, “The best executive is the one who has sense enough to pick good men to do what he wants done, and the self-restraint enough to keep from meddling with them while they do it.”

Humans have a natural drive to gain power over others and a propensity to keep it. Too often, people build themselves up at the expense of others, exhibiting the scarcity mindset. Maxwell contends the opposite, noting, “Pushing people down takes you down with them. Lifting others up lifts you up.” Leadership analysts McFarland, Senn, and Childress describe this as the “empowerment leadership model shifts away from ‘position power’ to ‘people power’ within which all people are given leadership roles so they can contribute to their fullest capacity.” Henry Ford and, subsequently, Henry Ford II are examples of undermining employees' leadership abilities, thus causing Ford Motor Company to languish with subpar growth for decades, continually losing its high-level executives. When empowerment is neglected or unattainable, barriers are subsequently created within an organization, and these barriers cause people to give up, often seeking employment elsewhere. The following are three barriers to empowerment:

1.     Desire for Job Security – “The greatest enemy of empowerment is the fear of losing what we have,” Maxwell points out. This is the fear of becoming dispensable or unnecessary, but Maxwell contends that consistently developing leaders from those around you only strengthens your position, making you more indispensable.

2.     Resistance to Change – John Steinbeck summarizes this well, saying, “It is the nature of man as he grows older… to protest against change, particularly change for the better.” Most are resistant to change and often fear it. Encouraging growth, progress, and consistent renewal, empowerment essentially brings constant change, i.e. the price of progress. Change is the Price of Progress.

3.     Lack of Self-Worth – Adlai Stevenson quipped, “You can’t lead a cavalry charge if you think you look funny on a horse.” Great leaders are never self-conscious. Lacking self-esteem is a feeling of powerlessness, and those without power cannot empower others. Admiral Stockdale noted that “great leaders gain authority by giving it away.”

The Law of the Picture – People Do What People See

Good leaders must consistently set an example of behavior and performance, both mentally and physically. “In general, the better the leaders’ actions, the better their people’s.” Dick Winters, considered by many to be “the best combat leader in World War II” was awarded the Distinguished Service Cross because he always led from the front, often risking his life to exemplify to his troops the performance and commitment expected. Followers need to see a clear picture of expectations from leadership, especially in difficult times. When leaders exhibit this living picture, followers gain renewed energy and motivation.

Maxwell points out that “great leaders always seem to embody two seemingly disparate qualities. They are both highly visionary and highly practical.” Leaders must establish the why, what, and how of the organization. And this is through the Mission (purpose), Vision (picture), and Strategy (plan). Leaders must clearly communicate and model this vision through action, creating the ‘picture’ for the team. Maxwell summarizes this well, stating that “leaders can afford to be uncertain, but we cannot afford to be unclear.” In pursuit of being of good example, remember the following:

1.     The People You Lead Are Always Watching What You Do – just as a child is forever watching a parents behavior, so are followers observing leaders actions. Maxwell notes “follwers may doubt what their leaders say, but they usually believe what they do.”

2.     It’s Easier to Teach What’s Right than to Do What’s Right – the members of your team must see their leaders walk the walk, setting a good example with their best work. As author Norma Vincent Peale quipped, “Nothing is more confusing than people who give good advice but set a bad example.”

3.     We Should Work on Changing Ourselves before trying to Improve Others – if you cannot lead yourself, then why expect others to follow you? We must first correct and align our behavior with our beliefs. “As a leader, the first person I need to lead is me,” Maxwell states. Only through properly leading yourself can you attempt to be the agent of change for a group.

4.     The Most Valuable Gift a Leader Can Give is Being a Good Example – Always strive to correct example for the people you wish to lead. In fact, “Leading by Example” was surveyed as the most important leadership trait to possess.

The Law of Buy-in – People buy into the leader, then the vision

Often we think of leaders as merely attracting followers because they align with the cause, but the opposite is, in fact, true. “People don’t at first follow worthy causes. They follow worthy leaders who promote causes they can believe in.” Maxwell uses Gandhi as a prime example which he was able to change the people of India’s vision from one of violent rebellion against the British establishment to a tactic of nonviolent civil disobedience. To coalesce in such an opposite reaction to oppression, the people first believed in his leadership and witnessed his behavior, then aligned faithfully with his vision of nonviolence. Maxwell summarizes with “The leader finds the dream and then the people. The people find the leader, and then the dream.”

A leader must be credible because the message delivered to the people is filtered by the messenger. And the leader is inseparable from the cause; thus, you buy into the leader to buy into the vision. If you don’t buy into the leader but do the vision, the result is to find another leader. Having great vision, a worthy cause, is not enough, you have to gain buy-in from the people. You must prove you can take them where they want to go.

The Law of Victory – Leaders Find Ways for the Team to Win

The greatest leaders are those that have never accepted defeat, winning at almost any cost. For the great benefit of the world, Churchill and Rosevelt understood this during World War II. See a world that would be so bleak if Hitler achieved his goal, there was no alternative to Victory.

Leaders recognize that victory is possible with these three factors:

1.     Unity of Vision – only with a common, shared vision by the entire business can success be achieved.

2.     Diversity of Skills – a business or team is the sum of its parts. With individuals possessing different strengths, the accumulation increases the likeliness of success.

3.     A Leader Dedicated to Victory and Raising Players to Their Potential – talented leadership must be combined with talented team members. A leader must nurture the team, providing motivation, empowerment, and direction.

The success of a team must be personal to the leader. Taking responsibility and remaining committed must be higher than anyone else on the team.

The Law of the Big Mo – Momentum is a Leader’s Best Friend

Even if you have all the skills, the right people, and tools, yet can’t get things progressing, the group is destined to fail. Maxwell states simply “if you can’t get things going, you will not succeed.” Often momentum is the difference between winnig and losing. Without momentum, the small tasks grow large, problems seem insurmountable, and morale suffers. But with momentum, the opposite is true. Problems feel small, tasks seem easy, and the future is exciting. To be successful, a leader must learn to foster momentum and reap the most from it. First, know the following:

1.     Momentum is the great exaggerator – Momentum may be most evident in sports. Very quickly, the viewers can see and feel the momentum as it builds by a team. And when momentum dies, a team seems to do nothing correctly, making no progress. Maxwell says, “Momentum is like a magnifying glass; it makes things look bigger than they really are.”

2.     Momentum makes Leaders look better than they are – People’s perspective of a leader changes when they have momentum, looking past mistakes and shortcomings. With momentum at their backs, leaders can look like geniuses, often given more credit than they deserve.

3.     Momentum helps Followers Perform Better than they are – when momentum is strong, team members have increased motivation to perform at higher levels.

4.     Momentum is Easier to Steer than to Start – much like waterskiing, it can be a struggle to get started, but once you’re moving, you can do great things with less effort.

5.     Momentum is the most powerful change agent – when an organization has great momentum, it is much easier to make changes. Maxwell summarizes with “People like to get on the winning bandwagon. They accept changes from people who have led them to victory before.”

6.     Momentum is the Leader’s Responsibility - the team can catch the momentum, but the leader was create it with vision, strategy, assembling a good team, and motivating others.

7.     Momentum begins inside the leader – it begins within the leaders, and “starts with vision, passion, and enthusiasm. If you model enthusiasm to your people day in and day out, attract like-minded people to your team, and motivate them to achieve, you will begin to see forward progress.”

John Maxwell's 21 Laws of Leadership: Part 2

The Law of Solid Ground – Trust is the Foundation of Leadership

Being the foundation, Trust is the most important trait for a leader to possess. Trust is the “glue” that holds a team together, and if often broken, you will never maintain a leadership position. Trust is built upon character and good values, and this trust is what makes leadership possible. Maxwell often states, “Everything rises and falls on leadership. Everything rises when leaders demonstrate competence and good values. Everything falls when leaders demonstrate incompetence and poor values.”  One cannot be trusted without good values, and Character and Competence have always gone hand in hand. Followers are, in essence, committing to taking a trip with the Leader, and for this to be a pleasant experience, they must continue to trust their leader throughout the trip. Followers, and leaders, pay the price for broken trust.  

Good character communicates the following, promoting trust in their followers:
1.     Character communicates Consistency – without inner strength, a leader’s ability to perform changes constantly. As NBA great Jerry West said, “You can’t get too much done in life if you only work on the days when you feel good.” Billy Graham is an outstanding example of this. He consistently showed his integrity through every action.
2.     Character communicates Potential – Maxwell writes, “Who do you think has the greater potential to achieve great dreams and have a positive impact on others: someone who is honest, disciplined, and hardworking, or someone who is deceitful, impulsive, and lazy?” The answer is so obvious it seems like a rhetorical question. Through strong character, followers begin to trust the leader’s ability to release their potential, and it promotes belief in themselves and the team. 
3.     Character communicates Respect – you can’t earn respect without trust. “When you don’t have character within, you can’t earn respect without,” Maxwell writes. Respect is earned through holding to your values and making correct decisions. When the inevitable mistake is made, Leaders must own it and admit the error. Equally important is putting the good of the followers and team above the leader’s self-interest.  J.R. Miller noted, “The only thing that walks back from the tomb with the mourners and refuses to be buried is the character of a man…. what a man is, survives him. It can never be buried.”

Craig Weatherup summarizes this well by stating, “You don’t build trust by talking about it. You build it by achieving results, always with integrity and in a manner that shows real personal regard for the people with whom you work.”

The Law of Respect – People naturally follow better leaders than themselves

Based on Maxwell’s observations, these are the top seven ways that leaders gain others’ respect:
1.     Natural Leadership Ability – there are some that are born with leadership skills & abilities. Keep in mind, that these skills can be learned over time as noted in the Law of the Lid and of Process. This natural ability will attract follows and gain you influence but without the additional traits below, the followers may be shortlived.
2.     Respect for Others – Good leaders show respect for their fellow man, especially the less powerful, thus gaining respect in return. Leaders acknowledge that following others is voluntary, and they earns respect by conveying respect to others.
3.     Difficulties Overcome – Respect is gained through making difficult decisions through challenging circumstances. There is a symbiotic relationship between leaders and followers. Leaders grow from the respect they have earned, and the followers grow from breakthroughs and accomplishments they may not have experienced without the leadership.
4.     Courage – the determination to succeed in the face of great obstacles is the courage that a leader should possess. Henry Kissinger said, “A leader does not deserve the name unless he is willing occasionally to stand alone.” Showing integrity while risking failure, and doing so under criticism or danger, is the courage necessary for a great leader.
5.     Success – accomplishments and achievements naturally draw attention from people, and there is a willing to follow in expectation of future success.
6.     Loyalty – in this era of constant change, loyalty to an organization gains the respect of followers.
7.     Value added to Others – the dedication to improving others may be the source for the greatest respect for a leader. This is the Law of Addition.

When you are respected, others will make a commitement to get the job done even in the face of risk. Dennis Peer said, “ One measure of leadership is the caliber of people who choose to follow you. This Law is summarized best by one of Maxwell’s favorite quotes, “Success is having the people who know me the best, respect me the most.”

Law of Intuition – Leaders evaluate everything with a leadership bias

Although the principles of leadership remain the same, the application changes by leader and situation, thus requiring intuition. Because this is instinctive knowing, this may be the most difficult to teach. Leaders seek an informed intuition that combines learned skills with natural ability. As Maxwell states “Leaders are Readers” of their situation, trends, resources, people, and themselves. Leaders can sense something before having all the facts, and they can look at the big picture. Leaders see everything through a scope of leadership bias, including the resources at their disposal and how to maximize them. These resources include financial, technology, people, raw materials, etc. Leaders must understand themselves, their own state of mind, but also the most important skill of reading others.

 To develop intuition as a leader, you can ask yourself these questions in a situation:
·      What do I feel? – my ‘gut’ instincts
·      What do I know? – the information that I possess
·      What do I think? – combine what you feel and know
·      What should I do? - Making a decision based on what I feel, know, and think

 Law of Magnetism – who you are is who you attract

The character that you possess is what you will attract in other people with the same traits. The members of your team are likely determined more by who you are than by what you want. This law is so strong that a leader must see and resist this to achieve diversity in the team.

If analyzed, your team will have more similarities than differences especially in these areas:
·      Generation – people gravitate towards other of similar age
·      Attitude – This is a very contagious trait where positive and negative personalities attract others with similar attitudes.
·      Background – The natural magnetism of common upbringing, race, culture, etc.
·      Values – people are attracted to leaders with similar values (positive or negative)
·       Energy – high-energy and low-energy seldom flock together
·      Giftedness – possess talent in a field attracts others in that field. Sports, Business, and Creatives are examples.
·      Leadership Ability – other leaders you attract will have similar ability and style to you.

 Law of Connection – Leaders Touch a Heart before they ask for a hand

Followers need to know that you value them, believe in them, and appreciate them. The leader's job, not the followers, is to connect with people. Leaders should be accessible and try to know something personal about them. Credibility is strengthened when followers relate to the leader on an emotional level. The stronger the connection, the more likely they want to help you. Maxwell summarizes this best by writing, “you can’t move people to action unless you first move them with emotion.”

How do you connect? Keep these in mind:
·      What people need to know: You believe in them – This belief must be genuine and communicated, giving them hope.
·       What people need to see: You will be an example – possibly the most impactful trait of a leader is ‘practice what you preach.’ Consistently modeling good values earns trustworthiness and exhibits authenticity. This integrity is an essential ingredient to gain followers.
·      What people need to feel: You value them – to genuinely care for and value someone draws them to you.

 “People don’t care how much you know until they know how much you care.” When a leader has consistently connected, it is evident through employees exhibiting group values, showing a strong work ethic for the team, and loyalty. And the aspiration of the group is adopted from the leader's vision

Law of the Inner Circle – those closest to you determine the level of your success

Leaders cannot succeed alone, and nobody achieves greatness alone. A leaders inner circle is what determines the level of success achieved. Advisors, mentors, key team members, and support from loved ones are all critical. John notes, “Leaders are hired to deliver results. There is no substitute for performance but without a good team, they often don’t get the opportunity.” Practicing this law requires you to be intentional in building relationships because too often people surround themselves with easy or comfortable relationships. Seek the best people to surround you and invest in making them better. Think about these 3 pre-qualifications before bringing them into your inner circle.
1.     Who They Are – they must possess good character and share your same values. Maxwell’s personal examples are integrity, positivity, value excellence, flexibility, loyalty, and value people.
2.     What They Do – they need to possess strengths in your area of weakness. Also consider how they interact with other members, making sure it is complimentary.
3.     How They lessen my load – in accordance with the Law of Addition, your inner circle must be adders or multipliers, sharing some of the leadership role.

 Your Inner circle must add value to you and be lifters, personally and professionally. Maxwell summarizes, stating “If the people around you don’t make you better, then you need to get around other people.”

John Maxwell’s 21 Laws of Leadership: part 1

Your leadership ability determines the lid, or maximum, of your potential. The lid creates a ceiling on what you can achieve; therefore, the higher the lid, the higher your potential. This is #1 on the list because you must believe & commit to this law to make the other 21 laws of leadership effective in your life, meaning you must be willing to make the daily effort to improve your leadership skills to achieve the greatness you aspire to.

Sports are a clear example of this because the outcomes are so immediate. You either win or lose at the end of the competition. Consistent & exceptional training is often the deciding factor in sports which continues to raise the lid, thus the potential to win (and be a leader in that field). Another example is the origin of the McDonald’s fast-food chains. Ray Kroc, who led the company to worldwide greatness, was not the creator of this burger concept. The McDonald brothers had a small and successful restaurant, but their leadership abilities, while robust in a store operation, did not allow them to expand successfully. There was a lid on their potential because of this inability to lead beyond a few restaurants. Ray Kroc invested in systematizing the McDonald’s franchise business & make it scalable. His leadership ability was exceptional in this area, thus raising the lid on the business's potential.  

You may be deemed a leader by a job title, but that does not determine you as a successful leader. One of the best ways to know if someone is a leader is to watch how influential they are in the lives of others. When they speak, people listen and often act on their words. Becoming a true leader is when people listen to you and change their behavior to replicate you or perform work on your behalf. As Maxwell states, “The true measure of leadership is influence, nothing more, nothing less.”

There are five myths about leadership:
1.     Leadership is Managing (false) – Just because you are deemed a leader by position title does not mean you possess actual leadership traits. Managing is often an operational perspective, but leadership creates positive change and moves people in a new direction.
2.     All Entrepreneurs are Leaders (false) – Entrepreneurs are skilled at seeing and pursuing an opportunity, but often they must partner with others to make this pursuit successful. One can be an entrepreneur and not possess the leadership skills to grow a business to maximum potential.
3.     The Knowledge Myth – Knowledge does not equal leadership. Knowing and understanding facts are essential to superior leadership, but it does not guarantee leadership skills. For example, many knowledgeable people in academia do not have the ability to lead.
4.     The Pioneer Myth – To be a pioneer and blaze a new trail in an area does not mean you are a great leader. Similar to an entrepreneur, a pioneer saw an opportunity and pursued it.
5.     The Position Myth – a leadership position or title does not mean you are a true leader. The position is the lowest level of influence with which a subordinate’s actions often only respond to a monetary incentive.

John Maxwell states “Leaders have only one thing in common: Vision and Foresight. They see before other people and they see more than other people.” They must understand and manage today, anticipate tomorrow, and cast a vision for the future. Leadership is more of a verb than a noun.

Most important is what you do incrementally over time. Leadership can be a learned skill; one does not lead out of personality but out of the process. Investing in the stock market is a good analogy for leadership. The compounding effects of incremental improvements lead to a lifetime of wealth creation. The ability to lead is simply a skill set that can be learned. This skill set includes respect, experience, discipline, people skills, communication, emotional strengths, and timing. Successful Leaders are learners and committed to daily improvements. This law highlights the difference between an event and a process. The process matures people and is often like freezing water where very little happens until nearing 32 degrees, in which a significant change is evident.

Law #4. The Law of Navigation: “anyone can steer the ship, but it takes a leader to chart the course.” Navigators see more & before others, and they plan more & before others. This law is the combination and skillful balance of:
- optimism & realism,
- intuition & planning, &
- faith & fact.

This balance is characterized by the critical traits of a Navigator as outlined below:
1.     Do not exaggerate situations and keep emotions from clouding your judgment. Analogous to the Wagon Wheel, there are drastic moves in feelings up and down if you reside on the outer rim as the wheel of life turns. And the closer you are to the hub of the wheel, the more you become emotionally grounded. Navigators can manage the rise and fall of emotions while navigating situations. Two factors assist Navigators in charting a successful course, delaying emotions while maneuvering problems. First, remain grounded by defining your internal and external definition of success. Second, constantly pursue being bigger on the inside than on the outside. This comes from having more faith than fear and drawing from a set of values that keep you directed on the right path & persevering.
2.     Navigators analyze past experiences to learn from them, knowing past failures offer more valuable lessons than successes. The larger the organization, the more the Navigator must see ahead because the larger an organization, the harder it is to change the course in midstream.
3.     Navigators understand the current conditions, estimate costs, and make future projections before committing to something. Navigation is honestly dealing with facts to understand the obstacles and adequately map a plan.
4.     Navigators listen to others. One person cannot see & understand everything needed, so a good navigator must seek other resources, experts, and team members.
5.     Navigators balance both fact and faith. You are confident in your abilities but must deal with facts. Jim Collin in Good to Great calls this the Stockdale Paradox and states, "You must retain faith that you will prevail in the end, but you must also confront the most brutal facts of your current reality." You are realistic about the current state but optimistic about the future, having faith in your success.

John Maxwell came up with this acronym to assist in navigation:
PLAN AHEAD
P = Predetermine the course of action
L = Layout your goals
A - Adjust your priorities
N = Notify key personnel
A = Allow time for acceptance
H = Head into action
E = Expect problems
A = Always point to success
D = Daily review of your plan

A leader's motives matter, and purposefully adding value to your employees, team members, customers, and all stakeholders should be the goal. Leaders have either a positive or negative influence on those they lead, so there is one critical question: are you making things better for those who follow you? Human beings are naturally selfish; therefore, this law must be purposeful.  Whatever your field, your intention should always be to add value by focusing on others, pursuing that which will better their lives. In addition, it is contagious, and others see the value added and inherently want to continue it to others. When you serve others, their success becomes your success.

Maxwell notes 4 guidelines for adding value to others:
1.     First, genuinely value others.  Maxwell describes this as “Leaders who add value by serving, believing in their people before the people believe in them, and they serve others before they are served.”
2.     Make ourselves more valuable to others. We can’t give what we do not possess, so we must intentionally pursue growth in order for us to continually be of value to others.
3.     Know and relate to what others value. We must learn about our peoples’ hopes, dreams, and aspirations to better understand motivations and properly assist in achieving them. True leaders listen, learn, and then lead.
4.     Do things that God values. God values people, so He desires respect and service for others.

Maxwell states, “The bottom line in leadership isn’t how far we advance ourselves, but how far we advance others.”

 To be optimally effective, leaders must do all 21 laws well. Since this is unlikely for most people, a team must be constructed around possessing all 21 traits. They must add value to the team by supplementing any laws that the leader misses. You need to give the team members ownership of objectives and, with this, the praise & reward for success. Practicing the law of navigation, and charting the course, is a path that creates “wins” for the team, clients, and all stakeholders.

Financial Analysis: Understanding IRR, Debt Coverage, and Cash on Cash

When analyzing a real estate investment, many financial projections must be made. The assumptions in these calculations often mean the difference between an enduring career in this industry or a gut-wrenching loss. Nearly every assumption matters to some degree, and the accuracy of these numbers, based on market statistics, is critical, so don’t gloss over any assumption. If there are one or many unknowns, then stress testing your return performance for these variables is a must.

Over the years, I have come to focus first on three primary figures that are of the utmost importance in my property financial analysis. Before getting excited about an Internal Rate of Return (IRR) that looks acceptable, you should review the Debt Service Coverage Ratio (DSCR), defined as the ratio by which the Net Operating Income exceeds the total Debt Service payment. NOI / DS = DSCR. For example, $120k NOI / $80k DS = 1.5 DSCR. To properly evaluate this, you must know what DSCR is required for the different types of loans you may be eligible for in the current lending environment. Since real estate investors seek cash flow over at least a portion of the holding period, a 1 DSCR is quickly a red flag of high risk for further review. It can show that the investment's potential upside hinges on loan markets loosening, the revenue increase, operating expense savings surpassing your projection (light value-add), and likely a combination of these. At a minimum, it highlights the need to raise enough upfront capital for operations or a higher capital reserve over a specified period, such as a lease-up or a renovation timeframe. Often loans require a 1.2 to 1.35 DSCR. Failing to meet this number can have severe repercussions, such as a springing guarantee by the borrower or increased cash reserve requirements.  If your projected DSCR is equal to the loan requirement, there is little room for your other assumptions to be incorrect before some of these negative loan terms are triggered. Also, remember that an elevated debt coverage ratio brings the bank's allowable loan value down on the property. For example, in the current market of January 2023, Freddie Mac and Fannie Mae are requiring between 1.25x to 1.35x DSCR. Because of the elevated interest cost, the maximum allowed loan cost can reduce to 55% to 60% of the property value.

Following a first glance at the after-debt IRR and debt coverage, I look at the Cash-on-Cash return (CoC). This ratio considers the leverage on the property and the equity investment. This ongoing cash flow is often a driver for investing in commercial real estate; therefore, it must meet your investors' expectations. A good annual return often makes the investor timeframe more flexible to holding through adverse market conditions. If this number is below the required return, further investigation is required of the assumptions of all income, debt, and expenses. Every line item will affect the CoC Return. If this figure greatly exceeds expectations, it also cautions that you may be overly ambitious in your assumptions of revenue, expenses, and timeframes. The return sought will differ based on different investors, property types, risk levels, and alternative investment returns. The Cap Rates acceptable to Institutional investors in Class A properties hit record lows during the post-pandemic boom, sub 3.5%. And with this drastic move lower in Cap Rates, the CoC moved in lockstep along with it.  Whether a 6% or a 12%+ CoC is needed to get investors interested in the deal depends on their specific situation and the current market. Today the five-year Treasury is approximately 3.61%, and index funds are mostly in the .75% - 1.75% range.

With the DSCR and the CoC meeting the investment requirements, I focus on the Internal Rate of Return for this investment. Distributions often happen monthly or quarterly; therefore, the timing of these must be considered in IRR calculation. The excel formula for this is XIRR which needs dates for the timing of the cash flow. A significant factor for the IRR comes from the projected disposition cap rate. This may be the greatest variable in your analysis because your holding period may change as disposition decisions adjust to market selling conditions. Any changes in duration can greatly affect the IRR. This means that you may hold the property for longer than originally projected in expectation of future lower cap rates, further emphasizing the need for strong DSCR and CoC. If you achieve the desired disposition cap rate in a shorter-than-projected hold period, the IRR will drastically improve, showing the power of the Time Value of Money. In addition, an Internal Rate of Return can be calculated on unleveraged and leveraged, considering debt. In a development analysis, I aim for a proforma with a leveraged IRR of 16%+ to proceed with the required work and risk of developing a project. For an investment purchase that is cash-flowing from the acquisition date, a lower IRR may be acceptable. But the critical thing to remember is to perform risk and sensitivity analysis for different income, expense, and time assumptions.

There are, of course, many more aspects of a proforma financial analysis to consider for every investment, and I will attempt to cover these in articles to come.

The Market: Past, Present, & Preparation

The pandemic changed many things worldwide, and the multifamily market is no exception. The market began drastically changing in 2021 when demand increased to a magnitude never seen before. Many factors contributed to this, including remote work fueling the desire to upgrade space and its new-found flexibility allowing employees increased mobility. Government stimulus gave a large swath of citizens more disposable income, including the Federal Reserve lowering the interest rates to record low levels. The spike in demand began the path to higher rents, construction of new apartments, and increased occupancy. Lower interest rates and higher home prices also contributed to increased demand. People wanted to sell their homes at the highest price possible, but the availability of new homes and an often-surprising price led to a shift from the property owner to property renter. For the first time in history, more than half of the apartment leasing agents in the nation spent their days telling prospects that nothing was available. By October 2021, the National average occupancy reached almost 95 percent.

The multifamily industry was operating at peak performance going into 2022. Renewal offers were sent with significant rent increases, occupancy remained extraordinarily high, and turnover was low. But as 2022 progressed, the macro-environment changed as the Federal Reserve enacted seven increases in the Fed Funds interest Rate to fight inflation. This rapid increase has had many repercussions, including dramatically slowing the homebuyers, thus, reducing new home inventory construction. In addition, new multifamily construction projects are being delayed because of rate and cost increases. These two dynamics should help to minimize an oversupply of housing.

So, where are we trending now? For the first time in 18 months, the national occupancy average is down under 92 percent. Rents previously increasing on average by 6.6 percent are now down to 2.9 percent. Construction that began early in the year is ultimately expanding the supply of apartment homes. As we are stable now, experts say we are trending downward and must prepare.

Hopefully, managers in the multifamily industry were planning for the inevitable market cycles. If you have been in this business for nearly two decades, you have experienced at least one of the most dramatic housing cycles, including the Great Recession. With a record recovery from pandemic lows, history tells us that the market cycle would eventually top out. Leasing Managers should have prepared for this, but if you did not, you could begin now. Create a waiting list and review your marketing plan to analyze proper targeting. Sometimes people start looking for an apartment home early. Encourage them to go ahead and apply to get on the waiting list. Temporarily waiving the application fee may be prudent. If you have an entire list of people interested in leasing a new vacancy, facing a significant turnover doesn’t feel daunting. A priority on resident retention is equally necessary and usually the most cost-effective marketing practice since the turnover cost may soon exceed the rent increase opportunity. Tenant appreciation needs focus, and service levels must be robust. Additionally, as rent increases continue at a slower rate, having some flexibility on rental rates is wise, leaving you some room for negotiation.  

There is no arguing that the pandemic created unpredictable factors for the multifamily industry. Similarly, the rapid increase in the interest rates in 2022 brought forth the top of the market cycle. As property managers, we must be proactive and prepare our communities for revenue stability.

Fixed-rate Loan with Yield Maintenance

There are many benefits to obtaining long-term financing on your multifamily projects from Fannie Mae or Freddie Mac. These government-sponsored enterprises (GSEs) agencies, Fannie Mae and Freddie Mac, provide federally backed mortgage guarantees, so the buyers of these bonds require minimal risk premiums. Therefore, these Agency Loans offer some of the most attractive loan terms available to multifamily properties, including fixed-rate loans that eliminate the risk of interest rate fluctuations.  These loans have durations of 5 years or more, require stabilized occupancy and income, and range from $5 million to $100 million. The Debt Service Coverage Ratio (DSCR) is typically 1.25 to 1.4, and the loan-to-value (LTV) range is 65% to 80%.

Origination and servicing of these loans for the agencies are made available through licensed lenders called Delegated Underwriting and Servicing (DUS) lenders. Examples of these include Berkadia, KeyBank, and Greystone. The GSEs set loan programs, but the underwriting methodology can differ between agency lenders, producing very different quotes. The underwriting differences can deliver varying loan proceeds even though Interest Rate, DSCR, and LTV may be equal between agency lenders.

One of these agency loans' most attractive loan terms is the non-recourse feature, meaning the borrower is not personally guaranteeing repayment of the loan. This certainly gives a property owner reason to sleep easier at night, but there are associated costs. With a fixed rate over longer durations, the rate is usually higher than a floating rate over the same period. Through this, the DSCR, and the LTV, the lender is compensated for this additional non-recourse risk. The Pensford analysis of float vs. Fixed-rate concludes that over time, the floating rate costs the borrower less because the market frequently overestimates the future Fed Funds rate. Also, remember that the higher interest rate raises the debt burden calculation of DSCR. Loan assumption is an often-allowed loan condition, adding to marketability in the right economic conditions, such as a higher Fed Fund rate & tighter lending environment.

A significant negative for these agency loans includes prepayment penalties such as Yield Maintenance. This loan covenant provides 100% call protection to the lender, where there is protection against market interest rate changes. The calculation for this fee considers the remaining term of the loan, past interest earned, and the loan rate compared to the current market interest rate. For example, let’s look at the 2022 interest rate market, where a dramatic increase occurred throughout the year. A loan interest rate from 2020 is significantly lower than 2022 new loan rates (earnings to Lender). In that case, the yield maintenance will be lower because, essentially, the Lender can reinvest the money paid back at higher rates in the current lending market. On the contrary to this example, executing a higher fixed-rate loan in 2022 with yield maintenance is undesirable, with expectations of lower market rates within 24 months. This lender protection allows for superior loan terms to be offered to the borrower, but it can be expensive to terminate early.

Disposition of the property can be significantly inhibited by this expensive yield maintenance clause, limiting the exit strategy available to the owner. Unless the past loan duration is five or more years and the current interest rate market is significantly higher than the loan rate, opportunistic selling of the property in the near term is usually cost-prohibitive. This added expense makes these loans generally suitable for business plans with long-term holding periods. Even the assumable loan clause can demand a higher selling cap rate because it is less versatile for a Buyer, lacks an interest-only period available with new loans, has lower leverage because of past principal reductions, and may have unattractive interest rates. There are positive attributes to these fixed-rate loans, but these negatives need to be extensively analyzed to determine whether they fit the investment group’s goals.

We will always underwrite deals conservatively at Colonial Company and Colonial Commercial Realty. Therefore, it is essential for yield maintenance and loan assumption costs to be included in future disposition calculations. Depending on the negotiated details, these increase the cost incurred by either party, and the cap rate is frequently adjusted upward to account for this, thereby lowering the sales price. And because of the current elevated interest rates today, it is reasonable to underwrite deals with some expectation that a refinance within the near term is likely. It is important to stress test various refi rates and start dates, keeping the assumptions credible, objective, and not overly optimistic.  Other considerations should be financing with a step-down prepayment penalty, a shorter loan term, and finding bank debt offering similar terms.

Three Types of Commercial Leases

Venturing into a small business is exciting, fulfilling, and not to mention, nerve-racking. Some business owners can do it out of their homes. For others, commercial space is needed to operate their business. Whether it is for a retail store, office, or restaurant, there are many ways landlords structure a lease, and it varies from property to property. There are three main types: Gross, Triple Net, and Modified Gross Lease.

What is a Gross Lease?

As with most commercial leases, a gross lease is calculated on a price per square foot for a certain period. The lease rate includes all the property expenses, such as utilities, maintenance, insurance, and taxes. This can benefit the tenant because it is easier to budget without worrying about fluctuating energy bills and unforeseen maintenance issues. Most leases come with an escalation clause that increases the rent after a specific time. With a gross lease, the price per square foot is usually higher, but the property’s operational expense risk remains with the landlord.

What is a Triple Net Lease?

This type of lease is the opposite of a gross lease. In a triple-net lease, the tenant pays the rent as well as insurance, property taxes, maintenance, and utilities. They are usually responsible for the care and upkeep of the building and property; therefore, the tenant carries the most risk. This is the most common lease for more sophisticated tenants and landlords, such as regional and national businesses or large, well-located Shopping centers. These property expenses are called Common Area Maintenance (CAM) charges and are in addition to the rent. CAM fees are estimated each year and paid along with rent. The property manager directs these maintenance needs for common space shared by multiple tenants. At the end of the year, the parties are expected to “true up” to reflect the accurate maintenance cost. This can involve an additional payment or a refund for the Tenant. During lease negotiations, an accurate estimate of CAM charges is essential to mitigate legal and relationship risks during the lease.

What is a Modified Gross Lease?

 A modified lease is a combination of gross and triple net. Depending on the landlord and the property, the rent might include property taxes and insurance but not utilities. It might consist of utilities but not maintenance. The tenant can be responsible for any combination of expenses. A tenant might see this type of lease in an office space. The tenant and landlord share the risk with this type of lease. 

It is essential to read through the agreement documents with every lease carefully. The tenant needs to understand their responsibilities as well as the landlords. Working with a commercial real estate professional can help business owners get the best terms and conditions for their needs. This allows the tenant to focus on its mission and grow the business.  

Financial Key Performance Indicators (KPIs) for Homebuilding: Part 2

Liquidity Ratios are critical to any business's longevity because they illustrate the ability to repay debt. Liquidity is defined as the ability to convert assets into cash. The Current Ratio focuses on current debts payable with current cash & assets. Current Assets refer to money and assets convertible to cash within 12 months, and Current Liabilities are any debts payable within 12 months. When Current Liabilities are subtracted from Current Assets, the difference is Working Capital and is a good measure of a business’s ability to expand or grow.

Current Ratio  =  Current Assets / Current Liabilities

 A low Current Ratio illustrates a capital shortfall and market cycle or revenue vulnerability, whereas a high ratio shows more liquidity but the inadequate use of resources. A calculation close to 2 is desired, but 1.5 is often typical in homebuilding. A more stringent test of a company’s liquidity is the Acid Test Ratio which uses “quick” assets instead of current assets.

Acid Test Ratio  =  Quick Assets / Current Liabilities

“Quick” is considered assets convertible to cash within 30 days. Historically, the Asset Test Ratio is a very low calculation in Homebuilding because inventory is not easily converted to cash. This is an industry with heavy financing and considerable inventory.

Leverage Ratios measure the financial risk of the operation and illustrate the risk for the lenders and investors. Owners’ Equity to Total Assets Ratio shows what percentage of the assets are financed by owners' investment instead of borrowed funds; therefore, the higher this percentage, the lower the risk to investors or lenders.

 Owners’ Equity to Total Assets Ratio = Owners’ Equity / Assets

 Another leverage ratio is Total Liabilities to Owners’ Equity, where a lower ratio show’s a stronger ownership position or lower risk for lenders or investors. Many factors affect whether this calculation is a high risk, including personal guarantees or personal assets as collateral.

Total Liabilities to Owners’ Equity  =  Liabilities / Owners’ Equity

Return on Investment ratios are likely the most widely known of all the KPI ratios. They are defined by either the total assets (resources) or a business or the owner’s invested capital.

 Return on Assets ratio = Net Profit / total assets

Return on Owners’ Investment ratio = Net Profit / Owners’ Equity

 Return on Owners’ Investment can be interchangeable with the term Return on Investment (ROI). This is not a Return on Total Investment. This ROI ratio can also be formulated as a product of three ratios; net profit, efficient use of capital, and the amount of debt leverage. The three formula relationships are as follows:

 Return on Investments = Return on Sales    X    Asset Turnover    X    Leverage

 Profit / Equity   =    Profits / Sales    X   Sales / Assets   X    Assets / Equity

 The Leverage is a setting of your investment risk level, meaning the higher the leverage, the higher the risk. Improvements (or increases) in any of these ratios improve the ROI, but care must be taken with the balance of leverage and associated risks.

Financial Key Performance Indicators (KPIs) for Homebuilding: part 1

Understanding and following critical financial metrics are essential to monitoring the performance of your Real Estate investments. These investments span various product types such as office and retail, including development and operations.  These Key Performance Indicators (or KPIs) are equivalent to checking the vital health signs of your investment or business. These assist Owners and Managers in isolating problem areas needing correction. In this article, we will focus specifically on Homebuilding, and the terms ratio, metrics, and KPIs will be used interchangeably. The key financial ratios in homebuilding analyze profitability, efficiency, liquidity, leverage, and return on investments.

The Balance Sheet and Income Statement are used to calculate these financial ratios. Metrics derived from the Balance Sheet measure the critical relationship between Investors and Lenders, while the Income Statement metrics evaluate the business operations. Although many more ratios can be derived from the financial statements, understanding these Key Performance Indicators is imperative in achieving an optimal real estate business. These metrics provide a standard of measurement for past performance, allowing comparison to industry peers, and can be used to help forecast trends. Homebuilding offers an excellent case study of how these KPIs can be applied.

Profitability Ratios present the operational performance for various expense categories in the income statement. These ratios are derived from an expense divided by sales or revenue. Management must establish target KPIs derived from industry peers and feasibility. Comparing the metrics of these major expense components allows management to see challenges, focus areas, and underperforming departments. The critical metrics for Profitability ratios follow the income statement order and are as follows:

Income Statement Ratios  (all divided by Sales) 

Revenue (Sales)
- Cost of Sales: Cost of Sales Ratio
Land Land Ratio
Direct Construction Cost Direct Construction Cost Ratio
Gross Profit Gross Profit Ratio

- Total Operating Expenses: Operating Expense Ratio
Indirect Construction Cost Indirect Construction Cost Ratio
Financing Expense Financing Expense Ratio
Sales & Marketing              Sales & Marketing Ratio
G&A Expense General & Administrative Expense Ratio

Net Profit Net Profit Margin                                        

The above illustrates how seeing the ratios in correlation with the income statement format will make it much easier to memorize.

Efficiency Ratios unveil how well the company uses its resources, such as sales and inventory, and are derived from numbers on both the Income Statement and Balance Sheet. These ratios evaluate how quickly it generates revenue from its assets and inventory. The numerator is Sales in both the Asset Turnover and Inventory Turnover Ratio. The denominator is either Assets or Inventory on the Balance Sheet.

Asset Turnover Ratio = Sales / Assets

Inventory Turnover = Sales / Inventory

The higher figures reflect more efficient use of resources to generate revenue. An example of an Inventory Turnover Ratio with Sales of $48,500 and inventory of $18,250 is 2.66 (48,500/18,250 = 2.66). Adjusting this ratio to illustrate as months will show approx. 4.6 months (365/2.66 = 137 days). Custom builders will have longer turnover times compared to production builders. A builder must understand the industry and market benchmarks for cycle time comparison and adjust accordingly, usually through construction process improvements or the spec home inventory. 

Focus on Who You Have: Resident Retention

            Everyone has heard the wise expression; count your blessings. This essentially tells you to be grateful for what you have. The same is true in the apartment industry. When a current resident decides not to renew their lease, the turnover cost is typically between $3,000 and $4,000. How is this possible? We must consider vacancy loss, maintenance salary, vendors, leasing cost and salary, and other items.  With this sizable cost, where exactly should our focus be, and what does the market say about this?

            Resident retention is probably the most critical aspect of a property manager's job, but many do not always prioritize this. If you search social media, you will see ads like “lease today,” “special rates,” and “call now” to lease your property. While attracting prospects is essential, your current residents can be neglected. In addition, are we attracting the people we are advertising to? There is no denying that the youngest generation renting apartments differs from the generations before. Renting is no longer a short-term stepping-stone for many but a phase of life that will last for several years. So, what are they looking for, and how do we keep them?

            The new generation of renters is not just looking for a place to sleep until they find the right home. They are looking for experience and a lifestyle. Buying a home is not as important to this generation as the last, and they are in no hurry to buy. They value being social, having certain home luxuries, and having experiences. They are more involved in the community and often seek new things to try. Your apartment or housing community must provide this through customer service, resident events, and incentives.

            This generation is looking for wine tastings, pool parties, meet-and-greet gatherings, and live music in a new apartment complex. They want to see the managers putting in the effort and envision the fun they can have in their new community. And these activities can be utilized in marketing material. Take pictures at the event and put them on social media so that your residents know you go above and beyond, and even better, your prospects see this too. These marketing expenses are thus targeting retention and new Prospects. Also, with the turnover cost, incentivizing the current resident to renew may be more cost-effective. Advertise an incentive for residents who want to renew. Again, you care for both new and existing in one fell swoop. 

            Lastly, we must provide excellent customer service to our current residents. How many of us have had new prospects tell us that their existing community is nonresponsive, be it maintenance needs or the office staff just not answering the phone? Make your residents a priority. Learn about their lives and be interested. Don’t just talk to them when there is a problem or time to collect rent. Check on them and make them feel important. Remember that these people already chose your apartment complex, so now, as Management, make residents happy they have you too. Management can be the deciding factor in a resident choosing to stay, so they deserve the best you can give them!

Urban Place: Site Study

Written by Josh Lowder, CCIM MRED, 2013

Portland Site Visit: reflection paper

Portland, OR stands as an impressive and comprehensive example of sustainable design possibilities in today’s construction industry. Areas such as the Pearl District and firms like Gerding Edlen and Interface Engineering show ingenuity in the development and redevelopment of old and new structures. Our field study gave us the opportunity to meet and learn from these sector leaders. 

Gerding Edlen is a cutting-edge development firm with a business model worth duplicating. Operating for 15 years with core values focused on sustainability, they offer services ranging from development, property management, green solutions and retrofit project management, and investment management. Gerding Edlen is an SEC registered investment advisor capable of managing accounts for investors and sponsoring funds. The funds focus on value-add opportunities for development and redevelopment in high growth urban markets in the United States. Their property types are diversified between office, retail, multi-family, and mixed-use. Their primary agenda and expertise is with sustainability, proving to now give them a competitive edge in today’s market. Users are drawn to these properties because of their environmentally friendly panache, reduced energy expenses, and employee enhancing features. These have all been ‘road-tested’ enough that the premium rents and increased Net Operating Income for these properties are attainable. Gerding Edlen has the expertise to execute these green developments and navigate the available financing incentives. They recently added a Property Management service because their expertise with green features gave them a superior advantage over the competition. The firm has 57 LEED certified properties with over $5 Billion in value. The manager that toured us around said the partners greatest talents were working through financing and networking with best-of-class business & community leaders. Further investigation into their specific projects and its means of success would be beneficial for any current developer. Our built world is progressing with a concentration on its environmental impacts, and it will only gain intensity, one day being mandated throughout the world. 

Interface Engineering was another exemplary firm visited during our field study. They shared some of their design insight through the solar shade study of a waterfront office building and the design of a LEED Platinum and Net-Zero elementary school addition.  The Solar study concluded the best location for the building in response to the preferable horizontal shades on the broad side of the building. These horizontal shades gave greater views and southern sun protection. Interface also gave a summary presentation on an addition/renovation project for Hood River Middle School totaling approx. 15,000 sq. ft. They wanted the structure to have the benefits of green features and provide students with a teachable building, meaning they will learn from the enhancements and its environmental cause. Also, an on-site garden allows biological, culinary, and community interaction and education. For electricity, the project utilized on-grid PV panels, which allows utility company backup when needed, but also ‘resale’ of unused power back to the power company in low consumption seasons. To minimize power use, windows & skylights featuring light and occupancy sensors for lighting controls were utilized. In respect to mechanical, radiant floor heating & cooling was used in conjunction with a horizontal geothermal heat pump system located under the adjacent football field. For decades a nearby stream had been diverted for various uses so the school was allowed for use in cooling system needs. Rainwater harvesting was used for the projects landscaping and gardening needs. Interface Engineering has 14 Net-Zero projects in design with 113 LEED certified buildings completed.

Portland features some of the finest industry-leading sustainable development created over the past decade. The city mixes historic structures with neighboring new projects in a beautiful and compatible manner. These will serve as inspiration for the commercial real estate industry that is in the midst of a transformation to reduce its environmental impact. 

 Written by Josh Lowder, CCIM MRED, 2013

Hurdle Rent and Land Residual Value

Analysis Explanation

Introduction:   This property is a proposed mixed-use building consisting of ground floor commercial and second floor through seventh as multifamily. The commercial space will be “black box” unfinished space and adaptable to retail or office. 

 Cost Allocation:  Because the uses are mixed it is necessary to separate the cash flows and cost allocations in order to apply the appropriate cap rate. I allocated the land cost based on a pro rata basis using the square footage. The site preparation and demolition costs needed to prepare the site for development are also allocated to the two uses, commercial or multifamily, based on their square footage. 

 Development Cost Breakdown:  The site prep and demo cost were treated as outlined above. For the Development cost the given “totalfile.pdf” file was used to derive the appropriate cost allocation. I used the $166.50 per sq. ft. amount from 55,000 sq. ft. exterior brick with concrete block on steel frame. This was applicable to a 7 story multifamily building of similar size, but the ground floor was going to be a commercial shell. From the data given, I believe the best way to achieve the ground floor cost is to deduct the interior finishes that were included in the above $166.50 PSF. After any of these adjustments the cost is regionally adapted per the instructions. This breakdown is in the attached excel file. 

Development Margin:  The margin is given to be 10%. I believe this is high, and this contributes to the infeasibility of the development at the land price based on my analysis. 

Operating Expenses:  For the multifamily portion a percentage of effective gross income of 41.2%. This number was derived from the IES Executive Summary 2012 of operating income and expenses for apartments. For further analysis, there will need to be a comparison of amenities and other features that contribute to this OPEX. For the commercial I allocated 30% even though the Lease will be Triple Net. I then deduct this OPEX psf to get the NNN lease rate. The reason for this is so that the vacancy is accurate. When the property is vacant there will be lost reimbursement revenue so this needs to be accounted for.  

Market Comps:  For the commercial space the market comps given needed to be adjusted to reflect the unfinished space of the proposed ground floor space. Normally an appraiser would adjust the comps but for ease of use, I adjusted subject space. To do this I added back in the development cost that were previously deleted excluding the residential specific costs. (the architectural, engineering, and contractor mark-up for the shell cost was used for estimating purposes). This cost was then amortized over an assumed 10 year lease. Adding this Tenant Improvement cost onto the Lease Rate (NNN) came to a hurdle rate of approx. $13.50 PSF. This was still lower than the comps provided, but the space is still 2-3x the size of comps, so some discount is expected for larger spaces. For the multifamily, the provided comps are much less expensive than the hurdle rent I derived. To obtain the hurdle rent, these apartments will have to be the highest class in the market. 

Acquisition & Reversion Cap Rate:   The cap rates used were derived from the Viewpoint 2013 IRR Perspective. I used the 2012 cap rates and referenced Birmingham, AL and Columbia, SC. I used both for size references and that colleges were present. But, Columbia is a capital city so the office cap rates will be stronger than the subject site. I used 6.25% for the going-in Cap Rate based from the Columbia, SC urban multifamily number. For the commercial, I used the 8.5% going-in Cap Rate from the Birmingham, AL rate. The reversion cap rate for commercial was referenced from Retail of Birmingham, AL at 8%. The office rates for Columbia and Birmingham were both higher. The multifamily reversion cap rate was taken from the Columbia exit rate because these two cities better reflect the college environments. 

Conclusion:  The land residual value combined came to roughly $350,000, or half of the sales price value. I think some of the allocation is disproportionate because the commercial is below the given comps and the residential is above, but I do not believe the rebalancing will solve the problem because the commercial is a minimal part of the project, 14%. I do believe the development Fee of 10% is too high, but this is the developer’s requirement. 

Written by Josh Lowder, CCIM MRED, 2013

The Big Short: a synopsis

            The Big Short is a shocking narrative on the events and players of what will undoubtedly be one of the greatest financial disasters of mankind. It gives the reader, whether financial expert or novice, a brutal understanding of the markets from homebuyer to fund manager, and the instruments of trade. It is the financial equivalent of reading a synopsis of Dr. Frankenstein’s inventive creations beyond the explicable, manipulations of the unassuming, and leveraging of enough electricity to power a monstrous doomsday machine.  

            To narrow the selection of most interesting aspects of The Big Short is no easy task. The moments of amusement coupled with utter disgust were certainly higher than anticipated. One of the most interesting, and disturbing, was the role of the credit rating agencies. There are various points in the market food chain where the reader can’t help but think, ‘here is where the virus could have been neutralized or impeded.’ The rating agencies of Moody’s and Standard & Poor’s are certainly such a juncture. The lack of understanding of the risk involved in CMO and CDO tranches and the underlying assets should have minimized the market for these. Instead of giving higher risk ratings because of their opaque nature, or simply refusing to rate something they don’t understand or for which they can’t adequately model, the agencies fold to the pressures of their peers, clients, bosses, and inadequacies of understanding. The ratings agencies wanted to appease their Wall Street counterparts. These wise ‘clients’ were reassuring them of their low risk status, and there was the fear they would simply go to another agency. The mere unawareness or disregard for the lax nature of the residential lending environment that was the foundation of these securities also add to the agencies complicity in fraud. In mu opinion, these understated ratings were gross misrepresentation, negligence, and borderline criminal.

            There are numerous lessons to learn from the catalysts of this financial crash with the probability of only a few being adequately addressed. There is a large degree of personal and moral responsibility involved, both of which are very hard to mandate. Though companies, such as banks, brokers, investors, and so on, can have ethical policies, morality is only instituted personally. Since morality is subjective, this example is better discussed ethically. The borrower of a loan should take personal responsibility in managing its finances. The lender should operate ethically, only lending to those most probable to repay, regardless of whether the lender sells the paper to another investor. In general, adequate underwriting should be required via regulation, both of which were absent during the subprime mortgage madness. The originator was driven by fees and was able to pool the loans for sale. Also, when the teaser rate expired, the struggling borrower might only refinance leading to more fees. But if the borrower and lender are like two basketball teams saying ‘we don’t have to keep the score, and we don’t have to call every foul,’ then the government was a cheerleader and a referee dressed as one. Governmental policy starting in the mid-1980’s began to push home lending which went as far as to threaten banks that didn’t adequately lend to its submarket even if the borrower was less qualified (to pay back). The Borrower certainly hears the message of ‘everyone deserves the opportunity to own its own home,’ hence the Lender and the Borrower come closer to the table whether their best reasoning says otherwise. Greed will always exist. It is the selfish desire for something, and the lender, borrower, politician, rating agencies, and regulators cannot defeat its subtleexistence. We just tend to think of greed as something big with a capital ‘G.’ Because of this, regulation must be present and, most importantly, monitored and enforced. There can certainly be overregulation, and we are currently in a period where the pendulum swung too far in the other direction. Credit is loosening and some markets are recovering better than others. 

            Secondary markets for home mortgage loans play an important role for the liquidity and speed of the markets. I do believe the private sector (eventually) performs better than governmental agencies based solely on the free markets nature of ‘survival of the fittest’ – provide a good or service that people want, operate efficiently or go out of business.  Freddie and Fannie certainly do not operate efficiently, and a quasi-government guarantee allowed them to operate irresponsibly and gave investors a false security. The residential real estate market is just too fragile at this time. A ‘wind down’ would cause a slowdown in the primary mortgage market likely stalling the economy even more. I believe that there is a need for the private sector to dominate the secondary market, but I don’t believe there are enough willing participants to make the transition seamless and worthy at this time.

            If the egregious subprime lending practices are corrected and the credit ratings act with integrity, some of these existing derivatives should be allowed as long as they are better regulated and simplified. There must be adequate paper trails, and there has to be true underlying assets, not fraud or the same asset used in a pool 100x over. There should be a limit to the amount of pooled assets or tranches and to the number of repackaging pools within pools which is how Wall Street gamed the rating agencies. This would at minimum make a paper trail easier to trace, and therefore easier to rate. I believe that if at any point the true underlying assets, its borrower, underwriting, and the location of its remaining ‘share’ (which may be split and held in another pool), then the instrument has become too complicated to rate and therefore should be banned. The idea of the issuer holding a percentage of the instruments they create is worthy of thought, but it all comes back to the riskiness of the underlying debt. 

 Written by Josh Lowder, CCIM MRED, 2013

Understanding Generation Y

One of the most critical skills of any prosperous company is the knowledge and understanding of its customer base. Generation Y is now one of America’s largest generational groups, surpassing the baby boomers, and they command increasing attention from real estate professionals. Urban Land Institute, Pew Research Center, and other analysts have performed valuable surveys to greater understand the quality-of-life ingredients needed to attract this generation to a municipality or residential development.  

            Generation Y stands in contrast to its parental generation and has notable characteristics that will shape their future real estate behavior. In 2010, Gen Y comprised 25% of the population and surpassed the baby boomer generation’s 24.6% portion of the U.S. population. This was equivalent to 77.4 million of Gen Y and 76.2 million Baby Boomers. This number may continue to grow because immigrants tend to be in the Gen Y age parameters. There are no definitive dates, but in general this cohort was born between the late 1970s and early 2000s. Gen Y will dominate the residential demand for decades to come, much like the baby boomers have done over the past 25 years. Pew Research shows this group is well educated with approx. 54% having some type of college education. The 2010 ULI survey respondents showed 31% of ages 25-32 years having a Bachelor’s degree, while 17% had advanced degrees/postgraduate work. This is higher than any preceding generational group. Gen Y is also ‘tech savvy’ having grown up in a time of vast technological advancements. Eight-in-ten say they sleep with a cell phone by their bed, remaining “always connected” with their handheld device. Gen Y views work differently than Baby Boomers in that more Gen Y’s ‘work to live’ and not the other way around. Balance between work and life is very important. They are goal oriented and favor efficiency, not working for long hours for the sake of appearances. Also, only 10% of the ULI respondents expect never to retire compared to their parents 25%. This is supporting evidence to another trait of Gen Y; they put more emphasis on experiences than on material possessions, preferring to spend money on vacations, food, and adventures. Gen Y is more ethnically mixed than any previous generational group at 40% compared to the Baby Boomer’s 27%. Most Gen Y’s enjoy the ethnic mix. When asked what unique traits they have, the answers in order of significance were technology, music/pop culture, liberal/tolerant, smarter, and clothes. Notably, work ethic was not ranked and it was a priority with all previous groups. In terms of marital status the 2010 ULI respondents were dispersed at 63% and 37% between two categories of Single/divorced/widowed and Married/partnered, respectively. Similarly, the households with children were just below one-third with children.

            Understanding the behavior and preferences of Generation Y will allow real estate developers to better position themselves for this flourishing demand. A unique characteristic to this segment evident by its illustrative branding as “emerging adulthood.” In 2010, One-quarter of the ULI respondents still rely on their parents or colleges for housing, while Renters and Owners were 38% and 36%, respectively. This leaves significant opportunity for apartments to serve this 26%, or possible 20 million renters, as they transition to independence. The study further divided this number by age groups of 18-24 yrs. and 25-32 yrs. which Renters by 38% and 37%, respectively, and Owned by 15% and 48%, respectively. Contrary to the generalization that young people want to live in urban settings, the ULI respondents were almost equally split between urban downtown, in-city neighborhoods or newer outlying suburbs, and older suburbs/small towns/rural areas. The 2010 response for Urban Downtown was 28%, but when asked where they desired to live in 2015 this increased to 34%. This shows some pent-up demand for urban living, especially in apartments. Understandably, ownership is based more in the suburbs & small towns, and renting is more prevalent in the city. The anticipated housing in 2015 for ownership is predominantly single-family residence. Inversely, the majority of rentals is expected in apartments/condominiums. The top four housing features ranked by Gen Y are Price/Rent, Size, Interior design/layout, and security. Green Features/sustainability were not as important with many preferring only if there was minimal cost difference. Size does not mean excess, because Gen Y does not value the large homes that previous generations lived in. The ULI respondents were asked what feature they considered most important when evaluating a residential neighborhood. “community character” was ranked first, followed by safety. Two-thirds of the Pew respondents said “you can’t be too careful” when dealing with people. Gen Y also puts more emphasis on experiences than on material possessions. The ULI respondents noted that spending time with family/friends, watching TV, reading, and listen to/play music ranked as the top 4 ways they spend free time. This shows that amenities matter, and the interior & exterior living experiences are important.  These activities can all be done within residential facilities and should all be addressed during design. Analogous to this is Gen Y’s preference for living within walking distance of shopping and social gathering places. The 2010 ULI survey noted that 64% preferred this walkability. 75% of this group uses some form of social media, therefore this medium should be used by all real estate professionals. For a generation that defines their unique trait as “technology”, advanced connectivity features will one-day be a requirement, but for now it is often the “leg up” against the competition. 

            Despite many of the behavioral differences, the goals and aspirations of Gen Y matched those of their parents. When ranking life’s priorities, Pew Research notes that Gen Y’s match the older generations with the top four as follows: Being a good parent, having a successful marriage, helping others in need, and owning a home. This reiterates the need for family-friendly design of living spaces and amenities.   Home Ownership, primarily suburban single-family residences, is still an American dream. But reality may hinder the fruition of these dreams for some time. 

            The current economic factors that face Gen Y may dampen the optimism or at least present obstacles. Entry into the job market has been impacted by the Great Recession, and this group has the largest unemployment rate, formidably at 10%. Pew noted that 37% were either underemployed or out work. But they have remained surprisingly optimistic. This may reflect some naivete and support the “emerging adulthood” branding. According to the National Foundation for Credit Counseling, only 58% of this generation pays their monthly bills on time. This group is also graduating with an average of $23,200 in student debt. At the same time, a majority of ULI respondents believe they will make a down-payment of less than 20% when purchasing their home. Based on the current mortgage markets, this is not realistic for most borrowers. Taking into account the expectations to own by 2015, the prolonged constraints financial markets will likely make this ownership difficult. It is almost as if in the same manner Gen Y’s prolonging maturity to adulthood, so the achievement of their goals be prolonged. Having said that, the higher education should enhance their pay scale helping attain the financially dependent goals.

Written by Josh Lowder, CCIM MRED, 2012

Philadephia Site Visit: A Time and A Place

            From the grilled calamari to the eight hours of sauna-like heat, these treats and tribulations were just side notes of a well-organized, professional educational trip to Philadelphia. The caliber of meetings and presentations put before the MRED students was exceptional, and we shared the room with leaders in the design and development industry. The scope of information presented is too vast to form a synopsis therefore I will focus on the elements that roused my curiosity for further investigation. These included modular structures, energy efficient technology and certifications, and political involvement or incentive programs.

            Onion Flats offered an opportunity to see first-hand s building features that are of interest to me. In the past I have researched modular construction and various ways it can be used to achieve a more permanent, site-built aesthetic. I believe that this method of construction will rise to prominence in the future due to many factors. This factory-built method can be wall panels or finished rooms and various stages between. The uses I have particularly investigated were for small school buildings that would create a more “historic” campus layout. Each building would be a two-classroom style one-story structure arranged with a green space square in the middle. This is a Duany Plater-Zyberk concept that was based on traditional schools. The other modular concept I previously investigated was with an architect with the intent to price the difference between a one-story home approximately 1900 sq. ft. in size to be built in a factory (priced by Rose outside of Birmingham) versus site construction. It was actually less expensive to site build in this instance, but that did not change my opinion about future growth in the modular industry. Like all things, there is a time and a place. I believe Onion Flats is using it correctly – being an owner in the modular company, using it for multi-story buildings, or multifamily property. It is beneficial to use in ‘crawl-space friendly’ locations because the piers needed for modular will blend in nicely. To truly conclude an opinion on the financials of this project, one would need much more information, but from the site visit, this particular project sounds rare. A budget of this type for only three Section 8 townhomes seems like a misuse of funds, but I know how bureaucracies can works. This was another example of ‘there is a time and a place,’ and the set budget was for three townhomes with no reason to contest otherwise. Because of this I do believe the builder is doing an admirable thing. I am fascinated with the passive house concept and the HVAC system he showed us. This certainly warrants more investigation. Through Internet searches, I have not found the ‘air-handler-in-one’ type system that he said has been used for years in Europe, but I have found the ERV (energy recovery ventilation) device and begun some reading. 

            All of the projects we viewed peaked my interest about green roofs, solar panels, and various other green features. Frankly, I don’t know very much about either, and I have heard the frequent “maintenance nightmare” comments. Living in a city like Montgomery does bring up warranty concerns since there may be no local installer at this point. These applications are also difficult to adapt to many architectural styles (on small lot footprints). But there is some level of ‘green’ that can work in any project. Liberty Property Trust and Onion Flats are great examples of the financial feasibility and profitability of some element of ‘green’. Liberty would not have invested $1 billion in sustainability if there were no benefit for its shareholders. Tax credits are available but these can vary from locales. I read in an article about Onion Flats that Philadelphia is as aggressive as ever before with tax incentives. A project’s market does have an effect on product and marketability of these green features because third tier markets either can’t afford or simply will not choose the upgrade. The difficulty in the Montgomery market is finding the features that work for all buyers. Few developers have the opportunity that was presented to Onion Flats: building multifamily sustainability on a large government budget (and as a test site for their next private development). But one of the best places to start ‘testing’ features in on your own home. I will continue to explore the Solar Panel possibilities to energize a portion of my home because I do have a perfect location available. 

            Financial elements of the projects we viewed are harder to analyze because the additional data and time were beyond the scope of meetings. But a few points I enjoyed hearing were Liberty’s emphasis on all cost in relation to rentable square feet. I know that this is prominent in commercial real estate, but I was reminded to sharpen my skills of comparable costs per RSF. Too often I think of total costs figures. It was also interesting that Brian noted that there was a $10-15 PSF premium on the foundation expense due to the poor soil condition that included surcharging. 

            An important point we heard is the critical involvement of the government, and the required power of influence, politically, by the developers. Liberty Property Trust would not have had the ability to develop the Navy Yard nor the Penn. Hospital building without government support. The Philadelphia Industrial Dev. Corp. and the Philadelphia Industrial Authority of Development were critical players in the financial feasibility of the project. It essentially allowed public funds to be used during the lengthy initial phases, protecting Liberty from lost opportunity cost and cash flow/TVM issues. For the hospital, the air rights and the design’s ROW intrusion would not have been possible without the Redevelopment Authority and local government support for city ordinance changes. Tower Investments took the perspective of being a large donor to local politicians, and wanting them to ‘stay out of his way’. I can imagine that his hoped-for casino project is going to take a great deal of political influence.

            I also enjoyed hearing the Erdy McHenry Architecture’s perspective on working with the developer on their goals and designing from the inside and moving outward. This allows the exterior to be dictated for the most part and both parties to be on a more common ground as the exterior is finalized instead of opposition. This opposition between architects and developers is all too common and a detriment to the industry. The success or failure of either has an effect on both. The monetary benefit in picking the right architect was perfectly illustrated by the unit layout creating dual exterior views, minimizing common hallways, and allowing 35,000 sq. ft. to be saved and reused in a separate office building. 

            One of the major reasons I am in the MRED program is to learn more about design and eco-friendly construction features. The Philadelphia trip coincided strongly with this aspect of the program, and I am impressed with the quality of professionalism we were exposed to on the trip. The field studies will prove to be an invaluable facet of the MRED program. 

Written by Josh Lowder, CCIM MRED, 2012

Boston Site Visit: WGBH Public Radio

The visit to the WGBH public radio & television studios on the first day of the field study gave some fresh takeaways for future projects. Most importantly, the need to understand and plan for alternative uses by a facility. A large portion of the studios revenue now comes from event rentals, spanning from Bar Mitzvahs to Fund Raisers. A high-end screening room necessary for the stations core business function can be leased for shows, presentations, and the film & sound needs secondary or primary. There is a large foyer with projectors, serving stations, lighting, and sound - all of which served core functions and event needs. The loading docks were located adjacent to the catering kitchen and serving space, and the electricity needs for the cooking ovens where provided on the docks themselves, allowing for unloading and immediate hookup. This ease-of-use has made WGBH a caterers top choice, therefore recommended by all event planners. In addition, the building gave good, hands-on examples of LEED materials and methods, which also added to the “wow” factor for use as an event space. The preplanning for audio, video and plumbing modifications enhanced the flexibility of the space. Sound & Film could be recorded from almost every location in the building. Each film studio had plumbing needs just in case there was a “cooking show” or other need. Without this preplanning the future retrofits costs would have made most of this impossible. 

Written by Josh Lowder, CCIM MRED, 2013