In the 1990s I worked with USWEST (now Qwest) Communications in a major effort to create better communications between management and union workers. At the outset, relations were hostile, distrustful, dysfunctional, and in many cases counterproductive. Management and the union, however, were seeking to form a mutually supportive partnership. But realizing even tiny steps toward that end seemed next to impossible. Our first task was to identify the “what’s in it for me” part of the assessment process. Our campaign— we dubbed it “Bridging the Gaps”—lasted about two years and shaped some of the material in this book. The key lesson was this: For this proposed partnership between management and the union to work, interdependence would be key. Having one group dominating the other would kill the relationship.
Management first had to find out what the union’s needs were. Through months of research—involving questionnaires, interviews, focus groups, feedback sessions, and so on—many needs were identified, clarified, and communicated. In the same way, union members learned more about the management side of the business—about dealing with economics, competition, regulation, and shareholders. Discovering what each party needed from the other was enlightening.
Histories of indices will be used by investors and their consultants to formulate strategic allocation policies. Asset allocators and academics also have an interest in long data histories when building allocation models. The asset–liability modeling exercises that many pension funds and insurance companies now undertake on a regular basis to review strategic benchmarks, all tend to use historical volatilities and covariances that are derived directly from index histories. There may be some advantage to investors in using the same index for the ongoing fund management benchmark as that used in the prior modeling exercise.
Conflicts of interest can only damage the standing of an index. Suspicion surrounding the motives of interested parties is almost as bad. The involvement of investment banks in index compilation tends to create such suspicions, particularly around constituent review time. Most bond indices are proprietary indices that use trader pricing. Thus they are susceptible to be biased by the positioning of the trader. For short positions, for example, the trader has an interest in pricing the bond on the lower end of the market.
Even the absence of positions on the trading book can distort an index, because those bonds are not marked actively. Indicative prices are highly susceptile to be erroneous. Hence, indices that are owned by exchangesor rely on the pricing of more than one investment bank are more likely to be accepted as independent. Especially among institutional investors the iBoxx index family has attracted a lot of interest, because it relies on pricing information of seven investment houses.
Capitalization rate? I know you’re thinking this is starting to sound complicated; definitely third-year college accounting. Well before you close the book, allow me to explain. First, it sounds way more complicated than it is. In numerical terms, the capitalization rate is the net operating income divided bv the purchase price:
Capitalization Rate = Net Operating Income -T- Purchase Price
So now you’re thinking, “Ken, how can I calculate the capitalization rate when I don’t have a purchase price yet? That’s what I’m trying to figure out through this whole exercise after all. Don’t tell me algebra is involved!” No, algebra is not involved. This is actually really easy. The purchase price here is actually the purchase price trends for a comparable building in your market. So this very complicated sounding word is actually something you can get very easily from brokers, real estate agents, or even the pro forma document for the property. The people in the business—your team members—will either know the capitalization rate for your market or help you calculate it, and that’s all there is to it.
Regardless of whether you will be using a property management company or not, calling one to visit the property and help you assess everything involved in running the place is a good idea, particularly if you are looking at a multi-unit building. Just call and say, “I’m looking at buying an eight-unit building, and I’m not sure if I want to run it myself or hire a company to do it. I’d like to show you the building and talk with you about it.” The hour or so you spend with the property management representative will be a good investment of time. And if you have to pay that person an hourly consulting fee, it’s worth it. Make the objective of the meeting twofold. First, you’ll want to learn what it will take to run the property, and second, you’ll want to get insight on how to minimize expenses.
At this point, we have verified the actual potential income for the pr< >pcrty. Remember that’s the income the property could generate at current rents with 100 percent occupancy. But certainly, it is highly unlikely that this property is or will be 100 percent occupied every day of every year from now until eternity. So we have to take into account vacancy and turnover from residents moving in and out. And while we’re at it, we should consider any other income generated from sources like laundry facilities, parking, and so on.
The typical pro forma lists these values as well. And surprise! these numbers, too, I have found to be inaccurate most of the time. Vacancies are usually understated and other income is usually over-inflated. The key here is to try to project what the vacancies and other income will be in the future. It’s nice to know where you’ve been, but where you’re going is really more important. That’s why the windshield is so big and the rearview mirror is so small.
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