The financial evidence supporting the return on investment for wellness programs is growing. Recent studies show that the medical care costs for people with chronic diseases account for more than 75 percent of the nation’s total medical care costs. In addition to incurring the direct costs of higher premiums, employers lose more than 39 million employee workdays each year just due to obesity-related illnesses. For example, according to the Centers for Disease Control and Prevention, people with diabetes lose 8.3 days per year from work, accounting for 14 million disability days compared to 1.7 days for people without diabetes.
Perhaps the most impressive statistic of all is the ROI achieved by employers who invest in employee wellness programs. According to Michael Pondrom, employee benefits specialist with Westland Insurance Brokers, on average, employers are saving between $1.50 to almost $5 in premiums for every dollar they invest in these programs. The key to actually realizing the savings is getting employees to act.
“True employee engagement results from increased focus on communication and, perhaps more importantly, incentives,” Pondrom says. “Since half of Fortune 500 companies offer wellness programs, it’s perceived to be a luxury that only large employers can afford, but fortunately, it’s possible for mid-sized employers to also offer this benefit without significant expense by outsourcing the design and administration of the program to an insurance broker.”
Smart Business spoke with Pondrom about how CEOs can achieve a next-level employee wellness program without the associated costs.
What evidence exists that CEOs will achieve ROI by investing in employee wellness programs?
For starters, more than 80 percent of chronic disease is preventable. So if employers can help to prevent the disease, they prevent most of the related direct, or hard, and indirect, or soft, costs. As an example, all of the research I’ve read indicates that an employee who controls his or her diabetes costs an employer only $24 in monthly health care premiums versus $115 in premiums for diabetic employees who don’t control the disease.
What constitutes a next-level employee wellness program?
Taking your wellness program to the next level of engagement is really a three-step process that can be facilitated by your insurance broker: Identify the risks, educate your employees and, most importantly, offer incentives.
The first step is to review the potential risks posed by the specific demographics of your employees. The most efficient and accurate way to accomplish this would be to first review your company’s claims data for clues. As an example, in reviewing the claims data for one of our clients, it became evident that they had an above-average incidence rate for cardiovascular-related claims among employees. As a result of the findings, we scheduled an on-site health fair for the employees, offering free screenings for early signs of cardiovascular disease through a specialized cardio-assessment firm. Many employees were unaware that they were at risk for cardio disease, and the screenings provided them with both the information and the incentive to take action and to make lifestyle changes.
Broker-coordinated health fairs are also an excellent avenue to reach out to those employees already diagnosed with a disease who just need information on how to enroll in a program.
How does employee education play a role in achieving engagement?
Education is an ongoing and critical element in any successful wellness program. There are numerous sources of free information that help employers achieve awareness among employees. The goal is not only to educate your employees on what programs are available, but also on how to use them and the advantages of using them. Your insurance carrier and broker can provide brochures, posters, online information sources, payroll stuffers, newsletters and nurse hot lines. Most of the materials are free; all you have to do is request them from your broker.
How do incentives drive employee engagement?
It’s vital that employers offer no-cost or low-cost incentives to incite employee lifestyle changes. Some employers are providing subsidized on-site healthy lunch programs or discounted gym memberships. I’ve seen very effective programs that pay employees as little as $1 for each pound of weight they lose. Like any incentive program, the plan must be well communicated and reinforced in order for it to work.
Which employee wellness program elements can be outsourced and what does outsourcing cost?
Your broker can implement and administer an employee wellness program that will not only provide all of the necessary employee education and on-site health fairs, but brokers can design, implement and coordinate low-cost or no-cost employee recognition and incentive plans free of charge. An employee walking club is an example of a zero-cost program that your broker can organize for you; low-cost programs that engender employee engagement include bonuses for weight loss and personalized coaching programs that average $4 per month per employee. All employers can impact their bottom line by driving employee engagement toward wellness, and it doesn’t require any additional internal staff time when they outsource.
MICHAEL PONDROM is an employee benefits specialist at Westland Insurance Brokers. Reach him at (619) 641-3241 or email@example.com.
At one of our recent events, Steve Demetriou told our audience that if he is spending a lot of time with his direct reports, then he has the wrong people in those positions.
Demetriou, chairman and CEO of Aleris International Inc., a $5 billion metals company, really struck a chord with that comment. While it may seem that the role of the CEO should be to spend a lot of time with his or her direct reports, that’s not really the case.
If you are spending a lot of time managing your management team, who’s working on the major strategic issues facing the company?
It’s always tempting to jump into the fray and solve day-to-day problems, particularly in the parts of the business where you have a lot of experience. If you came up through the ranks on the sales side, there will always be the temptation to meddle with sales and get things done the way you used to do them. But now you have someone else that’s in charge of that function, and you need to let that person do it his or her way.
There’s always a time and place for the CEO to get involved in the details, but these opportunities need to be chosen carefully and should produce maximum results.
This goes back to Demetriou’s comment. If you are spending a lot of time with a particular department head to straighten things out, then you probably have the wrong person running that department. Short-term fixes are fine, but if it’s a regular occurrence, you need to think twice about what is going on.
You also have to give your key people the wiggle room to get the job done. Give them the parameters in which to operate, then get out of their way.
The great American general George S. Patton is credited with saying, “Never tell people how to do things. Tell them what to do, and they will surprise you with their ingenuity.” Sure, you hold them accountable for results, but if you find the right people to begin with, then you don’t need to be managing how they manage others. CEOs have their own role to play within the organization.
Some like to spend more time with their front-line people who are closer to customers to stay current on trends and specific needs. Some like to talk to customers directly to make sure the product and service offerings are relevant in a changing market. Others like to tweak long-term plans and spend time refining the corporate vision.
The point is, no matter how you prefer to be spending your time, if you have the right people in your key positions, then you will have more time to focus on the things that are most important for the long-term success of your company.
So if you find yourself spending a lot of face time with your direct reports, you have to ask yourself two questions: Am I micromanaging these people? And, is this the right person for the job?
If the answer to the first question is yes, then it’s a matter of trusting them with the responsibility and the authority to get the job done and hold them accountable to that. If you aren’t micro-managing them but you’re still spending a lot of time with them fixing problems, then it might be time for evaluating whether you have the right people in your most important positions.
Ultimately, if you’re having to do their jobs, then who is doing yours?
FRED KOURY is president and CEO of Smart Business Network Inc. Reach him with your comments at (800) 988-4726 or firstname.lastname@example.org.
Sometimes numbers don’t add up. The San Diego housing market has been slumping, with housing starts down, residential builders closing their doors and scores of mortgage industry workers enduring layoffs. The application of basic economic principles to this scenario might suggest that commercial construction costs would be declining in the near future.
“The reality is that, while the residential market is down, there’s so much commercial and municipal construction going on in San Diego County that the cost for build-outs has continued to rise,” says Kirt Gilliland, senior vice president of project management and principal, Irving Hughes.
Smart Business recently spoke with Gilliland about San Diego’s rising construction costs and how they impact commercial leasing, our cost of living and Southern California’s future growth.
How do increased construction costs affect commercial leases?
The reality is that the cost of construction materials is driven by the international demand for basic construction materials like fuel, concrete and steel. Locally, the cost of living drives the cost of wages that contractors and subcontractors have to pay, whereby San Diego is still one of the most expensive markets in the country. As we’re negotiating new leases, construction costs continue to rise. Since some amount of build-out costs typically are amortized in a lease, the instinct is to want to ask for less tenant improvement money to lower lease rates, but it’s not that simple.
Why isn’t the housing slowdown cooling commercial construction costs?
There’s so much commercial and municipal construction going on that many of the housing subcontractors have simply been absorbed into these other environments. San Diego County’s adjoining suburban markets Vista, Escondido, San Marcos, Chula Vista and others are going through huge growth, building retail and commercial projects. Additionally, public entities, such as city governments and redevelopment agencies throughout the county, are all undertaking large projects. In National City, there’s been a proposal for a new sports facility for the Chargers, and they’re considering a new billion-dollar convention center, so the pipeline of work doesn’t have contractors concerned.
Add to all of that the work on Interstates 15 and 125, the ongoing hospital modernization projects and huge projects at nearly every college or university, and it’s easy to see why the demand for builders has not diminished. If you’re a pool installer, you may have seen a slowdown, but if you’re in concrete, framing, drywall installation or plumbing, you don’t care whether you’re doing a residential or a commercial project. There’s enough commercial construction out there now for workers.
What factors are driving the increased costs?
Increased costs include higher fuel costs, rising consultant fees, public improvement fees and ‘green’ requirements. Fuel costs not only impact the manufacturing of materials, they ripple their way through everything. Materials, equipment and workers have to be transported, so when gas prices increase, contractors are forced to pass the increase along to the end users.
Consultant fees are also on the rise for the first time in several years. There is now such a shortage of quality architects and engineers that most firms in town are scrambling to hold on to their good people or find good people. The higher salaries used to attract and retain these workers are then passed through to the corporate tenants and landlords hiring these firms.
Further, since government agencies have less money for public improvements, when people apply for building permits, the agencies are saying, ‘Great! No problem. You can have a building permit, but you have to pay to upsize the intersection, modernize the stoplights and add a merge lane onto the freeway.’ These are huge costs, and they get passed along to consumers or whoever is building the project.
What are ‘green’ requirements?
It is a general term for items like energy efficient equipment, the use of renewable resources and the process by which waste is recycled. We’re finding more clients that want to be somewhat green and do their part to combat global warming. These requirements add from 1 percent to 10 percent to the cost of a project, but they’re willing to pay the dollars to have these things done. Some of the green add-ons do have a payback, like solar energy systems that generate electricity and reduce utility bills.
How is San Diego’s cost of living impacting construction costs?
The cost of living in San Diego continues to rise and this affects wages and, ultimately, the cost of labor to install materials and equipment. There also is a shortage of labor here in town because people don’t come to San Diego for entry-level construction work. They can work someplace else and make the same kind of money without the high cost of living. In order to keep their best employees, contractors are raising their prices to retain workers.
How will this cycle play out?
I don’t see things changing any time in the near future. Some people are talking about the economy crashing, but in the last election, we approved several billion dollars worth of bonds for public improvements and construction. Just because there’s a housing slowdown doesn’t mean people aren’t being born here and moving here. As long as our population is increasing, there is going to be a demand for construction.
KIRT GILLILAND is senior vice president of project management and principal for Irving Hughes. Reach him at (619) 238-1518 or email@example.com.
There is growing concern about interest rate volatility and with good reason. A number of factors, including housing concerns, subprime issues and inflationary pressures, are pointing towards a period of volatility for interest rates.
Interest rate risk is the monetary exposure companies are faced with due to fluctuations in interest rates. When interest rates change a company’s floating rate debt is impacted, which can lead to unexpected increases in interest expenses.
“Since interest rate volatility is a certainty, companies should be concerned with managing this risk because of the effect on future cash flows,” says Chris Ramos, corporate banking officer of Comerica’s Western Market.
Smart Business spoke with Ramos about interest rate risk, how it can best be managed and the benefits that interest rate swaps provide.
How can a company best manage interest rate risk?
First, companies need to assess the impact on cash flow if interest rates were to rise and their tolerance to this risk. For example, a large company with significant cash flow relative to the amount of debt it has may be able to absorb, to a larger extent, the impact of rising interest rates. However, a highly leveraged company is going to be extremely sensitive to even a slight increase in interest rates.
Regardless of the level of risk tolerance, companies should evaluate which financial tool may be best suited to limit this risk and not only minimize the impact on cash flow, but also maximize the predictability of future interest expense.
What specific kinds of mechanisms are available?
Three commonly used mechanisms, aside from the traditional fixed rate loans, are interest rate caps, interest rate collars and interest rate swaps. Interest rate caps limit the cost of floating rate debt for an upfront fee while maintaining the benefit of a drop in interest rates. Interest rate collars combine a cap and a floor on interest rates for potentially zero cost, depending on where the maximum and minimum levels are set. Interest rate swaps essentially provide a fixed rate of interest on floating rate debt.
What benefit does an interest rate swap provide?
The primary benefit of an interest rate swap is that there is no cost to establish it, and it provides a fixed interest rate, eliminating the impact of rising cost of funds and enabling companies to better forecast their interest expense. Additionally, interest rate swaps are extremely flexible and can be structured to match any portion of the underlying floating rate debt.
How does this differ from a fixed rate loan?
It is, in fact, very similar to a fixed rate loan except that it is actually a combination of two separate agreements: a floating rate loan contract and an interest rate swap contract. As the interest rate on the floating rate loan fluctuates, the nominal cost or benefit associated with those fluctuations is offset by the nominal cost or benefit that results from having the interest rate swap contract.
Since the floating rate loan is a separate contract, there is no prepayment penalty for paying off the loan early. The interest rate swap contract can then either be used to hedge other outstanding debt or be cancelled.
What happens if the interest rate swap contract is cancelled?
If interest rates have fallen, then the contract is considered to be ‘out of the money,’ and the cost to unwind the contract is the market value loss, which is typically significantly less than a prepayment penalty on a traditional fixed rate loan. If interest rates have risen, then the contract is considered to be ‘in the money,’ and the owner of the contract may actually receive money for unwinding the interest rate swap. In this scenario, the borrower is actually paid for paying off the loan early.
CHRIS RAMOS is corporate banking officer of Comerica’s Western Market. Reach him at firstname.lastname@example.org.
Prior to 1978, buildings and property in California were assessed each year based upon their fair market value.
Proposition 13 stopped that.
Approved in June 1978 by 65 percent of the California voters, Proposition 13 enacted Section 2 of Article XIIIA of the California Constitution and provided for a property acquisition value assessment system.
Under the revised system, property values are assessed upon market value when there is a change of ownership or by new construction. Thereafter, the taxable value of property can increase annually by no more than the rate of inflation or 2 percent, or whichever is less. The current tax rate fluctuates statewide between 1 percent and 1.2 percent.
“The biggest injustice of Proposition 13 to office market tenants is the real estate tax pass-through,” says Craig A. Irving, principal, Irving Hughes. “If your company moves into a building with a low tax basis and that building sells later at market, you’re exposing the company to a potentially huge increase in occupancy costs.”
Smart Business asked Irving to illustrate some of the facts about real estate tax pass-throughs and the devastating effects they could potentially have on office space lessees.
How are lease costs determined?
Typically a tenant signs a lease for a defined period of time three-, five- and 10-year leases are most common. The first calendar year of the tenant's occupancy determines the base year for the operating expenses the landlord pays, and each subsequent year, the tenant pays additional rent for any incremental increases in expenses over the base year aggregate.
So as the cost of supplies, insurance, janitorial contracts, electricity and other maintenance expenses rise, the landlord passes those increases directly to the tenant. This is an inflationary hedge by the landlord. Never mind that a landlord likely collects 3 to 4 percent increases each year in the base rent and possibly parking revenue.
What is causing a large area of exposure for office tenants?
We represent tenants in office leasing and protect them in as many financial areas as possible. Rent and tenant improvements are the primary areas of focus for most tenants and brokers, but financial pitfalls lurk in many other areas of a lease transaction. None is more dangerous than the real estate tax pass-through.
How do real estate tax pass-throughs come into play?
Tenants pay rent and provide landlords the revenue to pay expenses, the mortgage and, in most cases, a return on their investment. Tenants, and the rent they pay, create the value in the buildings they occupy. The real estate tax pass-through creates a huge exposure for tenants because, under Proposition 13, every time a building is sold, it is reassessed for real estate tax purposes. The new value, and the new incremental tax base, gets passed directly through to the tenants. With buildings selling for higher and higher prices these days, tenants are getting hammered with significant real estate tax pass-throughs.
Can pass-throughs cripple an organization?
Here’s an example: Let’s assume a tenant signs a 10-year lease in 1999 for 20,000 square feet. The tenant receives a 1999 base year for operating expenses that totals $10 per foot per year in costs to operate the building, including property taxes of $1.80 per year based on an assessed building value of $150 per square foot. The fact that this tenant signed a lease for 10 years increases the value of the building and, five years into the lease, the landlord gets an offer to sell the building for $400 per foot. The seller makes a fortune and never looks back.
The new assessed property tax value after the sale is $4.80, and the difference between the base year assessed value and the new value is $3 per year, or 25 cents per square foot per month. This difference is now passed on to all the tenants in the building. In our example, the tenant will have to start paying an additional $60,000 per year for the remaining five years on the lease. This significant impact on the tenant's bottom line was probably never anticipated or expected.
What can be done about this?
Almost nothing. Proposition 13 tax protection is rarely negotiable unless a tenant has a lot of leverage from occupying a significant portion of a building, has exceptional credit and is in a tenant-favorable market. When weighing different options in the market, it’s important that tenants understand the cost basis of each building they are considering. Cost basis varies from building to building and submarket to submarket. A contingency must be considered if, on the surface, two buildings offer the same economic package, but one building has half the basis as another and Proposition 13 protection is not available. Tenants must understand the potential downside cost in the event their building is sold out from under them.
CRAIG A. IRVING is a principal at Irving Hughes in San Diego. Reach him at (619) 238-4393 or email@example.com.
Are you in touch with your company’s culture? If you’re considering a career move, are you taking into account that organization’s culture?
“Organizational culture is comprised of the assumptions, attitudes, experiences, beliefs, values, norms and tangible signs of the organization’s members and their behaviors,” says Dana Gibson, Ph.D., CPA, president of National University. “From organizational values develop organizational norms or guidelines that prescribe appropriate behavior by employees.”
During the interview process and upon joining an organization, a person will quickly sense the particular culture.
Smart Business asked Gibson how important it is to identify and fit in with an existing corporate culture.
Do executives place enough emphasis on corporate culture?
Most high-level executives understand corporate culture, but many are not convinced of its impact on their job. Studies indicate, however, that culture does indeed have a huge impact on an organization. Popular business books reinforce this. In his book ‘Good to Great: Why Some Companies Make the Leap … and Others Don’t,’ Jim Collins identifies one of the qualities of a great company as a strong culture. In their book ‘In Search of Excellence,’ Peters and Waterman note that a key to high performance is culture. In a study of some 200 companies over 11 years, Kotter and Heskett found that a strong sense of corporate culture is an indicator of stronger financial performance. The research is highlighted in their book, ‘Corporate Culture and Performance.’ Executives who don’t recognize the importance of culture will undermine their own effectiveness and that of the entire organization.
If preparing to transition, how can an executive evaluate the culture in the organization he or she is considering?
There are many listening and observation tactics that can help you determine the dynamics of an organization. During the interview process, look around. Look at the clothing, the types of furniture and how it is arranged, the facilities the cafeteria, the boardroom. Listen to the stories the people tell and the experiences they brag about. What are their rituals? What types of symbols e.g., the Mary Kay Pink Cadillac do they value? Review the reward systems, the employee orientation and training documents. Is there a formal or informal hierarchy? Is it in line with your personality and style?
How can the executive determine if he or she fits in?
If you’re a hierarchical person trying to blend into an entrepreneurial type of company, it’s probably a mismatch. Understand your leadership style and organizational personality. What type of organizational dynamics are you comfortable with? On the other hand, there are situations where a board wants to bring in someone with a different style to move the organization to a different place. Senior leadership is responsible for strategy, and it’s almost impossible to achieve strategic goals without a culture that is aligned. If an executive is being brought in to lead the company in a new direction, it will require deliberate effort to change the culture.
What happens when it’s not a good fit?
We’ve seen several high-profile media stories of CEOs who have had to step down. It happened with Carly Fiorina at HP and Bob Nordelli at The Home Depot. In certain scenarios, the culture is so firmly entrenched that it would be near impossible to change direction. For example, if the Ritz-Carlton, which has been focused on the customer for many years, were to try to shift its focus to cutting costs, the employees might not budge. When culture is good, the organization stays on track. If it has to change, top management must clearly understand what needs to be done.
Do corporate cultures change?
Cultures develop over time. In most cases, organizational culture ‘grows up’ over the years without a plan; other times, the direction is very deliberate. Often, the culture is a reflection of the original founders and is very ingrained. Can it change? Absolutely. However, be cautious. There are numerous examples of failures. The most successful changes have resulted from long, deliberate efforts on the part of the senior staff. Some organizations try a revolutionary approach rather than an evolutionary approach. It can happen that way, but that scenario usually involves a lot of turnover although, in some cases, that is the intention.
Obviously there is no one key to success. The advice would be to 1) set the mission and values and determine how they target culture, and 2) identify/build in symbols, training and rewards and communicate what is important to the organization.
Culture doesn’t change overnight, but it doesn’t have to take years. It depends on how strong the culture is and what type of shift you want to achieve.
DANA GIBSON, Ph.D., CPA, is president of National University, La Jolla, Calif. Reach her at (858) 642-8802 or firstname.lastname@example.org.
“I can’t believe this has happened to me,” said Steve, a young man whom I had been mentoring. “I never intended for my boss to find out this way,” he said with real anguish as we sat in my office late one night.
For several months, Steve had been questioning whether his current job was still a good fit. He had an important position, as well as a supportive relationship with his manager, who had invested heavily in him during the past two years. Steve’s loyalty to his manager had him torn about whether to explore other opportunities within his company.
In our last meeting, Steve decided that his intention was to stay in his current job and that if he chose to explore other positions in the future, he would first discuss it with his manager because of his loyalty to her. At least, that was the plan.
But in the weeks that had passed since that meeting, Steve began to have casual conversations about a position in another group at his company. As his interest grew, he sought out several people in that group and asked them to quietly recommend him to their manager. Steve also recruited a friend outside of work who knew the manager to send a recommendation, along with a copy of his resume.
It wasn’t surprising that all of Steve’s actions became known when the manager of the other group eventually called Steve’s current manager. It also wasn’t surprising that Steve’s current manager felt betrayed, not by Steve’s interest in the position, but by the way he had chosen to approach it.
The only real surprise was Steve’s sincere astonishment as he said over and over, “I can’t believe this has happened to me.” I wanted to grab him by the shoulders and shake him. It was obvious that Steve’s actions had made this outcome inevitable from the moment he began discussing the new position. Now, he sat in my office knowing that, at best, he had damaged an important relationship and, at worst, may have lost his job.
Have you ever experienced an outcome that was radically different than what you intended?
With every action you take, you define the path of your life. And every path has a trajectory toward a certain outcome. While it’s important to know what you really want in essence, to have a clear destination it’s far more important to ensure that the path you’re on will take you there.
If you want to become a trusted and respected leader in your team at work, examine your path. Are you completing every assignment with real excellence? Do you support and encourage the people on your team who are struggling? Can your teammates trust you?
If you want to become a loving and engaged parent or spouse, examine your path. Do you create time every week for the people who matter most? Do you regularly tell them how much they mean to you? Are you there when they need help?
It’s easy to focus on the illusion of who you intend to be and to miss the reality that the choices you’re making every day are leading to a completely different outcome. Like a person who talks of driving north while consistently heading south, if you’re not careful, you will trade in what you want most in life for what you choose to do in each moment.
Make a list today of the five most important things you want to become, such as a thoughtful spouse, a trusted friend or a successful leader. Now, beside each item, write five actions you took in the last week that are helping to create this outcome. Complete the exercise by listing any actions that took you away from these outcomes.
If you’re honest with yourself, the results of this simple exercise will show you the path you’re on and where you need to change.
In the end, it’s your actions, not your intentions, that determine your destiny. Choosing actions that align with your intentions will enable you to become the person you want to be and to create a life that is truly extraordinary.
JIM HULING is CEO of MATRIX Resources Inc., an IT services company that has achieved industry-leading financial growth while receiving numerous national, regional and local awards for its values-based culture and other work-life balance programs. The company was recently named one of the 25 Best Small Companies to Work for in America for the third year in a row by the Great Place to Work Institute and the Society for Human Resource Management. In 2005, Huling was awarded the Turknett Leadership Character Award for outstanding demonstration of integrity, respect and accountability. Reach him at Jim_Huling@MatrixResources.com.
The real estate market’s effect on businesses, big and small, is undeniable. When San Diego sees major changes in affordable commercial space, the economic impact is far-reaching.
“Building sale prices are at historic highs, as are asking rents, but the leases we are getting done haven’t changed much, materially, from 2005 and 2006,” says David Marino, principal with Irving Hughes in San Diego.
Smart Business discussed with Marino the causes and effects of the spike in local commercial real estate building sale prices.
What has been driving the record-high sale prices of commercial real estate?
Fundamentally, there is too much money chasing a fairly fixed supply of assets. After the Internet bubble of 2000, institutional investors allocated more money into real estate, which is a hard tangible asset. There has been a flood of capital through pension funds, private equity groups and REITs [real estate investment funds] that has driven the supply of capital out of balance with the asset base’s supply, and institutions rightly bet that commercial real estate was undervalued. Fueling the fire, commercial real estate sellers then reinvest in new assets at inflated prices through tax-deferred exchanges to defer paying capital gains taxes.
We have a financial engineering environment in commercial real estate. REITs have been gobbled up by private equity groups, whereby the assets are then broken up into smaller asset sales where the parts are more valuable than the whole. Most of the buyers of these parts are then other REITs and institutional buyers. In a market of high leverage and low cost of capital, owners are trading on the razor’s edge of cap rates to generate returns through flipping assets rather than operating them. Most of the buyers are from out of town and generally don't understand the market. But it turns out they don't have to, since they turn around and sell the asset to someone who understands the market even less.
Other than the supply of capital, what is the rationale of these buyers paying such premiums in San Diego?
The argument is that San Diego is running out of developable commercial land, but I have been hearing that for my entire 18-year career. Someone could say New York City is running out of land, but that has been the case for 100 years and there have been wild swings in asset value over that time. Also, buyers and their brokers argue that San Diego has macro-level job growth and population growth as well as a diversified economy. But most of that job growth hasn’t been in industries that occupy office space, so the translation of jobs and population to the demand for space is relatively weak. They also argue that rents are relatively lower in San Diego than in other major markets around the U.S., and investors believe there is room to push for rent increases. However, with the cost of labor, taxes, gas and living in San Diego, rents need to be affordable for tenants so that businesses will continue to start and grow in San Diego. Shockingly, some of these investors are putting 10 percent annual rent inflation in their pro formas.
Do you see the landlords getting these inflated prices?
No, but they have to build a pro forma that justifies hyped-up purchase prices. The reality is that virtually none of these landlords is making money on the cash flows from commercial real estate. They are buying with huge leverage and low-cost financing and then selling at a profit a year or two later. It's sad to me that many of these investors really don't care about the tenants or the tenants’ businesses or about putting capital into the buildings to make them better facilities.
One of the most painful effects of this buying and selling is that the tax basis becomes reassessed to the new value, and that tax increase gets passed right through to the tenants. Existing tenants have been hit with unexpected and nonbudgeted tax increases ranging from 30 cents to 60 cents per square foot per month. In the short term, tenants are paying for this buying and selling game, but in the long term when those tenants renew with new base years, or move and get a new base year, the owners are going to have to stomach those former pass-throughs, and landlords aren’t going to be able to build those higher tax costs into their new rents.
But wouldn't overall higher costs of buildings and taxes for the landlords mean they have to charge more, and that they would get it?
The capital markets for real estate are acting independently of the leasing market. The reality is that there has been virtually no net absorption in any submarket in San Diego in over a year, with the exception of Del Mar Heights, and that the market is stalled. All of these new buildings you see being finished are raising vacancy rates, and supply is beginning to exceed demand. Aggregate sublease space across all product types has been rising for more than a year, topping 4,800,000 square feet, which is the highest level we have seen in three years, and presents tough competition for landlords going into 2008. Meanwhile, landlords in lockstep, propped up by the brokerage community, are raising asking rents all over town. There is no economic supply-and-demand basis in reality for rents rising in an environment like this, but landlords and their outsourced sales and marketing departments the brokerage community are all trying to make it happen.
DAVID MARINO is a principal with Irving Hughes. Reach him at (619) 238-4393 or email@example.com.
Business owners often have much of their life and their savings invested into the properties they own, making it crucial to have the proper insurance coverage. A disaster that results in a partial or total loss of a property can result in major debt or bankruptcy for an owner.
While there are numerous ways to insure real property, all business owners can tailor their coverage to their own specific needs. The key to ensuring you have the proper coverage is to determine the value of a structure, says John Dorris with Westland Insurance Brokers.
Smart Business spoke with Dorris about different types of coverage and how business owners can find the type that works for their needs.
What is the first step business owners should take when insuring real property?
A business owner should be insured to value. This is the first step in ensuring you get indemnified to the full replacement cost of your structure.
Many insured’s don’t realize how much it costs to rebuild their property in case of a total loss. If a fire strikes your building, you may have to replace the entire physical structure. At times, this is more than the market value price of a structure, specifically on older buildings.
Can business owners receive full replacement cost?
Yes, and they should expect it. But business owners shouldn’t rely on insurance carriers to determine their building’s replacement costs. It is important for business owners to talk with their contractors, lenders, insurance broker and insurance company to get information on current day rebuild costs. Insurance brokers have access to many resources that assist in determining a property’s value.
What types of policy clauses should owners discuss with a broker?
Agreed value: Many policyholders like agreed value because it takes the guesswork out of what will be paid on a claim. Agreed value is an agreement made between the insurance company and policyholder that the limit of insurance listed on the policy is that buildings value, and that agreed upon value is what will be paid in the event of a total loss. Another advantage is that coinsurance is suspended.
Coinsurance: While some policyholders would like to avoid coinsurance, it is by no means a bad policy clause. Again, it depends on the needs of one’s company. Coinsurance is simply a policy clause that requires property to be insured at a specified percentage of its full value (usually 80 percent, 90 percent or 100 percent) in exchange for a pricing credit. However, if there’s a loss and the client has inadequate limits, the claim payout will only be a percentage of the total loss amount.
While these are just two examples of policy clauses to review, they show why it’s imperative to know your buildings value. When you do, you can make prudent decisions on how to insure it. Whether you chose an agreed value scenario or a scenario with coinsurance, you’ll feel comfortable your real property will be replaced without paying more than the deductible.
Is there a specific coverage that you would like business owners to contemplate?
Ordinance of law coverage: Ordinance of law is one of the most needed types of insurance coverage, but one of the most commonly overlooked. As your real property becomes older, building codes in your county are updated to reflect new standards for construction. In many instances, business owners don’t elect this coverage because they don’t think ordinance changes will affect them. As always, the problem comes after the loss.
Ordinance of law has three parts to it: demolition of undamaged portions of the building, increased cost of construction and debris removal after demolition. A structure may have been built in 1971 when the building code allowed for aluminum wiring, but in 1975 the building ordinance was upgraded to call for the same building to have copper wiring. If the policyholder has a fire loss that destroys half the building, he may be required to tear down the entire building and upgrade everything to current code. Since complying with this code requires a change in design and building materials, the additional costs for labor and materials will be substantial. Building owners who don’t purchase this coverage may find themselves paying hundreds of thousands of dollars to rebuild. So, for a minimal premium there is a substantial benefit when an insured purchases ordinance of law coverage.
Is proper coverage often overlooked?
It is not overlooked as much as neglected. Insurance buyers may not understand the importance of reviewing these limits on an annual basis. As we’ve seen in so many claims scenarios, business owners believe they’re insured properly only to find out after a loss that they’re underinsured. It is crucial to sit down with your insurance broker prior to renewal and review the current insurance program.
How can a business owner find the best insurance provider?
When looking for an insurance provider, business owners should choose an insurance carrier that focuses on their industry, tailors their policy forms to protect that industry, and offers risk management services to assist the policyholder in protecting their property as well as their business as a whole.
JOHN DORRIS is a commercial insurance broker with Westland Insurance Brokers. Reach him at (619) 641-3245 or firstname.lastname@example.org.
When Peter Farrell and a team of investors bought the rights to manufacture a medical device designed to solve snoring-related issues, he knew he was going to need a strong entrepreneurial culture in order to succeed.
Farrell helped develop the device while serving as vice president of research and development at Baxter Healthcare, so he understood the product very well. The challenge was that no one else really understood it or the problem it was supposed to solve.
The early estimates projected that 2 percent of adults might suffer from the condition that would be relieved by the device. But when Farrell launched ResMed Inc., sleep-disordered breathing remained largely unidentified as a medical problem by patients, and recognition of the disorder was nonexistent within the tough-to-convince physician community.
In classic marketing terms, Farrell, who serves as the company’s chairman and CEO, had to create the need for the product before he could meet the need through sales of the device.
The only way to do that was by establishing an entrepreneurial culture where everyone understood the product, so that the entire organization could help Farrell solve problems. It also required the establishment of a multifaceted strategic marketing plan that would continually build support and media exposure for the company.
Creating the culture
To help inspire the culture he desired, Farrell and his five founding partners distributed stock options to the staff, from the top of the organization to the bottom, including the employees out on the shop floor. Giving everyone on the team a stake in the outcome established trust and helped the firm attract and retain talent while the company was struggling to develop a market for its product.
“In the early days, trust was the glue that held everything together,” says Farrell. “I was very careful not to overpromise, and I wanted to make certain that people were looked after.
“The culture helped us retain people, and it actually helped us get investors because they knew we would need that type of culture to succeed, and it generated excitement.”
In addition to giving employees ownership in the company, Farrell maintains an open-door policy despite the firm’s growth. He says that hearing messages directly from the staff fosters a non-political environment where everyone feels free to speak up, and in the long run, he’s convinced that, as a CEO, having an open door is a profit-making posture.
“I’d rather get 10 e-mails on the same issue than not to hear about it at all,” says Farrell.
He says that his philosophy has contributed to the firm’s success by serving as the catalyst for directional changes within the organization.
For example, Farrell says that in the early days, the firm was developing a sleep diagnostic system intended for use in sleep labs. One day, a delegation of employees appeared at his office door and announced that after several years of investment, the plan had failed and needed to be scrapped.
“I was continuing to stay with the idea, and the physicians virtually ignored it,” says Farrell. “We must have wasted three to four years developing it, but the employees convinced me that we needed to go in a different direction, and it was the right call. As the CEO, you need to have an open-door policy because you want to find out where the next problem is coming from so you can focus on continuous improvement, and you have to be flexible and listen to your employees.
“I think my experience working for a large company like Baxter really shaped my thinking. In the early days, in particular, we really strove to keep things simple because bureaucracy is a cancer. We really needed to be fleet-footed and focus on outcomes.”
In order for the firm to succeed, it would need to continue to develop new medical devices as well as marketing strategies. Farrell says that he has maintained a lean organizational structure to keep new ideas surfacing and moving quickly through the pipeline.
Hiring for entrepreneurial spirit
Since its beginning with a staff of six, ResMed has grown to more than 3,000 employees worldwide. Sourcing and hiring large numbers of employees who demonstrate both a strong entrepreneurial spirit and the ability to thrive in the corporate culture have resulted from a hiring process that Farrell describes as both an art and a science.
“I like to hire opportunity-seekers who will also get things done in a timely fashion,” says Farrell. “We use the interviewing process, references and checklists to assess for traits like intelligence. I also like people who have a strong sense of urgency and will just go ahead and do something and ask for forgiveness rather than permission, because it’s essential to making progress.”
He says that he prefers apolitical employees for the firm’s candid culture, and he frequently asks candidates if they have ever said that they believed in something when, in fact, they really didn’t, as a barometer of their political nature.
“I also think that checking references and getting copies of transcripts are very important because I won’t hire a candidate who has lied on their resume,” says Farrell. “You can’t fix broken ethics.”
While hiring movers and shakers has been critical to the firm’s success, Farrell is the first to admit that hiring isn’t easy, and he doesn’t always succeed. However, he strongly values education and leads by example because he possesses a doctorate degree. Once he has the employees on board, he supports their development by advocating a continuous learning culture.
Through development of an internal university called The Learning Center, Farrell educates ResMed employees on everything from sleep-disordered breathing to leadership skills and how to work effectively in teams. The goal is that people grow along with the business, and employees feel valued and want to stay with the organization.
The other major challenge Farrell faced was to educate the health care market about the problem his product solved.
“The medical community works in silos, and traditional medicine stops when the lights go out, so no one understood the problem,” says Farrell.
ResMed initially funded medical research studies because Farrell says that he needed data to win the battle against ignorance and to convince the medical community of the disorder’s existence. The research studies found that sleep-disordered breathing was much more prevalent than Farrell had originally forecasted, affecting as much as 20 percent of the adult population.
Additional research studies showed links to other diseases, as well, but progress was slow. After several years of trying to convince doctors of the medical need for the product, Farrell finally achieved a breakthrough with cardiologists. Cardiologists were not initially projected to be the early adopters, but Farrell says that he learned from his experiences to be flexible and that start-up ventures are marathons, not sprints. So he took the initial endorsement from the cardiologists; then he focused on gaining the support of other physician groups.
Farrell compiled his first physician success stories and the results of the medical research studies, and he took the message out on the road. Because peer endorsement is important when marketing to professionals, ResMed uses thought leaders, who are recognized medical experts in their fields, who speak at medical conferences and symposiums, and convey the medical findings from the firm’s research studies.
His vision is effective marketing through education, and his goal is to educate everyone who will listen.
“We invite the physicians to seminars to educate them on the results of the research studies, and we even go out and educate our distributors’ sales forces because they have to have credibility and knowledge when they meet with physicians face-to-face,” says Farrell.
He also developed a public relations program built on unique alliances. Farrell approached a competitor with the idea of co-funding PR campaigns designed to build worldwide awareness of sleep-disordered breathing and its associated impact on other illnesses and conditions. The program raised device sales for both firms.
“This is not Coke and Pepsi,” says Farrell. “There’s a giant under-served market out there, and we needed to get the word out. There’s no industry association, so we had to make our own.
“Initially, it was also very difficult to get the attention of the medical community, so we tried something different. We launched an education and awareness campaign aimed at the patients. The idea is that by educating the patients, they will bring up the topic with their doctors. Our goal is to have something in the media every day which announces the results of one of our studies and helps to educate patients.”
His marketing campaign has solved the problem of demand as evidenced by 48 quarters of successive growth for ResMed, and his open-door policy keeps the news coming in, even when it’s not good.
“You can have a lot of success by getting into a monster market early,” says Farrell. “You are going to run into challenges and roadblocks along the way, but I get up in the morning and I’m glad I’m in the business. Of course, I also think that I’ve been successful because I have a high tolerance for bad news.”
But for the most part, the news has been good.
The company posted $607 million in net revenue in 2006, and its innovative culture has fueled approximately 1,300 patents granted or pending and 565 design registrations granted or pending worldwide as of December 2006.
“Now that we are successful, many people ask me why Baxter wasn’t interested in developing the product and the marketplace for themselves,” says Farrell. “If you’ve ever worked for a big company, that’s a really dumb question. Once a company gets big, (the executives) are so busy thinking about next quarter and maintaining their existing business that an idea like this would just die on its own backside there.”
HOW TO REACH: ResMed Inc., www.resmed.com