Leslie Stevens-Huffman

Wednesday, 25 April 2007 20:00

Flexible by design

When Ken Treaster was hired at Interior Specialists Inc. in August 1994, his original assignment was to learn the business and help the owner-operated firm expand outside of San Diego.

At the time, ISI was a local firm generating about $18 million in annual revenue, mainly from carpeting sales to new homeowners. The founder was looking for a little more time on the golf course; Treaster was just looking for a job.

Since Treaster was hired, the company has been sold twice, both times to venture investment groups, and he was named president and CEO of ISI in September 2000.

“When I exited college, I really didn’t have any specific goals except to move up the corporate ladder,” says Treaster. “Then when I got up there, I really wanted to move back down. I think part of the reason that I’ve stuck it out is the quality of the people involved in carpet manufacturing and the culture.”

The private equity investors sensed an opportunity when they initially purchased the firm. The industry was primarily made up of family-owned businesses, which were providing flooring, window coverings and countertop products to new home buyers.

Homebuilders were expanding their operations throughout the southwestern United States, in search of less saturated countercyclical markets, and an expanded ISI could ride on the coattails of the builders and capitalize further through unrealized revenue potential.

While builders usually have a transactional sales relationship with their customers that ends when the home is purchased, design services offer both repeat and adjunct sales prospects for other products and services needed by homeowners. The key to increased sales would be through owning the customer relationship.

Under Treaster’s watch, the Carlsbad-based firm has grown to more than $450 million in annual revenue, mainly through acquisitions, and has become one of the largest providers of outsourced interior design services in the country.

Maximizing the expansion opportunity required Treaster to acquire design firms with strong customer relationships that needed to be maintained through the assimilation process, as well as working closely with the private equity firms to maintain growth.

Finding the right match
The acquisition process starts with communication.

“When I speak with the management team from a prospective firm during the acquisition process, I am looking mostly for similarities in philosophy,” says Treaster. “I’m looking for great relationships with the builders, a good customer service level and a book of business that has been developed on value, not price. While I obtain most of my information about their philosophy through one-on-one meetings, I then validate many of the prospect’s assertions through a review of the financial data and by speaking with their vendors.”

Treaster says he has an advantage when he conducts interviews with a prospect in a new market because he can inquire about its bidding price points without being a competitive threat. Knowing the industry, he says that he can tell by the prices it is submitting in response to bid proposals what its true pricing philosophy is. If he hears that the owner often competes by bidding down the price, he expects that a review of the financials will show lower margins, and that may translate to less than desirable customer relationships.

If a prospective firm doesn’t look great on paper, that doesn’t necessarily rule it out as an acquisition prospect. The data analysis may reveal places where ISI could bring expertise or resources that would make the new acquisition financially successful because the solidity of the customer relationships has value.

“In 2002, we purchased a firm in Las Vegas that wasn’t making money, but they had good customer relations,” says Treaster. “We thought that we could improve their buying power, which would increase their margins and improve their back office function, which would improve their return on cash, all of which would make them more profitable.

“Another way that I evaluate an acquisition is looking at their data to see how aggressively they have pursued their turn on cash. I like to get down into the detail and classify which customers are paying slowly. If they are also paying slowly with other competing design firms that we’ve looked at, then they are probably a bad customer. If we’ve seen that the customer is turning invoices more quickly elsewhere, then we know we can move up the DSO [days sales outstanding, a measure of how quickly a company collects receivables] through process improvement.”

Treaster also has to take into account what his investors are looking for.

“One thing I’ve learned from working with private equity firms is to find out where their comfort level is and bring them deals that make sense to them and to remain flexible,” says Treaster. “In this case, the comfort level consists of deals in highly populated markets within the 11 Western states.”

Treaster says he has developed an acquisition sweet spot that seems to work well for the owners of the firm that he’s acquiring, as well as for ISI’s venture capital owners.

“What works best for us is acquiring firms that are $25 to $50 million in revenue, as they tend to have an owner who is over 50 years old and who has a limited exit strategy, because we can help with the succession of the business,” says Treaster. “Our model is to have the owner stay intact with the business for two to four years to make certain we maintain the customer relationships.”

Maintaining customer relationships
A prevailing wisdom among CEOs is to leverage the newly acquired acquisition debt by eliminating redundant functions and reducing costs through back office consolidation, especially when private equity firms want to see a return on their investments sooner rather than later. Treaster says that he originally went down this same path but soon learned that it often caused damage to locally built customer relationships.

“When we did our first assimilations, we centralized everything because we thought it would be easier to manage and it would save on costs,” says Treaster. “We found out that it just doesn’t work that well having someone from California call a customer in Arizona to collect cash.

“Also, the job-costing process isn’t as customer-friendly. So we refocused and put a local payables/receivables person in each of the local branches, and they develop relationships with the local builders. The result of the change is that we have experienced a higher level of acceptance in the local market, a more rapid turn on cash, and the customer relationships are better.”

During the due diligence process, Treaster reviews each customer and defines who in the organization owns the relationship. He also makes certain that the customer is introduced to ISI management during the assimilation period, reducing the possibility of customer loss down the road when the original business owner transitions out of the firm.

Treaster’s decision-making flexibility plays a vital role during the development of his assimilation plan. He says that he treats each situation differently and adapts his consolidation strategies for each acquisition using a centralized/decentralized model. He generally centralizes functions that don’t touch the customers and leaves the rest within the control of the local firm.

While the downside is running at a higher cost, Treaster says changing something that is working well for the customer is a mistake.

“What I’ve learned is that when companies are acquired, the last thing that 80 percent of the customers and employees want is change,” says Treaster. “So I’ve learned to change as little as possible that touches the customer. Centralizing functions can take the heart and soul out of the company you just bought.”

Managing growth
While effective assimilation is important, it can be a great challenge for CEOs to create a corporate infrastructure that can withstand rapid growth and to develop a management team that can handle hundreds of millions of dollars of increased business. Treaster says that the key to managing growth has been building a management team that has experience in rapid-growth environments.

With that primary selection criteria defined, Treaster has added a CFO with significant acquisition experience and a COO who has experience in a rapid-growth environment. They assist him in the due diligence process and make suggestions where to consolidate functions and develop the company’s operational infrastructure.

As an example, ISI has made significant investments in IT infrastructure. This provides newly acquired firms with greater data prowess and increases technical support while facilitating an operational cost reduction without negatively impacting customer relationships because the data can be accessed from anywhere.

“The most important ingredient in successfully managing growth is the quality of the people you have on your team,” says Treaster.

“They don’t have to be from the same industry, because floor covering is not brain surgery, but they have to have been around other environments that were supporting rapid growth, either through acquisitions or organic growth, and they have to thrive on it.”

Because part of ISI’s acquisition plan is to facilitate exit strategies for the owners of the companies it purchases, Treaster says that long-term growth in the acquired firms will be achieved by replacing the original owners with more professional business managers. While he says developing those managers is still a work in progress, he recently instituted a mentoring program with the goal of developing managers in- house for those opportunities, as well as increasing the firm’s bench strength.

Both moves will help take the company to the next level and reduce vulnerability resulting from owner or management departures.

Success with equity firms
Treaster says listening is key, not only with customers but also with investors.

“I think I’ve shown that I’m adaptable because I made the decision to centralize most of the back office functions post-acquisition and then reversed it,” says Treaster. “I think you have to learn to listen first and then formulate your plan.”

Treaster says that he developed his philosophy through experience. He says he learned early on, when he brought an acquisition prospect to the table that was located in Florida, that the private equity executives were not comfortable starting with such a broad geographic expansion right out of the gate. He refocused closer to home and found his suggestions were more on target.

“The private equity industry operates in a pretty high-risk, high-reward type of environment,” says Treaster. “I have learned not to give them any surprises so they feel comfortable that I am making good decisions.”

The “no surprises rule” has created a relationship built on trust, and so far, Treaster and his team have made decisions that have played out well, a situation that also keeps Treaster in the driver’s seat and the private equity firm in a supporting role.

“As for why my style is a good fit in working with equity firms, I think it’s because I don’t have an ego that has ever gotten in the way of making a good sound business decision,” says Treaster.

HOW TO REACH: Interior Specialists Inc., www.isidc.com

Monday, 26 March 2007 20:00

Storm warning

The 1987 amendment to the Federal Clean Water Act has proven to have far-reaching implications for San Diego County construction firms and anyone needing construction.

In January 2007, the San Diego Regional Water Quality Control Board adopted a revised National Pollutant Discharge Elimination System (NPDES) permit that requires local governments to further control urban sources of water pollution. As the effects of the amendment trickle down, many business and all new construction projects will be directly impacted.

The permit requires the proper management of runoff from rain and even housekeeping and gardening activities. In some cases, the runoff will need to be treated on-site before it can be released into the municipal storm drain system. Such treatment will require the local installation and maintenance of a water treatment system. The permit requirements will add to the construction costs of new homes or typical business development projects such as new parking lots.

“The new permit requirements not only are more extensive, but they require measures of effectiveness,” says John Lormon, chair of the Environmental and Land Use Practice Group at Procopio, Cory, Hargreaves & Savitch LLP. “All of this will have an impact on costs for homeowners, businesses and taxpayers.”

Smart Business spoke with Lormon about the business effects imposed by the permitting requirements and how CEOs can prepare for the changes.

How will the new urban runoff management program affect the construction industry?

The construction industry will be affected in several ways. For example, that industry is going to see changes in terms of how much land can be graded at any one time.

Because grading can alter the amount of runoff water and the pollutants contained in that water, the permit may only allow for a limited disturbance of land at one time. This could affect construction time lines and potentially project costs.

There are also implications for low-impact development projects such as the construction of restaurants, parking lots or office buildings. When you convert ground that previously absorbed runoff to hardscape, you are changing the volume, velocity and makeup of the runoff. This change is a major concern for water quality regulators; thus, new restrictions are being imposed on development.

Creating additional hardscape can also cause runoff to alter streams, banks and beds, changing habitats. Where site development exceeds 50 acres, the project proponent will be subject to additional requirements, including development and compliance with a hydromodification plan. In time, most projects will be subject to these requirements.

The permit requires the local government to reduce the discharge of pollutants in urban runoff to the maximum extent practicable through various management practices [such as treatment and development of management plans], and these requirements will be passed down from local governments to development projects through ordinances and the land use permitting processes.

These same water quality issues will affect environmental review and could create new mitigation requirements, further adding to project costs.

Are there wider-reaching implications?

Certainly, CEOs should expect to see some of these costs passed through to them under triple net leases, and the permitting process may slow down new construction projects or build-outs. The cost impact may not be as immediate for CEOs who lease building space, but as those buildings undergo renovation, or if the CEO relocates or expands the business, there is the potential for impact.

Also, the agencies have developed stormwater civil and criminal enforcement initiatives. Wal-Mart recently paid a storm-water violation penalty of $3 million.

How will this impact the cost of doing business and the cost of construction?

The building industry says that this may add as much as $30,000 to the price of a new home. Other estimates project a $100,000 cost of construction increase for office buildings, while the cost to government and taxpayers is projected to be $250 million over the five-year life of the current permit.

What should CEOs do in anticipation of this urban runoff management program?

First, they should pay careful attention to site selection and keep both the stormwater quality impacts and the potential cost escalation in mind.

Second, they should anticipate that new construction might be slowed or impacted by the permitting process.

Third, as CEOs look at all new real estate transactions, they should do their due diligence and strongly evaluate projects that might result in hydromodification or treatment requirements.

Fourth, the SEC requires public companies to disclose environmental liabilities.

Last, keep budgets in mind. All of these changes are a consultant’s dream, and any time there are uncharted waters to navigate, consultants are usually hired to help pave the way.

JOHN LORMON is chair of the Environmental and Land Use Practice Group at Procopio, Cory, Hargreaves & Savitch LLP. Reach him at jjl@procopio.com or (619) 515-3217.

Monday, 26 March 2007 20:00

Evaluating insurance needs

Sometimes, executives are so busy pursuing the American dream that they forget to protect the hard-earned assets they have accumulated along the way. Vacation homes, jewelry, boats and cars are frequently part of a burgeoning list of assets acquired by executives, while board-of-director roles, managerial assignments and international business travel are some of the responsibilities that accompany success. Each possession and professional activity needs to be evaluated by a broker for potential physical loss or liability exposure, and insured accordingly.

Approximately 70 percent of clients are underinsured, according to Michelle Baxter, personal lines broker with West-land Insurance Brokers. “It is more expensive to rebuild a home than to build it because of demolition and debris removal costs,” says Baxter. “Many homeowners fail to take those expenses into account when they calculate their home’s replacement cost, if they aren’t advised by a professional broker.”

Smart Business spoke with Baxter about how to close coverage gaps and reduce liability exposure with personal insurance.

How often should I meet with my broker?

Your broker should review your portfolio annually, including an evaluation of all of your assets and your lifestyle. The broker should ‘shop’ your coverage needs among several markets to determine the best value and insurance carrier for you. I say value as opposed to price because coverage should be placed with an A-rated carrier and certain markets cater to high-wealth individuals, so their policies contain clauses that provide protection for the kinds of exposures that executives frequently have. Saving on premiums in the short run often can cost you more in the long run.

What is my broker’s role in reducing my exposure to loss and managing my needs?

You should have one broker, who should place all of your coverage with one insurance company.

Primarily, this allows your broker to view your entire lifestyle and portfolio of assets for gaps in coverage and potential exposure. For example, if you purchase a vacation home and secure the insurance coverage through escrow at closing, that policy might have liability limits of $300,000. Meanwhile, your personal umbrella policy is with another carrier and it provides coverage for losses that exceed $500,000, resulting in a coverage gap of $200,000, which could be avoided by having one broker who oversees all of your needs. Hiring occasional or full-time workers, such as a nanny or housekeeper, can also increase your exposure, as does renting out a vacation home, so all of this must be taken into consideration.

Also, placing all of your coverage with one carrier is generally more cost-effective because it allows for premium credits and elimination of costly redundant coverage.

Finally, your broker should be the first person you call in the event of a loss. When you report a potential claim to a carrier, all insurance companies are notified regardless if the claim gets paid. In some cases, especially where the claim may be below your deductible, it might be best not to report it at all. Your broker will know what the right answer will be for each situation.

What are examples of personal lines protection that executives should consider?

Your broker should suggest a personal articles floater if you own jewelry, rare wines, collectables, musical instruments or fine art, and all items should be appraised. This will cover the items at full value against loss or mysterious disappearance without a deductible. If you own a condo as a primary residence or as a rental property, you have personal liability exposure that extends beyond the master policy written on the condominium association. For example, if a fire starts in your unit and damages other units, you might have financial responsibility to others.

Extended replacement cost coverage for homeowners is another recommendation. It provides additional protection in the event you discover that you are underinsured after a loss. For example, if you have purchased $500,000 in replacement cost coverage for your home, and after a fire you find that it will actually take $550,000 to replace it, the endoresement clause will provide for $550,000 in replacement coverage automatically; you need only pay the additional premium. Also, you don’t have to settle for coverage limits provided by the California Earthquake Authority. A professional broker has access to other markets that provide broader coverage for reasonable rates.

What are the other benefits of working with a professional broker?

Brokers can assist executives with busy lifestyles by recommending appraisal firms, companies that will scan valuable documents or videotape your belongings, so you have a catalog of your assets. They can also assist in calculating accurate replacement cost values for your properties. As your wealth builds, so does your exposure to loss and your need for professional guidance. It takes years to build the American dream; it only takes a few minutes to lose it.

MICHELLE BAXTER is a personal lines broker with Westland Insurance Brokers with 20 years insurance experience. Reach her at mbaxter@westlandib.com or (619) 641-3255.

Monday, 26 March 2007 20:00

Creative relief

A man’s home may be his castle, but given the escalation in residential real estate values in Orange County over the last few years, the castle’s sale may generate a substantial capital gains tax bill.

While recent changes in the real estate market have slowed the rate of increase in the average home price, several years of double-digit increases have left many Orange County residents with homes that have more than doubled in value.

At the time it was instituted, the Taxpayer Relief Act of 1997 brought what was thought to be welcome relief for taxpayers. It allows homeowners to exclude up to $250,000 of personal property gains for single individuals or up to $500,000 for married couples filing jointly from capital gains taxes. Subject to a two-year waiting period, the exclusion can be used over and over again.

A seller looking to downsize or sell before the two-year waiting period has expired, as in the case of a transfer or promotion, may be in for a surprise.

“I think some people may be startled if they have been carrying forward prior unreported gains resulting from the sale of one or more homes,” says Ryan Woodhouse, tax manager with Haskell & White LLP. “In that case, the $500,000 exclusion may not be adequate, so reducing taxes will call for some planning and creativity.”

Smart Business spoke with Woodhouse about the changes in the way home appreciation is handled for capital gains tax purposes and a creative solution to the problem.

What changes are there in the rollover residence replacement rule?

The main difference has to do with the deferral provision of the old pre-May 1997 rollover residence rule versus the exclusion provision currently in place.

The best way to illustrate this is through an example. Let’s say that a married couple here in Orange County has purchased and sold homes prior to May 1997, which created deferred capital gains of $20,000, $45,000 and $70,000, for a total of $135,000.

Because they always bought a more expensive home, the gain is deferred and they avoided any tax consequence from

the sale under the pre-May 1997 rule. Now, they want to sell their present home, which they purchased in 2000 for $500,000. It has a current market value of $950,000. Calculating the tax under the post-May 1997 new rule requires subtracting the previous deferred capital gain of $135,000 from $500,000 to arrive at an adjusted cost basis of $365,000.

After adjusting for improvements and deducting the cost basis from the sales price of the present home, the gain will most likely exceed the $500,000 deduction, and the balance will be taxed as capital gains.

What is the property exchange solution to capital gains taxes, and how does it work?

If the sellers are to realize gain in excess of the exclusion amount and do not immediately need all of the equity in their homes, such as in the case of trading down residences, converting the property from a primary residence to investment property status may offer an alternative to large capital gains taxes.

IRS 1031 (Like-Kind Exchange Rules) allows for exchanges of investment property without recognizing gain or incurring capital gains tax. The idea is to convert the property from its primary residence status

to a property held for investment. Then the owner can either continue to hold it for the production of income, or exchange it tax-free for another income-producing property.

What steps do you need to take to qualify for a property exchange?

The first step is to make your intentions to change the status of the dwelling from primary residence to investment property clear by leasing the property for a period of time, ideally for a minimum of two years but no longer than three. Once it is clear that the home is now an investment property, it can be exchanged for another income-producing property.

Under the rules of IRS 1031, when a former principal residence is exchanged for a like-kind property, any cash received in the transaction first qualifies under the $500,000 exclusion, and the balance is excluded from capital gains assessment.

What constitutes a like-kind property exchange?

Generally, this means that income-producing property has to be traded for another income-producing property, such as another residential rental house. One option would be to trade for a similarly priced property that can generate more revenue.

For example, if your home is worth $1.1 million, it is likely that the net income that could be derived from rental of the high-priced residence is substantially less than the net income that could be derived from a small apartment building that could be acquired in a swap with the $1.1 million equity value of the residence. If the owner wished to avoid involvement with management of real estate, a trade of the property for high-quality net leased property could be arranged.

All tax laws are complex, and 1031 is no exception. Be certain to consult with a tax professional and evaluate all of your options for dealing with capital gains taxes.

RYAN WOODHOUSE is a tax manager with Haskell & White LLP. Reach him at rwoodhouse@hwcpa.com or (949) 450-6341.

Wednesday, 31 January 2007 19:00

Value through audit synergies

Under Sarbanes-Oxley (SOX), CEOs and CFOs of public companies are accountable for assessing the integrity of the company’s financial and information technology controls as well as certifying to the fair presentation of the financial statements. While an increasing percentage of data used in compiling financial statements is captured, processed and stored in the company’s information technology

system, most IT audits are conducted independently from the financial audit, leaving potential gaps in the control systems. Coordination of audits may ensure that compensating controls are in place. Coordinated audits can detect situations where “super users” have universal access to the system or administrators independently set up and manage the security and permission levels for the operating systems, applications and network, thus creating an opportunity for collusion, fraud or confidentiality breaches, says Robert Greene, IT Audit Practice leader with Haskell & White LLP. “The CEO needs to understand that IT controls can complement financial controls. When these combined controls are understood and implemented, there is a greater assurance of the integrity of the financial statements and source data,” says Greene.

Smart Business spoke with Greene about how CEOs can create tighter controls by combining the IT and financial audit processes.

Why is there a tendency to separate the IT and financial audits?

Historically, CPAs did all of the auditing and the IT systems were not audited. Now, more and more data used by finance and accounting comes from IT applications, and the audit planning hasn’t necessarily kept up. The CPA usually has no IT audit experience and the audits are planned separately. IT audits primarily are focused on strategies to protect the firm’s data capabilities — not necessarily the financial statements. The CFO and CIO need to understand how IT and finance controls are interdependent; to create controls that will be effective for both.

What is the value of combining the two audits?

First, by understanding who creates and has access to the data, controls can be established that ensure both the integrity of the data and the manual processes that occur independently from the IT system.

For example, the company may have a manual control process that calls for the controller to approve any check exceeding $10,000. The CIO may not be aware of the process, and the software could be programmed to flag any entry that exceeds $10,000 when it is created. In this case, the new primary control would be the exception report generated by the system, the compensating control would be a review of an exceptions report by the controller, and the fail safe is a manual review of all checks over $10,000. This additional capability will allow the CFO to know how many checks should be coming through the manual review process and the CEO could also receive a copy of the report. Having the CIO and the CFO collaborate in creating controls will reduce gaps in both systems.

Second, when the entire team works together, it creates synergistic opportunities to advance the company’s mission and business plan, which fosters growth.

Third, by knowing that the controls in IT and finance work cohesively, the CEO and the board can have greater confidence in the effectiveness of the control system and the accuracy of financial statements.

How should the IT and finance audit teams work together, and what information should they share?

The finance audit team usually makes up the audit schedule. IT should be involved in planning to ensure it knows the time frame and how much time to allocate. The two audit teams should share any concerns in advance, to help stimulate both ideas and solutions. Generally, IT doesn’t understand the financial processes and finance doesn’t understand the IT controls. Therefore, the opportunity to design or recommend complementing controls may be missed.

Jointly, both parties should look at the entire flow of data from creating users in the system, to entering information, processing information and who has access to the information. This process mapping will reveal gaps, as well as opportunities to jointly author process controls and safeguards.

What are the best practices to achieve the optimum results from a combined audit?

First, IT and finance should author the audit plan together. They should talk about what is important to both sides and collaborate on the scope of the audit and the audit program.

Second, the CEO should insure that the budget is sufficient to conduct a thorough, combined audit.

Third, by integrating the process and control training to include both the IT and finance auditors, as well as the respective leadership teams, each group will be able to understand each other’s needs and see the value in combining the audits.

ROBERT GREENE is the IT Audit Practice leader with Haskell & White LLP. Reach him at rgreene@hwcpa.com or (949) 450-6340.

Sunday, 31 December 2006 19:00

The evolution of tenant representation

The commercial real estate industry has a dirty little secret, and it’s called conflict of interest.

We see the familiar “for lease” signs on buildings, and understand that those agents are working for the property owner. But when you are a CEO looking for a new building, things get murky. The conflicts are obvious when your agent also represents the building owner. But what about when the conflict is more subtle, or when you don’t find out?

Enter the tenant representative, who forsakes all landlord allegiances to represent only the tenant in commercial real estate transactions. Tenant representation has taken root in corporate America, where space users seek out tenant-only brokers and tenant-only brokerage firms have grown in response to this demand.

“We have divided the industry in half,” says John Jarvis, principal and senior vice president with Irving Hughes. “Brokers have to choose between representing landlords or tenants. The days of one agent doing both are gone.”

Smart Business spoke with Jarvis about what CEOs should know about engaging a tenant representative and how to benefit by having one.

What is tenant representation?
Tenant representatives are commercial real estate brokers who work exclusively for the tenant, or ‘space user,’ and never the building owner. ‘Tenant reps’ developed in response to the conflicts of interest that are rife in the industry. They are now a universally embraced, specialized sector of commercial brokerage, with a broader range of services focused on the tenants’ unique needs such as space programming, construction management, lease renewal consulting, site search, financial analysis and strategic negotiations.

Why should a CEO care if his broker is a tenant rep?
There is a very real risk of working with a partner who has blatant conflicts of interest. CEOs are sensitive to the issue of conflicts, and investment banking is a perfect example. As the CEO, you know when you are talking with a promoter, and you aren’t going to rely on him for business advice. Commercial real estate is exactly the same, and the landlord agents are the promoters.

I started in this industry as a traditional landlord’s broker 20 years ago, before the growth of tenant representation. I was given listings and told to go find tenants to fill the space. The objective was to get the buildings filled up at the highest rents, so that we could sell the properties as leased investments for the maximum possible price. But in the process of getting to know the tenants that would fill these buildings, I became aware of these insidious conflicts, and I’ve been a tenant representative since 1993.

How has tenant representation changed the industry?
In the old model, the landlords and their brokers held all the cards. The tenants were merely a means to an end. With the advent of tenant representation, the industry is waking up to the reality that the tenants actually hold all the cards, because the tenants pay the rent. In truth, landlords are utterly dependent on the rent tenants pay as their sole source of income.

The problem is that many tenants don’t realize they hold all the cards, and those that do understand aren’t always sure of the best way to play that winning hand.

What kind of savings can CEOs expect by using a tenant representative?
It is significant. For most companies, real estate is the second-largest expense after payroll, and every dollar we save goes right to the bottom line. But it isn’t just about the hard dollar savings. We are also mitigating risk and negotiating flexibility into our transactions, which can be extremely valuable.

Landlords will always look for the highest possible rent for the longest possible guaranteed duration. Tenants typically want the lowest possible rent and the greatest lease flexibility. So we get creative, develop our leverage, and negotiate solutions that work for our clients.

Is there resistance to tenant representation from the old-guard?
Absolutely there is. From the landlord’s perspective, we are educating customers and helping those customers to develop and use their leverage, resulting in lower rents, greater lease flexibility and more tenant-oriented protections and concessions. You can bet the landlord will try and keep us out of the mix. Also from the traditional brokers’ perspective, we are calling attention to their Achilles’ heel, the dual-agency conflict of interest when they try and represent tenants, and it’s an argument they can’t win.

JOHN JARVIS is principal and senior vice president at Irving Hughes. Reach him at johnj@irvinghughes.com or (619) 238-8154. Visit www.irvinghughes.com for more information.

Wednesday, 25 October 2006 20:00

Opportunities abound

When searching for commercial real estate space, CEOs have been taught that vacancy rate indicates how soft the market is.

“But vacancy rates are not what they appear to be,” says David Marino, principal and executive vice president of The Irving Hughes Group. “We need to stop talking about vacancy rates and start talking about availability rates. Availability rates will show that the overall market is much softer than landlords and their brokers would have you believe.”

A smart CEO also needs to understand the broader picture — including time on the market, sublease space and net absorption — to pull together a more comprehensive view of the marketplace.

Smart Business interviewed Marino to see how CEOs can improve their company’s bottom line through negotiating more favorable lease rates and obtaining better concessions when leasing space.

Exactly why is availability the better measure of the market?
Vacancy rates are just that — a measure of unoccupied space. However, when a company seeks facilities, it doesn’t look at vacant space, but rather at all of the space on the market — what is available, and not what is vacant.

Vacancy rates provided by the same brokerage firms that are promoting landlords’ listings do not count available space due to pending relocations. The listing brokerage community also conveniently ignores sublease space, because that space is not technically vacant — all 4.1 million square feet at least count, which is up from 3.3 million just a year ago.

The spread between vacancy and availability is extreme: Sorrento Mesa office vacancy is 14 percent, but availability is 26 percent; Carlsbad flex space is 19 percent, but availability is 24 percent; I-15 corridor office is 13 percent, but availability is 17 percent; I-15 corridor flex space is 21 percent, but availability is 27 percent. Another 5.2 million square feet are under construction in San Diego County — a figure not captured in vacancy or availability rates. That all paints a pretty scary picture for landlords in 2007.

Time on the market is critical in residential real estate, but why is this first time a commercial real estate professional has mentioned it?
Time on the market is the commercial real estate industry’s dirty little secret. The real estate industry does not want tenants to know how long space has been on the market. The time during which landlords are sitting with space will determine the best strategy for negotiations. Most CEOs are stunned by the amount of time landlords have been sitting on vacant office space.

The reason space has sat is that there has been virtually no net absorption for more than a year. Net absorption is the net result of space being leased versus space being put vacated. Local companies are growing marginally, but the mortgage industry is dumping space county wide, as are big corporations such as Merck, Pfizer, Ericsson, Intel, Nokia, HP (formerly Peregrine Systems) and Avent (formerly Memec).

The market has been running in place for over a year, and it’s in long-term equilibrium. Although landlords have raised asking rental rates, there is no basis for inflation in rents.

What kinds of opportunities does this equilibrium offer a CEO?
The cost of space is a company’s second-largest fixed cost. With this excessive time on the market and the overhang of sublease space, CEOs should consider adjacent submarkets that have greater availability and seek sublease opportunities that can be had for 20 percent to 30 percent below market. These conditions will favorably affect the ability to negotiate lower cost lease renewals into 2007 and 2008.

What is the best strategy to optimize a lease expiration or expansion in 2007?
Engage professional representation to position your company with the landlord and shop the market to fully develop leverage and alternatives.

The most disastrous approach is to call the existing landlord, or his broker, to renew the lease. The landlord now knows you want to renew your lease, and because there is no representation involved, the landlord knows the tenant has no information about market conditions and no alternatives on the table for consideration. Landlords are in business to create return for their shareholders, and renewals directly with tenants have the highest ROI for landlords. The savings of 12 to 18 months of vacancy, $15 to $20 per square foot in tenant improvements, and the credit risk of finding a new tenant all become financial windfalls for the landlord in a direct renewal. Our objective is to obtain those savings for our client.

DAVID MARINO is principal and executive vice president of The Irving Hughes Group. Reach him at (619) 238-5672 or david@irvinghughes.com.

Thursday, 26 October 2006 02:17

Preventive cardiac care

Each year, more than 700,000 Americans will have their first heart attack and 500,000 will have a repeat episode, according to the statistics on the Web site of the American Heart Association.

CEOs often represent the demographic group at the greatest risk for heart attacks because 49 percent of males will develop coronary heart disease after age 40, as will 32 percent of females. While diet, exercise, quitting smoking and stress management can help to reduce the chances of developing coronary heart disease, new technology has been developed that helps find potential problems and fix them before a heart attack actually occurs.

More than 60 percent of the people who come into the emergency room during a heart attack have never had any previous symptoms, says Dr. Oscar Matthews, medical director of the Cardiac Cath Lab at the Western Medical Center, Anaheim.

Smart Business spoke with Matthews about the best way for CEOs to insure cardiac health through lifestyle and a pro-active testing regimen.

What are the best ways for CEOs to prevent heart disease?
Due to the nature of their jobs, CEOs often have the opportunity to eat frequent meals that can be higher in fat and calories. I always advise eating slowly and taking small bites. This helps ‘fool the brain’ into thinking that your stomach is actually fuller than it really is, so it is important not to rush through meals. Also, stress reduction is very important for executives. You need to set aside time for relaxation which is accompanied by positive imaging and doesn’t include thoughts about work or pending business deals.

What types of diagnostic testing are available to help spot heart disease in its early stages?
One of the basic tests is the treadmill. The executive is connected to a monitor while walking on a treadmill. These types of tests have been around for awhile, but electrocardiogram tests alone are less than 60 percent effective in diagnosing coronary heart disease.

What is nuclear testing and how is it used?
We inject isotopes into the patient’s vein during a session of rigorous exercise. We are able to capture sophisticated images of the heart and the cardiac muscle as the isotope passes through the bloodstream and lodges in the cardiac chamber. The images are then analyzed for potential defects.

A normal cardiac muscle almost resembles a doughnut. If part of the muscle is not receiving a good supply of blood during the test, we will be able to see it in the image because a portion of the muscle will appear to be missing — almost as if someone has taken a bite out of the doughnut.

What happens if the test reveals problems?
If the imaging reveals potential blockages in the arteries, a coronary angiogram can be conducted to determine the extent of the blockage. A small puncture is made in the groin and using a catheter as fine as a hair, we advance into the chambers of the heart and the coronary arteries. There we inject contrast media (dye) from the catheter and illuminate the coronary arteries of the heart for imaging.

If we find that the arteries are less than 50 percent blocked, we normally recommend behavior modification and send the patient home and continue to monitor their progress annually.

If we find that the arteries are between 51 to 70 percent blocked, this is a gray area and one that can be difficult to diagnose. In these cases, we recommend an intervention to evaluate the lesions by performing an endovascular ultrasound that utilizes highly sophisticated equipment. Due to tissue characterization, some of these lesions may require the implantation of a stent which is also required to repair blockages in larger arteries or in cases where the artery is more than 70 percent blocked. The stent is a device that helps hold the artery open and prevents it from re-closing. We place a sealer on the groin after the procedure and most patients are able to go home in three hours.

How often should CEOs be tested?
Executives should plan on being tested every two years after the age of 40, especially if you are overweight, smoke or have other high-risk factors. The test should be conducted using state-of-the-art equipment and should be read by an expert in nuclear cardiology, both of which are available here at Western Medical Center. This type of testing improves the level of diagnostic accuracy up to 90 percent.

OSCAR MATTHEWS, M.D., is medical director of the Cardiac Cath Lab at the Western Medical Center in Anaheim. Reach him at oscardiomat@yahoo.com. For more information about Western Medical Center Anaheim, go to the Web sites www.westernmedanaheim.com and www.theheartinstitute@ihhioc.com.

Wednesday, 20 September 2006 20:00

Managing health care costs

The cost of offering health care to employees has continued to skyrocket. Many companies have had to pass along all or part of the premium increases to workers or increase plan deductibles in order to maintain a competitive business posture while continuing to offer the benefit of health insurance. Changes of this nature can sometimes lead to decreased employee morale.

A health care financing option that potentially provides a solution to the complex challenge of offering affordable health insurance to employees is the health savings account (HSA).

These types of accounts are very popular with employees, says Sandy Coventry, an independent insurance broker with Westland Insurance Brokers. Coventry says that HSAs make health insurance available to a greater number of people and that many professional-level employees recognize the tax advantages and empowerment potential of account ownership.

According to information gathered by America’s Health Insurance Plans, an association representing 1,300 health insurance companies, the number of individuals covered by HSAs increased from 1 million participants in March 2005 to almost 3.2 million in January 2006. The group projects that up to 14 million people will be covered by 2010.

Smart Business spoke with Coventry about the business advantages of offering HSAs and why CEOs might want to include this option as part of his company’s benefits plans.

Why should a CEO consider including HSAs as part of a comprehensive health care benefit plan?
The first thing to consider is the cost savings. HSAs are offered when an employee is covered by a high-deductible insurance plan. These types of plans often offer premium savings to the company and potentially the employee, depending upon how the premium sharing is allocated.

A recent study completed by United Health Group sampled 40,000 workers from 2003 through 2005. It found that the cost to employers per member in a high-deductible plan declined 3 to 5 percent during the period, while increasing 8 to 10 percent when employees were covered by traditional PPO plans.

Why would an employee want an HSA?
The premium savings from a high-deductible insurance plan often enables employees to cover their entire family, or it allows more employees to participate. The employee can ‘bank’ a portion of the premium savings into an HSA and use that money to meet the deductibles of the plan. Additionally, employee contributions to the account are tax deferred.

For many employees, especially those in higher tax brackets, it’s an opportunity to save money on premiums and lower their taxes. Any excess funds earn interest and continue to accumulate until they are needed, and costs at medical provider offices or pharmacies are paid right out of the account with a debit card. It’s like getting a raise for employees who have few medical expenses in a year.

What types of criteria are necessary to offer an HSA to employees?
Employees must meet the following criteria.

  • The employee must be covered under a qualified high-deductible health plan. For 2006, the minimum annual deductibles are $1,050 for single coverage and $2,100 for family coverage.

 

  • The employee must not be covered by another health insurance plan, either as an employee or a dependent, unless it is another high-deductible health plan or specific limited-coverage plans such as dental, vision, accident, hospital indemnity or long-term care insurance.

 

  • The employee may not be enrolled in Medicare under Coverage A or B.

 

  • The employee cannot be claimed as a dependent on another person’s tax return.

What are the steps for putting an HSA in place?
The first step is to research the most cost-effective health plan options that can augment or replace the company’s current medical plan offerings. Then decide on a budget for contributions to the employees’ HSA. Most employers use all or some portion of the premium savings as a funding mechanism for their employee’s HSAs. The company contributions act as an incentive for employees to enroll in the high-deductible health plans and the HSAs.

The last and most important step is to educate the employees so that they understand the risks of having a high-deductible health plan and the benefits of having an HSA to pay for out-of-pocket expenses.

Payroll stuffers, educational materials and enrollment meetings are valuable tools to use in successfully implementing a new HSA offering. The key is keeping it simple for employees by providing clear and concise information so that they can make the most informed decision about their health care plan.

SANDY COVENTRY is an independent insurance broker with Westland Insurance Brokers. Reach her at (619) 584-6400 or scoventry@westlandib.com.

Executives aren’t the only ones looking at options to mitigate the impact of health care reform. Employees fear repercussions from this legislation and are creating lists of “what- if” scenarios to deal with the fallout. According to surveys by Towers Watson, 67 percent of employees believe health care reform will increase their benefit costs and 44 percent would be open to new offers if current benefits were reduced or eliminated.

Allowing workplace uncertainty to linger can undermine engagement and productivity, yet thus far only a handful of employers have anticipated employees’ concerns or solicited their solutions or benefit preferences.

“The reality is some companies may decide to reduce health care benefits, and it’s better to begin a conversation with employees about the implications of health care reform rather than keeping them in the dark,” says Christine Infante, senior consultant with the Rewards, Talent & Communications Practice at Towers Watson.

Smart Business spoke with Infante about the best ways to invite employees into the decision-making process.

What’s worrying employees about health care reform?

Our surveys show that employees are increasingly concerned about the rising cost of health care; one in four says it’s a source of significant stress. Increased cost shifting by employers has impacted their ability to make ends meet today and save for the future, and many perceive that reform will only exacerbate their plight. In fact, more than half say the bill will reduce their available benefits and lower their quality of care and 40 percent say they would be uncomfortable purchasing their own insurance in reformed markets as an alternative to getting coverage through their employer. Since health care benefits rank third on the list of employee attractors, behind base pay and paid time off, employers should pay attention to their concerns and reduce workplace angst by giving them honest answers.

What’s the best way to initiate a dialogue with employees?

Employees and retirees are grappling with the complexities of the new health care law and it’s especially challenging to calculate the financial ramifications from key provisions like the excise tax on cadillac plans or the tax on Medicare benefits. So focus first on education by sending a letter that describes the various elements of health care reform, when they take effect and their impact on costs, since the implementation schedule runs all the way through 2014. Providing employees with information sets the stage for future benefit changes as they gain an understanding of the bill’s provisions and how each one impacts their existing coverage.

Next, invite an interactive dialogue by asking benefit managers to moderate an online discussion or chat session and invite employees, spouses and significant others to participate. An online forum allows the employer to create different topics or threads so you can learn what employees want, better understand their concerns, even test ideas — and it supports group learning 24/7. Finally, executives should enter the discussion by addressing employees during quarterly meetings or town hall sessions.

What’s the right message for executives?

Business leaders don’t need to be benefits experts to speak to employees; they just need a few sound bites to explain the company’s evaluation strategy and estimated time line. Just letting employees know that a plan is in place to assess the impact of health care reform on their benefits will restore a degree of confidence. Next, remind employees about the company’s strategy for controlling health care costs and that they can help by participating in wellness programs and being smarter consumers of health care services. Towers Watson research reveals that companies with the most effective health and productivity programs have senior managers who advocate wellness and take an active role in communicating with employees. In fact, when big decisions need to be made, 48 percent of managers at these organizations involve employees and 92 percent take the lead in explaining the reasons for the decisions.

What’s the best way to engage employees in the decision-making process?

Ask employees what’s important to them and what they value most about their benefits to make sure expenditures are aligned with the most impactful programs. This is the perfect time to revisit your company’s employment value proposition and remind employees about the total rewards they receive in exchange for their hard work. Many companies create cross-functional teams or task forces to evaluate the current budget and benefit programs and recommend possible changes. Be sure the teams encompass a cross-section of employees and stakeholders, since a 25-year-old employee with no dependents has a different set of priorities than a 45-year-old with college-age children. Members also serve as conduits by soliciting input from co-workers, which allows more employees to have a voice in the decision-making process. When presented with the facts and a slate of alternatives, employees have shown that they are capable of making sound decisions about health care benefits.

How should executives communicate benefit plan changes?

When addressing employees about changes to the company’s health care plan, executives should articulate the employment value proposition (the deal), reinforce the organization’s benefits philosophy and commitment to well being and explain the business challenges imposed by reform. Let employees know that the company is committed to managing costs and re-evaluating the plan should circumstances change. Finally, thank employees for their partnership and guidance in resolving this critical issue.

Christine Infante is a senior consultant with the Rewards, Talent & Communications Practice at Towers Watson. Reach her at christine.infante@towerswatson.com or (858) 523-5514.