Sequestration – Will it be as devastating as predicted?

You’ve heard it from both sides of the aisle – Nancy Pelosi, John McCain, President Obama, Mitch McConnell – sequestration will be “devastating.”  “We’ve got to avoid it, we’ve got to stop it,” said John McCain.  He is being universally echoed with similar quotes by all of the Democrat leadership in Congress.  Let’s begin this discussion with the facts. 

What is sequestration?  Sequestration is a budget law that requires across the board spending cuts amounting to $1.2 trillion over 10 years or $109 billion per year.   

How much will be cut in 2013?  The last minute fiscal cliff deal in early January included cuts of $24 billion for 2013, so in the remaining seven months of this fiscal year the government must cut another $85 billion. 

How much is the federal government’s budget for the current fiscal year?  $3.8 trillion

Where would the cuts come from?  Equal amounts would come from the Defense Department and discretionary social spending.  The Defense Department makes up about one-quarter of the total federal budget; discretionary social spending comprises about half of the total budget, and non-discretionary social spending and the interest on the debt making up the balance. 

So who will be most affected by the cuts?  The cuts on a percentage basis would be deepest in defense spending because it represents a quarter of the budget but half of the cuts.

What programs won’t be cut?  Social security, Medicaid, the food stamp program and veteran’s benefits.  Active duty personnel would also be exempt.  Interestingly, Medicare is not exempt.

When does sequestration begin?  Officially it begins March 1^st but in reality it will roll out over a period of several weeks.

So those are the facts.  Now let’s look at what the impact of these cuts in spending will have on our economy.  The Congressional Budget Office predicts that the sequestration cuts will reduce public- and private-sector employment by 750,000 jobs and will reduce our GDP by 0.5%.  In other words, our GDP, which is growing at about 2.0% right now, would slow to about 1.5%.  Depending on who you listen to the list of programs that will be affected is long and deep including:

• the Federal Aviation Administration,
• the National Parks,
• the Pentagon, 
• Health and Human Services, 
• Humanitarian Aid,
• Border Security,
• Education,
• Disaster Relief
• Law Enforcement 

The list appears to be endless.  This is what those in power are saying, in a nutshell, “The world is coming to an end as we know it.”  They may not use these exact words but that is what they are trying to convey.  I respectfully disagree.  Yes there will be consequences to making these cuts.  There will be some pain but the world will go on and in the long run we’ll all be better for it.  

Sadly, there are very few politicians in Washington who are willing to make modest cuts in spending, and make no mistake about it, that is what $1.2 trillion is over 10 years.  A cut of $85 billion in fiscal 2013 represents 2.3% of the total $3.8 trillion federal budget.  Do you actually believe that a 2.3% cut in spending is going to be “devastating?”  Have you had to make cuts in personal spending that have been much greater than this over the past several years?  I certainly have.   

The sequestration cuts are not perfect, they’re a blunt instrument to cut spending, rather than a deliberate plan that sets priorities, trims entitlements, and cuts other spending.  It would be better to replace them with better cuts but the reality is that Washington does not have the will to make spending cuts.  There is no political block in Washington that represents the constituency of the overburdened taxpayer.  In contrast, there are thousands of lobbyists on Capitol Hill that visit our congressional representatives in order to make sure that they’re constituency, whatever that may be, is getting their fair share of the spending pie. 

Don’t buy into the hysteria.  The cuts will not be devastating.  If the sequestration cuts actually happen, six months from now you’ll hardly notice. 

Sources: Sequestration Q & A, Money Watch, by Jill Schlesinger, February 22, 2013; Sequestration: The Facts About the Policy, BeforeItsNews.com, February, 19, 2013; The GOP Divide Over Sequestration (and Everything Else), The Atlantic, by Molly Ball, February 15, 2013.

Three Things to Consider When Choosing a Property Management Company

From time to time investors ask me to refer property management companies to them.  I’m glad to do it as one of the advantages of being a commercial mortgage broker is that I come in contact with lots of property management companies. 

Years ago, it seems like another lifetime, I was a property manager.  I managed three Class A apartments totaling over 500 units.  I had 23 employees under me.  Being a property manager was the longest three years of my life.  I will never do that again.  So I have a lot of respect for those property managers who do their jobs well.  It requires a certain type of personality that I frankly do not have.    

In the course of my work as a mortgage broker, I inspect lots of properties, talk with a lot of on-site managers and get to review many different types of operating statements.  Over the years I’ve gotten to know the good property management companies from those that are grossly incompetent.  So what makes a good property management firm? 

There are lots of questions you could ask, however I would focus my questioning on three broad categories:

How do you charge for your services?  I’m aware of at least three different ways that property management firms charge their clients:

1.   The most common is a property management fee based of effective gross income.  Is their management fee competitive with what is being offered in the market? 

2.   Sometimes property management companies will charge you a hidden fee when using their maintenance personnel.  This can happen when a property doesn’t have a full time maintenance man and the management company’s maintenance man is contracted out at an hourly rate whenever needed.  Does the management company charge the owner of the property an hourly rate equal to their cost of employing their maintenance man or do they charge the property owner at an hourly rate that’s well above what it actually costs the property management company to have this person employed by them?  Many times the property management company is charging the property owner an hourly rate that is well above what it’s costing them to have this employee on staff.  If so, they are making money on you every time a maintenance item is being fixed on your property.  Just by looking at the Maintenance & Repair costs I can usually tell which property management companies are charging an excessive hourly rate for their maintenance personnel. 

3.   Do they charge the owner of a property an asset management fee?  If so is the fee a reasonable expense for the services rendered and again is it really a hidden profit center for the property management company?    

Are their operating statements easily readable and disclose all important information?  The quality of operating statements I see varies widely from hand written to very detailed computer generated reports.  Income and expense items to watch: 

1.   Do the operating statements begin with gross potential rent or do they begin with effective gross income?  In other words do the statements show vacancy, bad debt, and concessions?  If the statements do not show gross potential then owners can’t determine quickly how much vacancy the property is experiencing.   

2.   Do the operating statements show all payroll expenses including free rent?

An owner cannot make informed decisions on his property without having accurate and detailed operating statements that show the “good, the bad and the ugly.”

Can I help select my on-site manager?  No matter how good the property management company is, the on-site manager has the most influence on a property’s performance.  And the only way to determine the quality of an on-site manager is to observe how well they do their job.  I would focus on these issues:

1.   How is the property’s curb appeal?  Is trash found lying on the grounds picked up regularly?  Are trash enclosures hidden and well maintained so as not to be an eyesore?  Are flower beds weed free and attractive? 

2.   How well do they stay on top of collecting monthly rents?  Some managers are passive about collecting rents which over time will cause collection problems.  Other managers promptly post notices and stay on top of renters who pay slowly.

3.   How quickly do they get a unit ready to be re-rented?  In a tight rental market that we are in, every day a unit is waiting to be cleaned is money out of your pocket.  Ask the manager what type of system she has for getting units market ready. 

A good on-site manager is worth their weight in gold and can have a significant impact on the property’s cash flow.   The old adage, “You get what you inspect, instead of what you expect” is very true in property management.    

Choosing a property management company and an on-site property manager in many instances can make the difference between a property that does well and one that limps along.  Call me if you need a recommendation.