Over time, the cost of operating a real estate facility can become comparable to the very cost of the building’s construction. As a result, there is a widespread discussion currently running among experts and operators concerning ways to optimize expenditures. CRE has decided to jump into the ring to discuss this topic. With the assistance of experts, we clarify what optimization is, how to decrease operating costs without sacrificing quality services and which operations are considered the most expensive.

Optimization begins by setting a budget and seeking the most efficient means for managing and operating a real estate facility. Every building is unique in its own way and requires the development of an individual program for optimizing expenditures. The popular practice in the West is to hire independent consultants who can design the most efficient means for managing and operating a real estate facility. Yaroslav Shuvalov, director of the real estate management department at Knight Frank, argues that, “Recently, the opportunity to hire outside consultants to analyze and develop measures for optimization has appeared in Russia. However, this service is not cheap and could cost as much as $40,000 or more.”

For facilities already in operation, optimization can be achieved by conducting an audit of the current management system. “If a management company can broaden the line of services and improve their quality for the same price, then they are optimizing,” adds Shuvalov.

The following list is a breakdown of typical real estate operating expenses, as presented by Facilicom group of companies:

• Labor costs for specialists (including taxes) 65%70% (including reclassification)
• Management of a facility 7%10%
• Expenses for materials 8%10%
• Amortization and depreciation of equipment, installations, uniforms, etc 5%8%
• Overhead costs, etc 15%20%

In addition, operating costs include:

• The cost for electricity, heating, water supply
• The cost of periodic subcontract work (technical servicing and maintenance of the elevators, window washers, etc)
• Amortization and depreciation for overhauling of equipment and installations
• Building and professional liability insurance for contractors
• Waste and snow removal

From the list above, it is obvious that the largest expense is for the salaries of specialists. Accordingly, it is easy to understand that the services involving the largest number of personnel are the most extravagant and optimizing these expenditures can be achieved in several ways. For example, professionally selected modern engineering systems save on maintenance staff (as well as on energy resources), while optimizing the flow of visitors and tenants through modern security devices decreases the number of security posts and administration.

In terms of cleaning services, a lot depends on the level of quality demanded by both the company and the client. “Not every company can afford a wide range of cleaning services, and decreasing manpower for such services is a good way to optimize expenditures,” believes Eduard Apsit, general director at Facilicom. Apsit adds, “Theoretically, it is possible to save on everything, with importance being placed on understanding and figuring out what can be foregone and what cannot. In Finnish offices, for example, the employees themselves keep their working areas clean, with the main cleaning taking place once a week. It is possible to choose a more intensive schedule for cleaning, but it will cost considerably more.”

The Tender

As has already been noted, one of the means for real savings is to take a professional approach to formulating a budget for managing a real estate facility. At this point, the main operating quality criteria are determined, the amount that the owner is set to pay for operating expenses is agreed upon, and the arrangement for interrelationship with the management company is set.

One must also note that the intelligent preparation of the tender and bidding documentation is a very important step for optimizing expenses. “There are very few Russian companies with a professional attitude toward organizing tenders for the services of a management company,” believes Konstantin Baranov, managing partner at Colliers International FM. “This needs to change, as only a fully workedout tender package sets the rules of the game and lays the main criteria for quality.” Anna Derkach, general director at PRAKTIS PFM, agrees: “It is of the utmost importance that the client and the management company set identical goals and expectations of operation for the management company at the facility.”

Furthermore, specialists emphasize that nobody in Russia factors in the cost of operation, although operating a large facility requires a lot of money. An owner more often than not tries to decrease the cost of services to a profitable rate for a constant length of time. “On the other hand, in the West, particularly in Finland, a tender is not accepted until the owner determines how many hours are necessary to spend on the servicing of the square meters. The most efficient management model is developed only by following this. There is an independent institute of consultants that analyze and calculate the most efficient means during a new tender, construction of a facility and reorganization of work. However, in Russia, the most experienced clients simply organize tenders themselves, thereby receiving all of their information from the participants,” argues Apsit.

When determining an optimization strategy, there must be certain terms and conditions set to encourage parties to sensibly and efficiently spend funds. However, Baranov argues that in Russia, “An owner and a management company, more often than not, think about setting a minimum budget rather than how to implement an efficient management system. If an efficient management system were in place, both parties would be interested in optimization.”

According to Baranov, a flexible budget plan increases incentives for both parties in the optimization process. “In other countries, the following interrelationship between a management company and an owner is economically viable: the parties agree on a budget, which is adjusted monthly or quarterly, but there is an agreement that the funds saved will be divided equally between the owner and the management company.

Accordingly, the management company has an extra incentive to hire the best supplier and service and to analyze how efficient the business processes are within its own company. There are a number of Western organizations that hire management companies and set this goal, but this is an exception rather than the rule. The main reason for this is the lack of enough experience on the part of the developer, and due to the rampant demand for real estate, discussions for setting terms and conditions to optimize funds do not happen very often,” says Baranov.

Moreover, negotiations are often conducted on behalf of an owner by a party who does not have practical experience in managing real estate facilities, thus negatively affecting future work of the management company. Moreover, good workmanship is necessary when there are not enough personnel. Indeed, there is a wellknown debate whether it is possible to make eight hats from one skin. The answer is yes, but this is unlikely to be to the satisfaction of the client.

Any means are good to achieve a goal, and it is namely this principle that guides those for whom winning a tender at any price is necessary. Indeed, an obvious example is the unjustifiably understated services of a management company, which, in conjunction with a haphazard tender, jeopardizes the quality of services. According to Baranov, “If an owner looks at only the figures, he risks being left with the cheese instead of the cream. Competition on the market is growing, and companies competing with one another must lower prices. However, there is a fine line which cannot be crossed; otherwise, quality will be seriously sacrificed, and the owner could end up losing in this battle.”

Various administrative structures, created by the owner in more than 50% of the cases, increase the cost of managing a real estate facility. “Optimization must begin with the internal structure of the owner and company. For example, is it necessary to have additional employees, or is it simpler to change management companies or reduce staff to two employees who could adequately assess the activity of the management company and be the contact point between the owner and the management company?” questions Baranov.

Starting Over

Developer errors can also be the cause of increased expenses but consulting with professional experts at the design stage can minimize them. “Developers often forget that it is necessary to provide for technology to conveniently dispose of garbage and clean common areas, and sometimes they forget to include the number of employees of the tenant firms when planning cafeterias, elevators, control for entering and exiting, etc,” says Shuvalov.

The first decisions influencing the cost of service are made at the design stage of a building. Indeed, specifically at this time, those responsible for the vital functions of the real estate facility – the developer, consultants, architect, designer, general contractor and many others – meet to evaluate all design solutions in terms of construction cost, efficiency and degree of difficulty in completing the facility.

However, it is just as important to seek consultation on the cost of servicing a real estate facility, given that in the long run, this is a large investment that could exceed the cost of the construction. “Recently, management companies are increasingly being hired to work on projects. It is important to study all design solutions as early as possible to operate a facility efficiently. The efficient investment of funds in the long run is more important for optimization than is an instantaneous result,” explains Evgenia Vlasova, managing director at Sawatzky Property Management.

“Oftentimes, a facility is not equipped with an engineering system and installations or these services are inconvenient or extravagant,” says Shuvalov.

For example, the control panels for a building’s engineering system are often in several locations. “This increases the costs and complicates the operating process, given that it is necessary to install additional roundtheclock security points and administration,” says Derkach. “However, this could be avoided at the design stage by hiring experts, including management company specialists, who can assist in creating a centralized operating system.”

Moreover, excessive design solutions also increase expenses and can be eliminated to significantly optimize on expenditures without lowering the quality of managing the facility. A good example is eliminating unnecessary entrances and exits that are more for aesthetics and do not affect the flow of visitors. The installation of excess zones requires additional expenditures on security systems, installing security posts, etc. According to Sawatzky Property Management, the services of just one security post to control entry and exit costs around $30,000 annually, while expenses on technical maintenance of the access control electrical security systems cost $10,000 per year.

It is also important to consider that similar changes in the architecture at the design stage could increase leasable premises, thus generating additional income for the owner. When designing fashionable yet extremely expensive systems, especially ones that are completely automated and controlled, an owner must think about whether this is a necessary expense.

“New buildings are complicated in terms of their engineering and maintenance installment; therefore, one of the most expensive items is the servicing and technical maintenance of the engineering systems and equipment,” believes Shuvalov. “Expenses on this can be optimized by using modern technology, such as a building management system (BMS). This system remotely controls the operating parameters of the engineering equipment and reacts in a timely manner to any emergency situation, thereby preventing more serious damage to the building or to the tenants’ property.”

As such, intelligently installing modern technology and operating systems in a building decreases operating expenses by 15%20% and lowers costs for electricity by 40%. Although these systems are rather expensive, they recoup their expense quite quickly.

The selection of service providers for optimizing expenses on management is reliable and widely offered. When selecting a service provider, preference should be given to producers with liberal pricing policies in terms of service, while the number of service centers and the presence of a Moscow representative office are important. “Designers offering engineering equipment have a direct material interest given that they receive a commission from the producer when they install said producer’s equipment. By consulting with a management company, an owner does not commit to a specific producer; rather, he chooses the optimal variant in terms of quality and the cost of service. Also, having a large spectrum of service companies allows an owner to save 10%­15%, and maybe up to 20%, on expenses for the servicing of engineering systems,” says Baranov.

Oftentimes, a building’s “smart” dispatch system is programmed so that only the producer can make alterations in the system’s operation. Accordingly, in time, service costs exceed the cost of the equipment several times over. “If the management company can independently alter the operation of the dispatch system, 30%40% can be saved on servicing,” underscores Baranov. Using heat pump apparatuses, instead of the traditional climate control systems, can also reduce expenses on electricity.

The most expensive item, according to Baranov, is installing a building’s physical security, given that often most personnel work specifically here. As such, optimizing the arrangement by which visitors enter and exit the building can save on security.

“Holding a tender to select a contractor, for example, once every three years, also saves on operations. Frequently, such tenders result in signing a contract with a previous contractor, but, this time, on different terms and conditions. Moreover, we have had a very interesting experience when we hired two different contractors to complete the same work. Having analyzed the results, we understood that we managed to save nearly 10% while also receiving more quality and efficient service,” says Shuvalov.

Even if a management company intends to work with a longtime contractor, it is still worth finding out what prices the competing companies charge for their services. Often this type of comparative shopping reduces the costs of a business partner.

Show Me the Money

Funds saved as a result of optimization could go into the budget of either the management company or the owner. However, the tenant remains the odd man out, as he rarely benefits from a decrease in operating expenses. “At this time, lowering operating expenses is not a widespread practice, as rates for operating expenses are fixed in many cases. Frequently, saving on operating expenses (sometimes even in excess of reasonable optimization) is simply additional income for an owner,” concludes Shuvalov.