When looking at investing in a portfolio of commercial real estate, it is important not only to look at the performance (across many metrics) of each individual asset – but also to look at how these metrics may change when looking at balancing an entire portfolio.

In order to drive the best possible returns – one cannot simply be a ‘collector’ of property, one needs to establish, analyse and interrogate a range of suitable information to ensure that the individual assets ‘layer’ well with all the others.

Currently, our management pack comprises the following schedules – designed to be of use both internally in day-to-day management of the firm, but also to the Board of Directors:

Primary Statements

• Cash Flow m/m, actuals & forecast, current year, trailing 12 month, forecast 12 month
• Profit & Loss q/q, actuals & forecast, current year, trailing 12 month, forecast 12 month
• Balance Sheet q/q, actuals & forecast, current year, trailing 12 month – Whilst technically possible to forecast a balance sheet – Manston’s view is that such an exercise is largely one in futility. Who is to say precisely where the markets are today for our assets, never mind in 12 months+ time!

Supporting Schedules

• Land & Buildings
• Lease Schedule
• Rental Forecasts
• Void Property Schedule

Working Papers

• Payments Schedule
• Mortgage Schedule
• Current Assets
• Current Liabilities
• Journals
• Interest Rate Schedule
• Trial Balance
• Net Income by Property

This is heavy going stuff – and it would be unreasonable to expect our board to read, digest and understand this entire pack ahead of each relevant meeting. As an investor or non-exec. director – you cannot be expected to have the same granular understanding of the day-to-day performance of the business – and you need information that is both relevant and easy to digest; you need the executive to point you towards the important bits, without fear or favour.

So – we provide a ‘dashboard’ of KPIs – highlighting relevant areas for further inspection.

KPIs are the headline metrics which we, as a business, find most useful in providing a summary of performance. They are backed up by our full management pack, which goes into highly granular detail, to allow full interrogation of any chosen KPI. The next 3 of these newsletters will explore these three KPI areas in more detail.

At Manston, we roughly divide our KPIs into three distinct categories:

• Finance

• Property

• Leases

Whilst we nominally split them into these three sections – it should be noted that there is a large amount of overlap between the sections – this is an art, not a science!

Finance

The lifeblood of every business and so the obvious starting point for designing a useful dashboard of information. As all roads lead to Rome, so all KPIs ultimately lead to money (even if only indirectly, such as HR metrics) – but some are more financial than others.

Our key measurements here (although certainly, this is not an exclusive list) are:

• Gross Income Yield (current year and previous)
• Debt Weighting
• Break-Even Calcs
• Debt Cost Metrics
• Cash at Bank (or on term deposit)
• Overhead
• Receivables

Gross Income Yield (current year and previous)

A nice simple headline indication of what your income yield on the portfolio is. This is simply the total rent received for a year (or annualised, if working with part year data) divided by the total book value of the property assets you hold. I always like to include the previous year with nearly all of my KPIs to quickly identify trends – which can then be dug into in more detail as may be needed.

We also include our Estimated Reversionary yield for the current year as well – an estimate for what our rent-roll would be if all new leases started today, at the correct market price. Frequently leases will generate income either above or below the market level – and it is always a good sense check to measure yourself against this yardstick.

If our Passing Rent to ERR (Est. Reversionary Rent) ratio is below ‘1’ then we can expect to increase our rent roll as leases come back to market or undergo a rent review – if however our ratio is significantly above ‘1’ then we should prepare to receive a lower level of rental income in the future as leases revert to market norms. This is a typical ‘lead’ indicator – pointing to potential future changes that we should be aware of and prepare for.

I think this illustrates the fundamental flexibility of a good KPI – it doesn’t always provide (indeed, I would argue, rarely provides) a neat answer to a meaningful question – but it acts as a signpost, allowing deeper analysis of emergent issues.

Debt Weighting

By debt weighting – I mean the Loan to Value ratios of your portfolio. This is highly important, as your debt is likely to be subject to strict lender covenants on how high this ratio can be – similarly you may not want to run an LTV too low and risk out on the benefits of sensible leverage within the portfolio. Simply put, LTV is the value of relevant debt to that of the relevant asset (or assets)

At Manston – we run three LTV calculations concurrently – Debt to our Total Property book value, Debt to our Charged Property book value and Debt to our Charged Property bank valuation value.

As we at Manston have historically only provided fixed charges on certain of our assets – it is important to understand with clarity the difference between these interconnected measures. An LTV of 60% across the whole portfolio (with a covenant of 60% maximum) is cause for quite some alarm; however an LTV of 60% over charged properties with a total book LTV of 25% whilst still a situation requiring remediation – is less a cause for concern and won’t result in your bank manager lurking in a darkened alley for you, ready to beat you over the head with a copy of the latest capital adequacy rules.

Often you will see a very similar measure employed in KPIs – that of the ‘gearing’ of the business. But as where LTV = Debt/Asset Value (with asset value roughly being debt + equity), Gearing is expressed as a function of debt to equity.

• Debt of £140m
• Equity of £200m
• Asset Value of £340m
• LTV = 140m/340m = 41%
• Gearing = 140m/200m = 70%

It is really personal preference that matters when choosing – just be careful not to mix them up!

Break-Even Calcs

These calculations (again done on the same three bases as above) are a ‘stress test’ metric – how much pressure can we put on the business before we start to breach our LTV covenants above?

These indicators show the maximum amount that the portfolio (or part of the portfolio) can fall in value before the LTV levels rise to a pre-determined cap rate (for us, we use our maximum covenant rate). For instance – I can look at an LTV of 34.3% and know that I could withstand a c. 43% drop in property prices before I breach covenant of 60% LTV.

Debt Cost Metrics

Highly important – as this is another of the two covenants which are likely to be watched by your lender most closely. You may well have security to keep a nice low LTV – but can you afford to service the debt – both interest & margin and capital repayments? This is perhaps particularly relevant in ultra-low yield environments, where NIYs of 4% or so are not unheard of. Again – there will be limits covenanted for with your lender here.

Usually – one of two measures can be adopted here: Interest Cover or Debt Service Cover

Interest Cover is simply a ratio is interest (+margin) costs of the debt against the rent-roll receivable from the relevant assets (whole portfolio, charged assets, etc.). If you have an ICx of 3x – then this means that your income covers your repayments 3x.

Debt Service Cover adds in the cost of capital repayment, and so usually a lower limit is covenanted for (maybe 1.4x).

It should be remembered however that both of these metrics look at Gross-Rent-Roll, and make no direct account of either direct costs or overheads – so attention needs to be given to your costs of running and maintaining the portfolio as well, remembering that the lenders have to come first!

Manston watch ICx as our covenant with the bank, but also monitor DSCx as an internal measure – showing the ‘belt, braces & large piece of string’ approach we adopt to monitoring and managing the debt layer of our capital stack.

Cash at Bank (or on term deposit)

Cash is King – absolutely. In property it would be terribly easy to run a profitable business, with nice big black numbers at the bottom of your P&L statement – and still to run out of cash – sometimes remarkably quickly.

Quick, highly idealised, example – I borrow at a 100% LTV to purchase a £5m asset, yielding 7% with a rock solid covenant for 10 years. With interest rates + Margin at 6.5% – there is a good wedge of clear blue sky between what I pay to the bank and what I receive – a nominal profit of c. £25k + any unrealised gains in value on the asset itself. However when you account for the non-profit line item of capital repayment on amortising debt, over say 30 years (so call it 3.33%/annum), the cash cost of supporting the debt rises to 9.83% and whilst I still turn a profit, I lose cash at the rate of £141k per annum. How am I going to fund this shortfall?

Manston maintain clear policies over minimum cash balances, and engage in heavy scenario modelling within our management accounts to ensure that we always retain a ‘buffer’ of cash at hand, regardless of the commercial eventualities we may face.

We like to present, front-and-centre, what our cash balance is – this not only guides internal decision making (shall we buy, shall we sell?) but also provides comfort to our stakeholders that we are acting prudently and with forethought.

Not wishing to over-complicate the process – we do not split out cash at bank and cash held on short term deposit (say anything below 3 months call) – but just provide a single number for cash realisable on relatively short notice. Whilst some trading firms may consider 3 months to be quite a period of time for cash to be held up – in investment CRE, we are lucky that things can move quite slowly, and large cash calls can be planned for well in advance, to enable our Treasury function to liquify and allocate cash as needed.

Overhead

In brief – this is the amount of debt that it is possible for us to draw from our lenders, without the rigmarole of having to go back to credit committee for approval – in essence this is debt pre-approved in principle. We may or may not have security in place to actually draw this money down – but it establishes the principle of how much we could draw down with sufficient security.

This isn’t a target for debt to deploy – nor is it a maximum cap to debt we could employ. This is a useful proxy measure for debt deployable with relative speed, and can increase our certainty in bidding for property – knowing that we may be able to draw cash prior to completion and be a ‘cash’ bidder, rather than have to simultaneously charge & complete, which can be less attractive for a vendor.

Receivables

As with (nearly!) all business – we like to know who owes us money, how overdue it is, and whether or not it needs prodding. Apart from the usual credit monitoring undertaken by our finance department, we found that investors asked questions about accounts receivable more often than almost any other question – so we brought it to the front of our ‘pack’.

I believe firmly in nuance when it comes to receivables – as rarely are two cases alike. This is why we split receivables into three categories – Practically Overdue, Questionable and Bad.

1. Practically Overdue

• • Given the nature of CRE leases, with some payments monthly, some quarterly at quarter end, some on ‘old English’ quarter days, some on ‘new English’ quarter days, some contracted to quarters but with side letters permitting monthly payments – we may have a large amount of overdue receivables at the end of any reporting period – however, we know that this is only technically overdue due to timing issues. We don’t worry about this at all, it isn’t overdue in a practical sense.
  • Practically overdue debt however, warrants some brief attention – debt that is now actually past-date once timing issues have been stripped out. It may be that a new accounts clerk with a tenant has had trouble making the payment and it will be resolved shortly, or it may be a warning sign. Flagging it at this point keeps it front and centre of peoples’ minds.

2. Questionable

• • This is where we have initial concerns about the reasons for delay – a good payer is suddenly a week or two later than usual, the accounts department have noticed a lack of response to communication – this warrants flagging.

3. Bad

• • This is truly ‘bad’ debt, where have severe reservations about being paid and may need to write the value off.

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These are the financial KPIs that we find particularly helpful at Manston – but this is not say that this list is exclusive. We choose these KPIs because they keep us informed quickly about the areas of the business most likely to be of relevance to our considerations.

A business with many different debt facilities may find it helpful to report on weighted average cost of debt, or average time to maturity; a more operationally intense business may focus on more profit metrics (GP, OP, PAT, EBITDA, etc.); a supplier heavy business may look to accounts payable, payable days, etc. – and whilst Manston reports on all of these within the relevant schedules, they are not important enough to warrant star billing on the dashboard.

KPIs should paint a picture of where the business is at any given time, sign-posting areas for further research – but fundamentally remembering that each business is unique and requires a different range of measures to accurately reflect its true position & health.

Ultimately – as an investor – you want clarity. Meaningful information (good and bad) presented consistently, cleanly, comparably, comprehensibly and comprehensively.

In the next instalment – we look into the (ahem) bricks & mortar of the business – by examining our suite of ‘Property’ KPIs.