Two bedrooms and the Internet

BRE furnishes its apartments with technology. In return, technology furnishes BRE with FFO growth potential.

San Francisco-based BRE Properties (NYSE: BRE) is betting that technology will improve the financial performance of its multifamily communities. Over the past 18 months, the REIT has wired the lion's share of its 72 apartment properties, which contain 20,521 units, with high-speed Internet access. Another nine communities with a total of 2,113 units, expected to come on line over the next year or so, will offer residents similar connectivity.

BRE's technology strategy supports the company's belief that customer satisfaction can add significantly to its financial performance. "We offer very high-quality properties, not by any means a lower-price alternative," says Frank McDowell, BRE's president and CEO. "We believe our tenants choose to pay for a high-quality home and high-quality service, and we don't think the industry generally has spent as much effort as is warranted on service."

BRE's apartment communities reside primarily in the western United States, in California, Arizona, Washington, Oregon, Utah and Colorado. The company has developed or acquired its properties with an eye toward locations near businesses, transportation and employment centers to ensure easy commutes for residents.

Apartment types include suburban garden units and urban infill developments, as well as townhouses with attached garages and mid-rise flats over street-level retail. The variety of property types reflects the company's interest in satisfying various lifestyle preferences.

But the real breakthrough in the company's efforts to boost customer satisfaction came with the installation of high-speed Internet connections in its units, which was followed recently by a portal service that allows residents to browse the Internet, request maintenance and pay rent online. These high-speed connections also accommodate pay-per-view movie services supplied independently of conventional cable connections.

Tenants like the high-speed service. And BRE's accountants like the results. "We think broadband connectivity is crucial to the future of our industry," says McDowell. "Part of this is customer service, and part of it is how we run our properties, how we communicate between properties, regional offices and the corporate headquarters."

From old-style to a multifamily focus BRE has not always pursued forward-looking strategies. Founded in 1970, the company grew by acquiring and developing a variety of property types, including industrial, retail, office and apartment assets. As the company grew, it farmed out its property management chores.

McDowell came on board in 1995, accepting the board's assignment to re-position the company within a single property type. With a background in managing public multifamily companies, McDowell turned BRE's attention toward multifamily by acquiring the REIT of California in 1996 and the assets of Trammell Crow Residential-West in 1997. Those moves added management depth and brought property management capability to BRE.

During 1997 and 1998, BRE disposed of 14 commercial and retail properties for approximately $108 million. At the same time, BRE acquired 29 multifamily properties, developed seven new ones and sold five. As of closing on Dec. 20, 2000, BRE's stock price was $31.88, and the company's 52-week high was$33.63.

In 1999, McDowell retained Los Angeles-based J.D. Power and Associates to track the satisfaction of BRE tenants. J.D. Power gained fame by studying customer satisfaction for major automobile manufacturers and other consumer products manufacturers. BRE has been receiving quarterly reports from J.D. Power since the middle of 2000.

What do those reports show? "We're the first multifamily company to use J.D. Power," says McDowell. "So we have no peer competition with which to compare ourselves. But we do compare ourselves to other industries that study customer satisfaction. I think our results so far are good. But the real benefits will come in the future as we learn more about satisfaction levels."

The leap to warp speed At the heart of McDowell's vision of customer service lies VelocityHSI, which BRE rolled out in 4,000 units at the end of 1999. VelocityHSI provides residents with high-speed Internet connections.

By the end of this year, VelocityHSI will offer a full-service Internet portal called KlickLANE to virtually all of the apartment communities on its client list, which includes BRE and may soon include other multifamily companies. Meanwhile, BRE has spun off VelocityHSI and currently owns less than 10% of the independent company's stock.

VelocityHSI came about as the logical next step in a technology initiative launched by McDowell. Shortly after his arrival, BRE built a high-speed company intranet, linking nine regional management offices and the corporate offices. The convenience of that system led management to search for ways to tie individual property offices into the system.

"At first we thought that the increased productivity of such a system would overcome any cost concerns," says LeRoy Carlson, executive vice president and COO with BRE. "But it did come down to cost. The high-speed connections we needed cost $1,200 per month per property."

The BRE system requires a type of telephone line service called T-1, which provides transmission speeds of 1.5 megabytes per second as well as regular voice telephone service. But at $1,200 per month, T-1 service simply costs too much to serve only as a property management tool.

On the other hand, as a customer amenity, it offers revenue potential. Suppose a development with 300 properties were wired with T-1 service. Suppose further that families in 100 of those units opted to subscribe to the high-speed Internet service made possible by the T-1 connection.

The resulting revenue would not only pay for the management office connection, but also generate auxiliary monthly revenue for the property. "At that point, it becomes a lucrative business," says Carlson. "And that's the idea that spawned VelocityHSI."

When BRE rolled VelocityHSI out in late 1999, company officials were not planning to divide the BRE focus between multifamily and technology businesses. Instead, they believed they were incubating a business with an independent future capable of offering a valuable service to multifamily property developers and owners.

"The technology business has a different risk profile than the real estate business," says McDowell. "In 1999, capital was available to technology companies that was not readily available to real estate companies. The valuations in the two sectors were very different. Since then, all of that has changed, but our original premise remains: BRE and VelocityHSI are two different businesses, and VelocityHSI must fund itself."

An independent, self-sustaining VelocityHSI does that, while fueling the BRE customer service engine. BRE currently offers VelocityHSI's high-speed Internet access service to residents for approximately $35 per month. VelocityHSI provides the service, and residents opting to subscribe write checks to VelocityHSI, which then shares its revenue with BRE or any other apartment owner making VelocityHSI available to its residents.

But a revenue-sharing slice of $35 per month per unit does not do justice to the role BRE envisions for VelocityHSI's services. McDowell sees VelocityHSI as a technological platform that can improve the efficiency of BRE's business operations and, more importantly, add to BRE's ability to build customer satisfaction and FFO performance.

Customer satisfaction and FFO McDowell's decision to retain J.D. Power suggests that the company's talk about customer satisfaction is more than just talk. Automobile manufacturers know that satisfying a customer goes a long way to selling that customer his or her next car.

Accordingly, satisfying a tenant during his or her first year on a lease can go a long way toward selling another year-long lease to that tenant. Consistently selling new leases to existing tenants can add substantially to an apartment REIT's FFO, according to McDowell.

"Historically, the multifamily business has assumed that turnover in tenants was just part of the business," he says. "No matter what you did, a certain percentage of tenants would leave in the next year or so. We don't accept this idea. When we look at our residents, we see that a fairly large percentage stay a year, and a large minority will stay three, four and five years. In other words, there is nothing fundamental in the business that says residents are only going to stay with you for a year to 18 months.

"Our strategy is twofold in this," he adds. "First, we want to try and attract people who are at least amenable to considering a longer residency. And second, to make sure those people are very satisfied with the quality and breadth of services we provide. And those services must be not just good, but important to those residents."

According to McDowell, it costs BRE approximately $1,500 when a tenant decides to move out. That figure includes the cost of renovating the apartment, marketing to a new tenant and revenue losses stemming from the vacancy.

For a REIT with 22,000 units, reducing turnover by 4% a year can produce a savings of $1.32 million per year, which flows directly into FFO. And that is what McDowell's customer satisfaction efforts have achieved for BRE.

According to New York-based Morgan Stanley Dean Witter, BRE's turnover rate from January through September of this year stood at 66%, four points lower than the same period in 1999.

"We would like to reduce turnover by another five to 10 points," says McDowell. "This is a key element of our strategy."

BRE's customer satisfaction strategy and related technology initiative give the company a way to mine segments of its customer base for further incremental reductions in turnover. By offering upscale apartments, BRE attracts a substantial number of people who rent by choice rather than need. These renters, for one reason or another, do not want to own a house, even though they can afford one. Perhaps they have no time to care for a home. For whatever reason, approximately 20% of BRE's tenants rent by choice and not need, according to McDowell.

McDowell estimates that renters by choice made up only 12% to 15% of the market five years ago. "By attracting renters by choice on the margin and by keeping a percentage of them for two years, the effect on the bottom line can be huge," he says.

At BRE, one of the main ways to create that effect on the bottom line and attract renters by choice is by offering superior technology.

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