Learn to Value Real Estate Investment Property

From a quantitative perspective, investing in real estate is somewhat like investing in stocks. To profit, investors must determine the value of the properties they buy and make educated guesses about how much profit these investments will generate, whether through property appreciation , rental income or a combination of […]

From a quantitative perspective, investing in real estate is somewhat like investing in stocks. To profit, investorsmust determine the value of the properties they buy and make educated guesses about how much profit these investmentswill generate, whether through property appreciation, rental income or a combination of both.

Equity valuation is typically conducted through two basic methodologies: absolute value and relative value. The same is true for property assessment. Discounting future net operating income (NOI) by the appropriate discount rate for real estate is similar to discounted cash flow (DCF) valuations for stock, while integrating the gross income multiplier model in real estate is comparable to relative value valuations with stocks. Below, we’ll take a look at how to value a real estate property using these methods.

The Capitalization Rate

One of the most important assumptions that a real estate investor must make when valuing properties is choosing an appropriate capitalization rate, which is the required rate of return on real estate, net of value appreciation or depreciation. Put simply, it is the rate that is applied to net operating income to determine the present value of a property.

For example, if a property that is expected to generate net operating income (NOI) of $1 million over the next ten years is discounted at a capitalization rate of 14%, the market value of the property would be determined to be $1,000,000 / .14 = $7,142,857, where the net operating income divided by the overall capitalization rate equals market value.

The $7,142,857 market value represents a good deal if the property is selling at $6.5 million and it would be a bad deal if the sale price is $8 million.

Determining the capitalization rate is one of the key metrics in valuing an income-generating property. Although it is somewhat more complicated than calculating the weighted average cost of capital (WACC) of a firm, there are several methods that investors can use to find an appropriate capitalization rate.

The Build-Up Method

One common approach is the build-up method. Starting with the interest rate, add in:

  1. the appropriate liquidity premium (which arises due to the illiquid nature of real estate)
  2. recapture premium (which accounts for net land appreciation)
  3. risk premium (which reveals the overall risk exposure of the real estate market)

Given an interest rate of 4%, a non-liquidity rate of 1.5%, a recapture premium of 1.5% and a rate of risk of 2.5%, the capitalization rate of an equity property would be summed as: 6+1.5+1.5+2.5 = 11.5%. If net operating income was $200,000, the market value of the property would be: $200,000/.115 = $1,739,130.

Obviously, performing this calculation is very straightforward. The complexity lies in assessing accurate estimates for the individual components of the capitalization rate, which can be challenging. The advantage of the build-up method is that it attempts to define and accurately measure individual components of a discount rate.

The Market-Extraction Method

This method assumes that there is current, readily available net operating income and sale price information on comparable income-generating properties. The advantage with the market-extraction method is that the capitalization rate makes the direct income capitalization more meaningful.

Determining the capitalization rate is relatively simple here. Assume an investor is considering buying into a parking lot that is expected to generate $500,000 in net operating income. In the area, there are three existing comparable income generating parking lot properties.

  • Parking Lot 1 has a net operating income of $250,000 and a sale price of $3 million. In this case, the capitalization rate is: $250,000/$3,000,000 = 8.33%.
  • Parking Lot 2 has a net operating income of $400,000 and a sale price of $3.95 million. The capitalization rate is: $400,000/$3,950,000 = 10.13%.
  • Parking Lot 3 has a net operating income of $185,000 and a sale price of $2 million. The capitalization rate is: $185,000/$2,000,000 = 9.25%.

Based on the calculated rates for these three comparable properties (8.33, 10.13 and 9.25%), an overall capitalization rate of 9.4% would be a reasonable representation of the market. Using this capitalization rate, an investor could determine the market value of the property. The parking lot investment opportunity would be valued using at $500,000/.094 = $5,319,149.

The Band-of-Investment Method

The capitalization rate is computed using individual rates of interest for properties that use both debt and equity financing. The advantage of the band-of-investment method is that it is the most appropriate capitalization rate for financed real estate investments.

The first step is to calculate a sinking fund factor. This is the percentage that must be set aside each period to have a certain amount at a future point in time. Assume that a property with net operating income of $950,000 is 50% financed, using debt at 7% interest to be amortized over 15 years. The rest is paid for with equity at a required rate of return of 10%. The sinking fund factor would be calculated as:

Interest rate / 12 months
{[1 + (interest rate / 12 months)]# of years x 12 months}-1

Plugging in the numbers, we get:

.07/12
{[1 + (.07/12)]15×12} – 1

This computes to .003154 per month. Per annum, this percentage: .003154 x 12 months = 0.0378. The rate at which a lender must be paid equals this sinking fund factor plus the interest rate. In this example, this rate is: .07 + .0378 = 10.78%, or .1078. 

Thus, the weighted average rate, or the overall capitalization rate, using the 50% weight for debt and 50% weight for equity is: (.5 x .1078) + (.5 x .10) = 10.39%. As a result, the market value of the property would be: $950,000/.1039 = $9,143,407.

Comparable Equity Valuations

Absolute valuation models determine the present value of future incoming cash flows to obtain the intrinsic value of a share; the most common methods are dividend discount models (DDM) and discounted cash flow (DCF) techniques. On the other hand, relative value methods suggest that two comparable securities should be similarly priced according to their earnings. Ratios such as price-to-earnings and price-to-sales are compared to other intra-industry companies to determine whether a stock is under or over-valued. As in equity valuation, real estate valuation analysis should implement both procedures to determine a range of possible values.

Calculating a Real Estate Property’s Net Operating Income

Where:

  • NOI – net operating income
  • r- Required rate of return on real estate assets
  • g- Growth rate of NOI
  • R- Capitalization rate (r-g)

The net operating income reflects the earnings that the property will generate after factoring in operating expenses but before the deduction of taxes and interest payments. Before deducting expenses, the total revenues gained from the investment must be determined. Expected rental revenue can initially be forecasted based on comparable properties nearby. By doing the proper market research, an investor can determine what prices tenants are being charged in the area and assume that similar per-square-foot rents can be applied to this property. Forecasted increases in rents are accounted for in the growth rate within the formula.

Since high vacancy rates are a potential threat to real estate investment returns, either a sensitivity analysis or realistic conservative estimates should be used to determine the forgone income if the asset is not utilized at full capacity.

Operating expenses include those that are directly incurred through the day-to-day operations of the building such as property insurance, management fees, maintenance fees and utility costs. Note that depreciation is not included in the total expense calculation. The net operating income of a real estate property is similar to the earnings before interest, taxes, depreciation and amortization (EBITDA) of a corporation.

Discounting the net operating income from a real estate investment by the market capitalization rate is analogous to discounting a future dividend stream by the appropriate required rate of return, adjusted for dividend growth. Equity investors familiar with dividend growth models should immediately see the resemblance. (The DDM is one of the most foundational of financial theories, but it’s only as good as its assumptions. Check out “Digging Into the Dividend Discount Model.”)

Finding a Property’s Income-Generating Capacity

The gross income multiplier approach is a relative valuation method that is based on the underlying assumption that properties in the same area will be valued proportionally to the gross income that they help generate. As the name implies, gross income is the total income before the deduction of any operating expenses. However, vacancy rates must be forecast in order to obtain an accurate gross income estimate.

For example, if a real estate investor purchases a 100,000-square-foot building, he may determine that the average gross monthly income per square foot in the neighborhood is $10, based on comparable property data. Although the investor may initially assume that the gross annual income is $12 million ($10 x12 months x 100,000 sq. feet), there are likely to be some vacant units in the building at any given time. Assuming that there is a 10% vacancy rate, the gross annual income would be $10.8 million ($12m x 90%). A similar approach is applied to the net operating income approach as well.

The next step in assessing the value of the real estate property is to determine the gross income multiplier. This can be achieved if one has access to historical sales data. Looking at the sales prices of comparable properties and dividing that value by the gross annual income that they generated will produce the average multiplier for the region.

This type of valuation approach is similar to using comparable transactions or multiples to value a stock. Many analysts will forecast the earnings of a company and multiply the earnings per share (EPS) figure by the P/E ratio of the industry. Real estate valuation can be conducted through similar measures.

Roadblocks to Real Estate Valuation

Both of these real estate valuation methods seem relatively simple. However, in practice, determining the value of an income-generating property using these calculations is fairly complicated. First of all, obtaining the required information regarding all of the formula inputs, such as net operating income, the premiums included in the capitalization rate and comparable sales data, may prove to be extremely time-consuming and challenging.

Secondly, these valuation models do not properly factor in possible major changes in the real estate market such as a credit crisis or real estate boom. As a result, further analysis must be conducted to forecast and factor in the possible impact of changing economic variables.

Because the property markets are less liquid and transparent than the stock market, sometimes it is difficult to obtain the necessary information to make a fully informed investment decision. That said, due to the large capital investmenttypically required to purchase a large development, this complicated analysis can produce a large payoff if it leads to the discovery of an undervalued property (similar to equity investing). Thus, taking the time to research the required inputs is well worth the time and energy.

The Bottom Line

Real estate valuation is often based on similar strategies to equity analysis. Other methods, in addition to the discounted net operating income and gross income multiplier approach, are also frequently used – some unique to this asset class. Some industry experts, for example, have an active working knowledge of city migration and development patterns. As a result, they can determine which local areas are most likely to experience the fastest rate of appreciation.

Whichever approach one decides to use, the most important predictor of a strategy’s success is how well it is researched.

FYI on ROI: A Guide to Calculating Return on Investment

Return on investment (ROI) is a financial metric of profitability that is widely used to measure the return or gain from an investment. ROI is a simple ratio of the gain from an investment relative to its cost. It is as useful in evaluating the potential return from a […]

Return on investment (ROI) is a financial metric of profitability that is widely used to measure the return or gain from an investment. ROI is a simple ratio of the gain from an investment relative to its cost. It is as useful in evaluating the potential return from a stand-alone investment, as it is in comparing returns from several investments.

In business analysis, ROI is one of the key metrics – along with other cash flowmeasures such as internal rate of return (IRR) and net present value (NPV) – used to evaluate and rank the attractiveness of a number of different investment alternatives. ROI is generally expressed as a percentage rather than as a ratio.

How to Calculate ROI

The ROI calculation is a straightforward one, and it can be calculated by either of the following methods:

Methods to calculate return on investment (ROI)

Interpreting ROI

 Note the following points with regard to ROI calculations:

  • As noted earlier, ROI is intuitively easier to understand when expressed as a percentage instead of a ratio.
  • The ROI calculation has “net return” rather than “net profit or gain” in the numerator. This is because returns from an investment can often be negative instead of positive.
  •  A positive ROI figure means that net returns are in the black, as total returns exceed total costs. A negative ROI figure means that net returns are in the red(in other words, this investment produces a loss), as total costs exceed total returns.
  • To compute ROI with greater accuracy, total returns and total costs should be considered. For an apples-to-apples comparison between competing investments, annualized ROI should be considered. These concepts are discussed in greater detail below.

A Simple ROI Example

Let’s assume you bought 1,000 shares of hypothetical company Wicked Widgets Co. for $10 each. Exactly a year later, you sold the shares for $12.50. You earned dividends of $500 over the one-year holding period. You also spent a total of $125 on trading commissions when you bought and sold the shares. What is your ROI?

Your ROI can be calculated as follows:

Sample calculation of return on investment (ROI)

Let’s deconstruct this calculation step by step.

  1. To calculate net returns, total returns and total costs must be considered. Total returns for a stock arise from capital gains and dividends. Total costs would include the initial purchase price as well as commissions paid.
  2. In the above calculation, the first term – [($12.50 – $10.00) x 1,000] – shows the gross capital gain (i.e. before commissions) from this trade. The $500 amount refers to the dividends received by holding the stock, while $125 is the total commission paid.
  3. Dissecting the ROI into its component parts would result in the following:

ROI = Capital gains (23.75%) + Dividend yield (5.00%)

Why is this important? Because capital gains and dividends are taxed at different rates in most jurisdictions.

Here’s another way of calculating ROI. Let’s assume the following split of the $125 paid in total commissions – $50 when buying the shares and $75 when selling the shares.

Initial Value of Investment (i.e. cost of investment) = $10,000 + $50 = $10,050

Final Value of Investment = $12,500 + $500 – $75 = $12,925

Additional example of return on investment (ROI) calculation

Note the slight difference in the ROI values (28.75% vs. 28.60%). This arises because, in the second instance, the commission of $50 paid upon purchase of the shares was included in the initial cost of the investment. So while the numerator in both the equations was the same ($2,875), the slightly higher denominator in the second instance ($10,050 vs. $10,000) has the effect of marginally depressing the stated ROI figure.

Special ROI Considerations

Annualized ROI

The Annualized ROI calculation counters one of the limitations of the basic ROI calculation, which is that it does not consider the length of time that an investment is held (the “holding period”). Annualized ROI is calculated as follows:

Annualized return on investment (ROI) calculation

where n = number of years for which the investment is held.

Example: Assume you had an investment that generated an ROI of 50% over five years. What was the annualized ROI?

The simple annual average ROI of 10% (obtained by dividing ROI by the holding period of five years) is only a rough approximation of annualized ROI because it ignores the effects of compounding, which can make a significant difference over time. The longer the time period, the bigger the difference between approximate annual average ROI (ROI / holding period) and annualized ROI. 

Example of annualized return on investment (ROI) calculation

This calculation can also be used for holding periods of less than a year by converting the holding period to a fraction of a year.

Example: Assume you had an investment that generated an ROI of 10% over six months. What was the annualized ROI?

Example of annualized return on investment (ROI) calculation for period of less than a year

(In the mathematical expression above, six months = 0.5 years).

Comparing Investments

Annualized ROI is especially useful when comparing returns between various investments or evaluating different investments.

Example: Assume your investment in stock X generated an ROI of 50% over five years, while your stock Y investment returned 30% over three years. What was the better investment in terms of ROI?

Example of comparing investments using return on investment (ROI) calculation

Stock Y had a superior ROI compared to stock X.

ROI with Leverage

Leverage can magnify ROI if the investment generates gains, but by the same token, it can amplify losses if the investment proves to be a dud.

Example: In an earlier example, we had assumed that you bought 1,000 shares of hypothetical company Wicked Widgets Co. for $10 each. Let’s further assume that you bought these shares on 50% margin, which means that you put up $5,000 of your own capital and borrowed $5,000 from your brokerage as a margin loan. Exactly a year later, you sold the shares for $12.50. You earned dividends of $500 over the one-year holding period. You also spent a total of $125 on trading commissions when you bought and sold the shares. In addition, your margin loan carried an interest rate of 9%. What is your ROI?

There are two key differences from the earlier example:

  • The interest on the margin loan ($450) should be considered in total costs.
  • Your initial investment is now $5,000 because of the leverage employed by taking the margin loan of $5,000. 

* This is the margin loan of $5,000

Thus, even though the net dollar return was reduced by $450 on account of margin interest, ROI is substantially higher at 48.50%, compared with 28.75% if no leverage was employed.

But instead of rising to $12.50, what if the share price fell to $8.00, and you had no choice but to cut your losses and sell the full position? ROI in this case would be:

Negative return on investment (ROI) calculation including margin loan

In this case, ROI of -41.50% is much worse than ROI of -16.25% that would have resulted if no leverage was employed.

Unequal Cash Flows

When evaluating a business proposal, one often has to contend with unequal cash flows. This means that the returns from an investment will fluctuate from one year to the next.

The calculation of ROI in such cases is more complicated and involves using the internal rate of return (IRR) function in a spreadsheet or calculator.

Example: Assume you have a business proposal to evaluate that involves an initial investment of $100,000 (shown under Year 0 in the “Cash Outflow” row in the following Table). The investment generates cash flows over the next five years, as shown in the “Cash Inflow” row. The “Net Cash Flow” row sums up the cash outflow and cash inflow for each year. What is the ROI?

Calculating return on investment using the using the internal rate of return (IRR) function

Using the IRR function, the calculated ROI is 8.64%.

The final column shows the total cash flows over the five-year period. Net cash flow over this five-year period is $25,000 on an initial investment of $100,000. What if this $25,000 was spread out equally over five years? The cash flow table would then look like this:

Calculating return on investment using the using the internal rate of return (IRR) function

Note that the IRR in this case is now only 5.00%.

The substantial difference in the IRR between these two scenarios – despite the initial investment and total net cash flows being the same in both cases – has to do with the timing of the cash inflows. In the first case, substantially larger cash inflows are received in the first four years. Because of the time value of money, these larger inflows in the earlier years have a positive impact on IRR.

Benefits of ROI

  • The biggest benefit of ROI is that it is an uncomplicated metric that is easy to calculate and intuitively easy to understand.
  • ROI’s simplicity means that it is a standardized, universal measure of profitability with the same connotation anywhere in the world, and hence not liable to be misunderstood or misinterpreted. “This investment has an ROI of 20%” has the same meaning whether you hear this in Argentina or Zimbabwe.
  • Despite its simplicity, the ROI metric is versatile enough to be used to evaluate the efficiency of a single stand-alone investment, or to compare returns from different investments.

Limitations of ROI

  • ROI does not take into account the holding period of an investment, which can be an issue when comparing investment alternatives. For example, assume investment X generates ROI of 25% while investment Y produces ROI of 15%. One cannot assume that X is the superior investment unless the timeframe of investment is also known. What if the 25% ROI from X is generated over a period of five years, but the 15% ROI from Y only takes one year? Calculating annualized ROI can overcome this hurdle when comparing investment choices.
  • ROI does not adjust for risk. It is common knowledge that investment returns have a direct correlation with risk – the higher the potential returns, the greater the possible risk. This can be observed firsthand in the investment world, where small-cap stocks typically have higher returns than large-cap stocks but are accompanied by significantly greater risk. An investor who is targeting a portfolio return of 12%, for example, would have to assume a substantially higher degree of risk than an investor who wants a return of 4%. If one focuses only on the ROI number without evaluating the concomitant risk, the eventual outcome of the investment decision may be very different from the expected result.
  • ROI figures can be exaggerated if all the expected costs are not included in the calculation, whether deliberately or inadvertently. For example, in evaluating the ROI on a piece of real estate, associated expenses such as mortgage interestproperty taxes, insurance and maintenance costs must be considered because they can take a hefty chunk out of ROI. Not including all these expenses in the ROI calculation can result in a grossly overstated return figure.
  • Like many profitability metrics, ROI only emphasizes financial gain and does not consider ancillary benefits such as social or environmental ones. A relatively new ROI metric known as “Social Return on Investment” (SROI) helps quantify some of these benefits.

The Bottom Line

Return on investment (ROI) is a simple and intuitive metric of profitability used to measure the return or gain from an investment. Despite its simplicity, it is versatile enough to be used to evaluate the efficiency of a single stand-alone investment, or to compare returns from different investments. ROI’s limitations are that it does not consider the holding period of an investment (which can be rectified by using the annualized ROI calculation) and is not adjusted for risk. Despite these limitations, ROI finds widespread application and is one of the key metrics – along with other cash flow measures such as IRR and NPV – used in business analysis to evaluate and rank returns from competing investment alternatives.

Top 10 features of a profitable rental property

Looking to purchase and profit from a residential rental property ? From the first decision to get into the landlord biz to actually buying a building, the idea may be daunting for the first-time investor. Real estate is a tough business and the field is peppered with land mines […]

Looking to purchase and profit from a residential rental property? From the first decision to get into the landlord biz to actually buying a building, the idea may be daunting for the first-time investor. Real estate is a tough business and the field is peppered with land mines that can obliterate your returns. Let’s examine the things you should consider when shopping for an income property.

Starting Your Search

Although you may want a real estate agent to help you complete the purchase, you should start searching for a property on your own. Having an agent can bring unnecessary pressure to buy before you have found an investment that suits you. The most important thing is to take an unbiased approach to all the properties and neighborhoods within your investing range.

Your investing range will be limited by whether you intend to actively manage the property or hire someone else to manage it. If you intend to actively manage, you should not get a property that’s too far away from where you live. If you are going to get a property management company to look after it for you, proximity will be less of an issue.

Let’s take a look at the top 10 things you should consider when searching for the right rental property.

1. Neighborhood.The quality of the neighborhood in which you buy will influence both the types of tenants you attract and your vacancy rate. For example, if you buy in a neighborhood near a university, the chances are that your pool of potential tenants will be mainly made up of students and that you will face vacancies on a fairly regular basis (i.e., during summer). Be aware that some municipalities attempt to discourage turning homes into rentals in some ‘hoods by imposing exorbitant permit fees and various bureaucratic red tape.

2. Property Taxes.Property taxes are not uniform across an area and, as an investor planning to make money from rent, you want to be aware of how much you will be losing to them. High property taxes may not always be a bad thing if the neighborhood is an excellent place for long-term tenants, but the two do not necessarily go hand in hand. The municipality’s assessment office will have all the tax information on file or you can talk to homeowners within the community. It is also wise to consider the likelihood of property tax hikes in coming years. A town in financial distress may hike taxes far beyond what a landlord can realistically charge in rent.

3. Schools.If you’re dealing with family-sized accommodations, you need a consider the quality of local educational facilities. If a property is good, but the nearby schools are poor or non-existent, it can affect the value of your investment. Although you will be mostly concerned about the monthly cash flow, the overall value of your rental property comes in to play when you eventually sell it.

4. Crime.No one wants to live next door to a hot spot for criminal activity. Go to the police or the public library for accurate crime statistics for various neighborhoods, rather than asking the owner who is hoping to sell the property to you. Items to look for are vandalism rates, serious crimes, petty crimes and recent activity (either up or down). You might also want to ask about the frequency of a police presence in your neighborhood.

5. Job Market.Locations with growing employment opportunities tend to attract more people – meaning more tenants. To find out how a particular area rates, go directly to the U.S. Bureau of Labor Statistics or to your local library. If you notice an announcement for a new major company moving to the area, you can rest assured that workers will flock to the area. However, this may cause house prices to react (either negatively or positively) depending on the corporation moving in. The fallback point here is that if you would like the new corporation in your backyard, your renters probably will too.

6. Amenities.Check the potential neighborhood for current or projected parks, malls, gyms, movie theaters, public transport hubs and all the other perks that attract renters. Cities, and sometimes even particular areas of a city, have loads of promotional literature that will give you an idea of where the best blend of public amenities and private property can be found.

7. Future Development.The municipal planning department will have information on all the new development that is coming or has been zoned into the area. If there are many new apartment buildings, business parks or malls going up, it is probably a good growth area. However, watch out for new developments that could hurt the price of surrounding properties by, for example, causing the loss of an activity-friendly green space. Additional new housing could also provide competition for your property.

8. Number of Listings and Vacancies.If there is an unusually high number of listings for one particular neighborhood, this can either signal a seasonal cycle or a neighborhood that has “gone bad.” Make sure you figure out which it is before you buy in. You should also determine whether you can cover for any seasonal fluctuations in vacancies. Similar to listings, the vacancy rates will give you an idea of how successful you will be at attracting tenants. High vacancy rates force landlords to lower rents in order to attract tenants. Low vacancy rates allow landlords to raise rental rates.

9. Rents.Rental income will be the bread-and-butter of your rental property, so you need to know what the average rent in the area is. If charging the average rent is not going to be enough to cover your mortgage payment, taxes and other expenses, then you have to keep looking. Be sure to research the area well enough to gauge where the area will be headed in the next five years. If you can afford the area now, but major improvements are in store and property taxes are expected to increase, then what could be affordable today may mean bankruptcy later.

10. Natural Disasters.Insurance is another expense that you will have to subtract from your returns, so it is good to know just how much you will need to carry. If an area is prone to earthquakes or flooding, paying for the extra coverage can eat away at your rental income.

Getting Information

Talk to renters as well as homeowners in the neighborhood. Renters will be far more honest about the negative aspects of the area because they have no investment in it. If you are set on a particular neighborhood, try to visit it at different times on different days of the week to see your future neighbors in action.

The Physical Property

In general, the best investment property for beginners is a single-family dwelling or a condominium. Condos are low maintenance because the condo association is there to help with many of the external repairs, leaving you to worry only about the interior. Because condos are not truly independent living units, however, they tend to garner lower rents and appreciate more slowly than single-family homes.

Single-family homes tend to attract longer-term renters. Families or couples are generally better tenants than singles because they are more likely to be financially stable and pay the rent regularly. As a landlord, you want to find a property and a neighborhood that is going to attract that type of demographic.

When you have the neighborhood narrowed down, look for a property that has appreciation potential and a good projected cash flow. Check out properties that are more expensive than you can afford as well as those within your reach – real estate can often sell below its listing price. Watch the listing prices of other properties and ask buyers about the final selling price to get an idea of what the market value really is in the neighborhood. For appreciation potential, you are looking for a property that, with a few cosmetic changes and some renovations, will attract tenants who are willing to pay higher rents. This will also serve you well by raising the value of the property if you choose to sell it after a few years.

Of course, a key step in ensuring a profitable endeavor is to buy a reasonably priced property. The recommendation for rental property is to not pay more than 12 times the annual rent you can expect to get. So how is the potential rent determined? You are going to have to make an informed guess. Take the average rent for the neighborhood and subtract your expected monthly mortgage payment, property taxes (divided by 12 months), insurance costs (also divided by 12) and a generous allowance for maintenance and repairs. Don’t get carried away with overly optimistic assumptions; setting the rent too high and ending up with an empty unit for several months chips away at the overall profit in a hurry.

In contrast, don’t underestimate the cost of maintenance and repairs. These costs depend on the age of the property, the tenants and how much you plan to do yourself. A newer building probably will require less than an older one. An apartment located in a complex for seniors is unlikely to be subjected to the same amount of damage as a residence-turned-frat house.

Doing your own repairs cuts down the cost considerably, but it also means being on call 24/7 for emergencies. Another option is to hire a property management firm. The firm handles everything from broken toilets to collecting rent each month but it comes at a price; expect to pay about 10% of the gross rental income for this service.

If all these figures come out even or, better yet, with a little left over, you can now get your real estate agent to submit an offer and, if everything goes well, order business cards with Landlord emblazoned across the top.

Making the Purchase

Banks have considerably tougher demands for giving loans for investment property than for primary residences. They figure that, if times get tough, people are less inclined to sell and leave their homes, whereas they’d have much less emotional attachment to a business property.  Be prepared to pay at least 20% to 30% for a down payment plus the usual closing costs. It is also important to have the property thoroughly inspected by a professional and to have a lawyer review everything before signing.

Make sure you get the best mortgage rate if you’re going to have to finance your purchase. And don’t forget homeowners’ insurance: Renter’s insurance only covers a tenant’s belongings; the building itself is the landlord’s responsibility, and that insurance may be more expensive for a similar owner-occupied home. The property’s mortgage, insurance and depreciation are all tax-deductible (up to a certain amount).

The Bottom Line

Every state has good cities, every city has good neighborhoods and every neighborhood has good properties, but it takes a lot of footwork and research to line up all three. When you do find your ideal rental property, keep your expectations realistic and make sure that your own finances are in a healthy enough state that you can wait for the property to start generating cash, rather than needing it desperately. Real estate investing doesn’t start with buying a rental property – it begins with creating the financial situation that makes it feasible buy one.

How to calculate the ROI on a rental property

Many investors diversify their investment portfolio with real estate. Owning properties can provide investors with steady rental income or capital appreciation when the property is sold for a profit. However, it’s important to measure the return on investment properly to determine the level of profitability of the property. Unfortunately, […]

Many investors diversify their investment portfolio with real estate. Owning properties can provide investors with steady rental income or capital appreciation when the property is sold for a profit. However, it’s important to measure the return on investment properly to determine the level of profitability of the property.

Unfortunately, because ROI calculations can be easily manipulated – and certain variables can be either included or excluded when making the calculation – figuring out a meaningful ROI can be a challenge, especially when investors have the option of paying cash or taking out a mortgage on the property. In this article, we’ll review two examples for calculating ROI on a residential rental property.

Review: What Is ROI?

Return on investment or ROI measures how much money or profit is made on an investment as a percentage of the cost of the investment. ROI shows how effectively and efficiently investment dollars are being used to generate profits. Investors use ROI to determine how well their investment is performing, but also in comparing their ROI with the performance of other investments. 

To calculate the profit on any investment, you would first take the total return on the investment and subtract the original cost of the investment. However, ROI is a profitability ratio meaning it gives us the profit on an investment represented in percentage terms. To calculate the percentage gain on an investment, we take the net profit or net gain on the investment and divide it by the original cost as shown in the formula below: 

For instance, if you buy ABC stock for $1,000 and sell it two years later for $1,600, the net profit would be $600 ($1,600 – $1,000). The ROI on the stock would be 60% ($600 (net profit) ÷ $1,000 (cost) = 0.60). For more information please read FYI On ROI: A Guide To Calculating Return On Investment.

Calculating the ROI on Rental Properties

While the above equation seems easy enough to calculate, with real estate a number of variables, including repair/maintenance expenses, and methods of figuring leverage – the amount of money borrowed (withinterest) to make the initial investment– come into play, which can affect ROI numbers. 

When purchasing property, the terms of financing can greatly impact the price of the investment; however, using resources like a mortgage calculator can help you save money by helping you find favorable interest rates.

Cash Transactions

If you buy a property outright, calculating its ROI is fairly straightforward.

Here is an example of a rental property purchased with cash:

  • You paid a $100,000 in cash for the rental property.
  • The closing costs were $1,000 while remodeling costs totaled $9,000 bringing your total investment to $110,000 for the property. 
  • You collected $1,000 in rent every month.

A year later:

  • You earned $12,000 in rental income for that year.
  • However, there were expenses including the water bill, property taxes, and insurance totaling $2,400 for the year or $200 per month.
  • Your annual return was $9,600 for the year ($12,000 – $2,400).

To calculate the property’s ROI:

  • Divide the annual return ($9,600) by the amount of the total investment or $110,000.
  • ROI = $9,600 ÷ $110,000 = 0.087 or 8.7%.
  • Your ROI was 8.7%.

Financed Transactions

Calculating the ROI on financed transactions is more involved.

For example, you purchased the same $100,000 rental property as above, but instead of paying cash, you took out a mortgage. 

  • The down payment needed for the mortgage was 20% of the purchase price or $20,000 ($100,000 sales price x 20%).
  • Closing costs were higher which is typical for a mortgage totaling $2,500 up front.
  • You paid the same amount of $9,000 for remodeling.
  • Your total out-of-pocket expenses wer $31,500 ($20,000 + $2,500 + $9,000).

Plus, there are ongoing costs associated with the mortgage.

  • Let’s assume you took out a 30-year loan with a fixed 4% interest rate. On the borrowed $80,000 ($100,000 sales price minus the $20,000 down payment), the monthly principal and interest payment would be $381.93.
  • We’ll add the same $200 a month to cover water, taxes, and insurance, making your total monthly payment $581.93.
  • Rental income of $1,000 for a total of $12,000 for the year.
  • Your monthly cash flow was of $418.07 monthly ($1,000 rent – $581.93 mortgage payment).

One year later:

  • You earned $12,000 in total rental income for the year at $1,000 per month.
  • Your annual return was $5,016.84 ($418.07 x 12 months).

To calculate the property’s ROI:

  • Divide the annual return by your original out-of-pocket expenses (the down payment of $20,000, closing costs of $2,500, and remodeling for $9,000) to determine the ROI.
  • ROI: $5,016.84 ÷ $31,500 = 0.159.
  • Your ROI is 15.9%.

Home Equity 

Some investors add the home’s equity into the equation. Equity is the market value of the property minus the total loan amount outstanding. Please keep in mind that home equity is not cash-in-hand. You would have to sell the property to access it.

To calculate the amount of equity in your home, review your mortgage amortization schedule to find out how much of your mortgage payments went towards paying down the principal of the loan (which builds up the equity).

The equity amount can be added to the annual return. In our example, the amortization schedule for the loan showed that a total of $1,408.84 of principal was paid down during the first 12 months.

  • The new annual return including the equity portion equals $6,425.68 ($5,016.84 annual income + $1,408.84 equity).
  • The ROI = $6,425.68 ÷ $31,500 = 0.20.
  • Your ROI is 20%.

The Bottom Line

Of course, in our examples above, there could be additional expenses involved in owning a rental property, such as repairs or maintenance costs, which would need to be included in the calculations ultimately affecting the ROI. Also, we assumed the property was rented out for all twelve months. In many cases, vacancies occur particularly in between tenants and the lack of income for those months must be factored into your calculations. (For more, see “How to Value a Real Estate Investment Property.”)

However, the ROI for a rental property is different depending on whether the property is financed via a mortgage or paid for in cash. As a general rule of thumb, the less cash paid upfront as a down payment on the property, the larger the mortgage loan balance will be, but the greater your ROI. Conversely, the more cash paid upfront and the less you borrow, the lower your ROI, since your initial cost would be higher. In other words, financing allows you to boost your ROI in the short-term since your initial costs are lower.

It’s important to use a consistent approach when measuring the ROI for multiple properties. For example, if you include the home’s equity in evaluating one property, you should include the equity of the other properties when calculating the ROI for your real estate portfolio.

What Went Wrong With Brookfield Property Partners (Part 5): Development, LP Investments And Why BAM Is Superior – Brookfield Asset Management Inc. (NYSE:BAM) | Seeking Alpha

Dec. 17, 2018 9:00 AM ET|9 comments  | About: Brookfield Asset Management Inc. (BAM)BPRBPY, Includes: OPVVLFWPC

Ján Mazák

Ján MazákLong only, value, growth at reasonable price, long-term horizon(830 followers)Summary

BPY’s debt has increased because of significant development programme. The company could have paid it off instead, reaching its leverage targets, but returns would suffer.

Opportunistic LP investments are an inseparable part of the business and a key reason to choose BPY/BPR over other REITs.

Payout ratio looks elevated at first sight, but distributions are not in jeopardy if one relies on BAM’s backing. Various insiders are purchasing units (BPY itself, BAM, several directors).

BAM is a superior option to BPY thanks to its higher growth rate, better financial position and the high correlation between the upside in BPY unit price and BAM’s benefits from such an increase.

BAM is, therefore, superior to almost any REIT on the market.

When Brookfield Asset Management (BAM) spun off Brookfield Property Partners (BPY), the company aimed to create a vehicle that would allow retail and other small investors to access the full Brookfield real estate platform. In return, BAM would obtain a source of permanent capital to seed its funds and enjoy significant fees for decades.

One thing that has been unclear over time was whether those small investors would prefer a Bermuda-registered limited partnership (which is what BPY is), or a U. S. based REIT. In 2018, this has been resolved by creating BPR, a REIT with shares economically equivalent to units of BPY and convertible into them.

Despite the successful creation of those vehicles, returns for unitholders have been poor and definitely worse than anticipated. This series of articles analyzes why it was so and whether it is likely to continue in the future. After analyzing financial performance and debt, we are going to wrap it up with a brief discussion of development and opportunistic LP investments (the two most profitable activities of BPY) and a comparison of the investment opportunities provided by BPY and BAM. The data underlying our analysis come from presentations, supplemental information and financial reports available on the company website.

What BPY is

BPY is an all-encompassing real estate vehicle where investors have little to no say with regards to where their money will be invested. The management has few limits on capital allocation and acts opportunistically; it has no problem selling 10% of the portfolio in a year and investing the money into fresh development in another real estate segment. Thus if you want to have a strict control over what portion of your capital goes into a particular segment (e.g. retail properties), how much development risk you are undertaking etc., BPY is not a vehicle for you.

On the other hand, if you are a know-little investor that likes Brookfield’s track record and management, want to participate in almost all of its real estate activities, and let them make all the capital allocation decisions, BPY is very suitable. I also believe that it is quite attractive at unit price below $17; the price is so low that it fully offsets the effect of high fees.

This is what you get with BPY:

  • long-term ownership interest in more than 100 high-quality Class A shopping malls (having performed more or less in line with large peers over the last 5 years);
  • long-term ownership interest in several iconic locations like Brookfield Places in New York and Calgary (it would not make sense to name something after your company and then sell it a couple of years later);
  • temporary ownership in less-promising ~25 U. S. shopping malls and lots of office and mixed-use buildings located mostly in USA, Canada, Australia and UK; typical ownership period is perhaps 10 years;
  • access to Brookfield’s opportunistic real estate funds targeting 20% returns (between 15 and 25% of your capital will be invested there);
  • participation in extensive never-ending development and redevelopment programme;
  • cash distributions anticipated to grow by at least 5% a year, consuming all FFO from office and retail buildings and partially financed by gains from opportunistic funds.

These things are not separable and are all important parts of BPY’s business strategy. One of the reasons to create BPY was to allow retail investors access to Brookfield’s real estate funds originally only available to big institutional investors. It thus must be quite frustrating to the company that investors do not appreciate it and instead of assigning some premium value to the units, they trade with a considerable discount (both vs. NAV and in comparison with peers).

Tenants

In the office portfolio, no single tenant takes a large share, but the concentration in banks and financials-related sectors is significant. (These tables, taken from 3Q18 report, reflect the situation after the GGP acquisition.)

The retail portfolio is also diversified.

Cost of external management

Investors often shun externally-managed REITs because of agency risk and potentially higher cost (especially if hefty fees are involved, as is the case with BPY). I have tried to compare general and administrative expenses of BPY with some competitors (the management and equity-enhancement fee is included in that category).

It is obvious that BPY is more expensive even before the management fee is applied (about twice as much in both office and retail segments). The comparison is only illustrative because each REIT has its own definition of G&A and NOI (or don’t report NOI at all) and the expense strongly depends on the amount of asset transactions and property development. Anyway, BPY’s high asset turnover does come with a cost.

Developments

The amount of development activity has increased over the years in line with growth in assets (see the following table). A natural question to ask is what is the effect of developments on the financial picture.

The properties being built are carried on the balance sheet at development costs, and the fair value model is only used for periods subsequent to the initial recognition of the property on the balance sheet. My understanding is that this would imply positive fair value gains, potentially substantial, in addition to growth in NOI and FFO, when the properties are leased and BPY starts to collect rent.

We will consider two pro forma scenarios based on annualized results for the first half of 2018. In the first one, all the unfinished developments (carried at construction cost on the balance sheet) are sold at par and the whole proceeds are used to reduce debt. This would result in no change in equity, $6B debt reduction, and $240M saved on interest expenses.

In the second scenario, the developments are finished immediately (in reality, it will have only been done by 2021), resulting in 7.5% NOI yield as anticipated by the management ($450M of additional NOI) and an increase in fair value of $2.2B corresponding to 5.5% cap rate (carrying value of $8.2B after leases start producing rent).

As far as credit metrics go, both interest coverage and debt/EBITDA are similar in both scenarios, with debt/capital a bit higher if developments were undertaken. What are the reasons for the development programme, then?

First, EBITDA/equity is higher in the second case, about 12.5% vs. 11.7%. Second, this static picture does not fully capture same-store NOI growth of 2-4% embedded in the developed properties. Third, fees paid to BAM will be meaningfully higher in the second scenario.

Opportunistic investments

Another reason why the debt has piled up is an increasing portion of assets allocated to the opportunistic segment. (The table below does not include data from earlier years because they were not reported consistently. The income statement figures for 2018 are calculated by taking results for the first half and multiplying them by two.)

Again, we might want to consider what would have happened if it retired debt instead of doing opportunistic investments.

The resulting credit metrics do look slightly better, but we would have lost the most profitable segment producing 15-25% returns. This segment is one of the key reasons why to invest in BPY and distinguishes the company from other REITs.

Payout ratio

The target is to pay out about 80% of FFO. While this makes some sense, it does not shed any light on whether the retained 20% is sufficient to pay for maintenance of the properties or even leave some capital for reinvestment. In the first years of BPY’s existence, this topic was rather ignored during discussions with the management on the basis of lots of realized gains that can be used to fill whatever shortfall there might be. One has to keep in mind, however, that the environment will not always be so favorable. Since 2018, the relevant data are disclosed in a nice table (page 14 from 2Q18 supplemental info).

Apparently, it is heavily relying on opportunistic realized gains (in contrast with total realized gains which are larger, but less predictable – the strategy in Core Office and Core Retail is more about holding quality properties through thick and thin). These gains are quite hard to analyze from the outside, but I find its argument (given in pages 47 to 52 of the 2018 Investor Day presentation) fairly convincing.

One thing is apparent: BPY is not a vehicle for passively collecting rent from a given set of properties, with payout well covered by NOI. If you are interested only in vehicles of that type, you will have to look elsewhere; for instance, into the net lease REIT space with companies like Realty Income (O) or W. P. Carey (WPC). Such REITs, despite being fine companies, are not great investment opportunities at present: either they trade with a much lower yield (e.g. O), or have worse prospects for dividend growth (e.g. WPC), or have less reliable tenants and/or lower quality properties, thus their higher yields only reflect higher risk.

A possible way of viewing BPY is that you have a rather normally operating REIT, with AFFO of ~$1 a year, all paid out in distributions (yield ~6%). At present, 97% of the distributions goes to unitholders, but the IDR portion will grow to 10% over the next 5-10 years. This portion of the distributions can be expected to grow by 2-3% a year thanks to same-store NOI growth and perhaps another 1-2% coming from occasional recycling of capital and development. (The pace of those two activities has accelerated significantly since 2017; especially the asset dispositions are done at a pace one would find quite unusual for a typical REIT, but over time it would probably slow down as debt is decreased and unit price gets more in line with NAV. Disposals are also likely to diminish during periods of the real estate cycle.)

The remaining portion of the payout, about $0.30, comes from a possibly very lumpy opportunistic source which tends to generate 20% IRR but with uncertain timing of cash flows, so it should perhaps not be relied upon when calculating the income from your portfolio. The management has control over this portion and much better insight into it; it considers the gains to be fairly reliable and to be a source of a key competitive advantage of BPY.

I do not believe the dividend will be cut even if it was not covered by cash flows temporarily. It would not make sense for Brookfield to create a flawed vehicle if it could have created a healthy one just by adjusting the payout ratio and then enjoying decades of hefty fees. It has quite a good control over the opportunistic funds cash flows and will not pointlessly increase distributions just to cut them back in a few years, damaging its reputation and losing billions in future fees as a consequence.

I believe that the only problem here is that it is unable to demonstrate its confidence in well-covered payouts to others since BPY’s public track record is too short and involves neither a general recession nor a real estate downturn. It seems that the market does not think that Brookfield’s private funds’ track record also applies to BPY, despite the fact that BPY invests directly in those funds to get its share of 20% opportunistic IRRs. (Note also that the fees paid for those LP investments are subtracted from the equity-enhancement fees.)

Repurchases

Between 2015 and 2017, BPY repurchased units worth $230M at a ~23% discount to analyst consensus NAV (page 7 of the ID 2017 presentation). Since the GGP acquisition (end of August 2018), insiders have notably increased their unit purchases (check the SEDI reports). One of the reasons is the increased float; in the first 5 years, buybacks have been restrained due to low liquidity.

There are at least three groups being active on this front. First, there are directors and officers (altogether, three of them purchased about 40 thousand units in 9 transactions). Second, BAM is buying on a daily basis; almost 10M units over the last 3 months. Finally, there is BPY itself that bought 1.3M units below $18 on average and cancelled them.

BAM vs. BPY opportunity

If BPY units closed the discount to NAV (with NAV unchanged at $29/unit) on $17 per unit it would mean a 70% return. The resulting distribution yield would be 4.5%. What are the benefits to BAM from such a development?

First, BAM holds 522M units, so the price appreciation produces a $6B+ gain. Second, it will earn 1.25% on the increase in market cap of BPY, that is, $150M a year in fees. Capitalized at 20x multiple it uses in its presentations, that’s another $3B. And we are not done yet. This unit price increase would allow the company to issue new units, fix the debt issues and get lots of dry powder for acquisitions. If the company nailed down another deal similar to Forest City, with $10B equity investment from BPY, it would obtain $2.5B of capitalized value from management fees and another $3B from IDRs charged on distributions. Altogether, we have $15B gain, which is almost 40% of the current $40B of market cap.

It seems that a quick increase of the price of BPY units will benefit BPY unitholders more than BAM shareholders. There are, however, at least two intricacies undermining such a conclusion. First, such a gain would be one-time. As discussed in the previous articles of this series, BPY has had trouble pushing its return on equity towards the upper bound of its 12-15% targeted range, even in the rather favorable environment of the last decade. The best one would expect over a long term is the current yield plus 5-8% distribution growth, thus ~14% even if it is as cheap as it is. On the other hand, BAM anticipates growing its fee-bearing AUM at 14% CAGR and its fees at 18% CAGR over the next 5 years and possibly far longer into the future; there is basically no way how BPY can match that. (BAM was way more successful in achieving its targets than BPY. The company exceeded them over the last 5 years.)

The second problem is that BAM will also grow thanks to its business unrelated to BPY. If closing of the BPY discount took two years, in that time BAM might easily earn another 40% of its market cap from infrastructure, renewable power and private equity, handily beating the gains of a BPY unitholder. And mind you, those quick gains might not come at all, and pocketing 7.5% distribution growing at a moderate pace while BAM is compounding at 20%+ CAGR will not feel like a win.

When we consider risk-adjusted returns, the situation is skewed in BAM’s favor even more. With $32B of group-wide liquidity, diverse operations and very little corporate debt, the company will not only survive downturns, but can go on a shopping spree targeting 20-40% IRRs during major recessions.

There is another consideration. A BAM shareholder benefits from low price of BPY units (which can be acquired on the cheap), high price of BPY units (equity can be issued to grow BAM’s fee empire), low price of BAM shares (via repurchases), and high price of BAM shares. On the other hand, a BPY unitholder has no benefits from BAM share price changes, can enjoy only modest repurchases of BPY units (since BPY is financially quite restrained by its debt at present), and issuance of new units is likely to be only mildly accretive to ordinary unitholders (but very accretive to BAM’s fee earnings).

To sum it up, if one holds BPY, he might just miss the boat with BAM.

Other considerations

  • “To allow for synergies and cost savings between BPY and GGP to be effectuated following closing of the transaction, BAM, which provides management services to BPY and will also provide services to BPR following closing, has agreed to waive, for one year, the management fees payable by BPR and the incremental management fees BPY would otherwise be required to pay in respect of the units issued in exchange for GGP shares.” (Nice gesture, though it will distort another 4 quarters of data.)
  • Many investors, who can be safely assumed to understand the Brookfield empire, have a preference for BAM versus the listed partnerships. In particular, insiders hold half of their stake in BAM through Partners Value Investments (OTC:PVVLF) in a rather convoluted way I have analyzed half a year ago. If you can withstand extreme illiquidity and can cope with the tax-related side of the matter, PVF.UN or the related warrants PVF.WT traded on TSX Venture exchange in Canada offer a very compelling investment opportunity. (Imagine a safely leveraged exposure to BAM share price appreciation – about 1.25x – at a 20% discount to NAV.) Lou Simpson also holds a large stake in BAM but none in the listed partnerships.
  • While it is theoretically possible that BAM might want to take BPY private on the cheap, I find it extremely unlikely. It would damage BAM’s reputation and lead to future losses of fees many times larger than any gains to be had from such a transaction.
  • The debt is much less dangerous than one would judge from the BPY figures alone. Consider that BAM has about half of its capital in BPY; the company surely does not want any disaster there. From its viewpoint, with $32B of liquidity, of which perhaps a half is eligible to be invested in a way helpful to BPY, the upcoming maturities of $3-7B a year do not look dangerous at all. At present, it has $1.2B of free cash flow after dividends and without tapping into carried interest, and it is expected to grow to $4B over the next 5 years, hence I believe it is not worried at all about BPY’s survival. (The other listed partnerships have better credit profiles, especially with regards to upcoming maturities.)
  • In my analysis, I have not found any major problems within BPY. The operating performance of both office and retail segments is in line with highest-ranked competitors and the opportunistic (LP investments) segment advantageously distinguishes it from other REITs. The risks arising from the precarious financial position (excessive leverage) are mitigated by having BAM as a parent. But it might not allow everyone to sleep well at night when the safety of his investment depends on goodwill of others.
  • There is some level of agency risk, but BAM is fairly well aligned with BPY unitholders; this risk can be avoided altogether if one invested in BAM shares instead. BAM has a more favorable risk/return profile anyway, so essentially the only argument in favor of BPY is the income it generates.
  • One might consider selling secured puts. Depending on actual market conditions, which change quite often for options, it is sometimes possible to target 15%+ annualized returns if one is not assigned the units, or 8%+ distribution yield if one is.
  • As mentioned before, there is a chance for a quick gain if investor perception of BPY changed over the next year or two, and this short-term jump would not be fully reflected in the corresponding increase in BAM’s share price. Keeping a small stake in BPY alongside a large one in BAM might have a profound psychological effect – it can quench the feeling of missing out on an abundant opportunity. (I have successfully used this strategy with cryptocurrencies in the last few years.)
  • It seems to me that the strategy of replacing richly-priced REIT holdings (e.g. O) with a mixture of BAM and a couple of high-yielders (BPY, MICTGEKMIENB, etc.) to the extent that one needs current income might prove quite beneficial over the next decade.

I guess I have thoroughly exhausted the subject in this five-part series and would like to thank all the readers that have followed it so far. But rest assured that when I have more of something interesting or useful to say on the topic, I will.

Disclosure: I am/we are long BAM, BPY, ENB, KMI, MIC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

What’s different about the Indian millennial? — People Matters

One cannot generalize the characteristics of Gen Y across the globe. A look at the influencing factors that determine the characteristics of generations!

What's different about the Indian millennial?

If context becomes so important in definition of everything in todays world, we cannot ignore the influencing factors in determining the characteristics of generations

Indian Gen Y still in formative years with younger entry age to workforce and moving even at younger age from their home for technical and higher education

Characteristics in individuals develop by way of experiences. And the influencing factors that nurture these characteristics become crucial in deciphering the behavior and bring to light the various motivations that help employees connect with their work and be more driven to do better.

We cannot generalize the characteristics of Gen Y (Millennials) across the globe as the influencing factors in each geographical location are different. Most of the research available today is based on the Gen Y (Millennials) in developed economies like the US and Europe which can be misleading at times as we cannot build the engagement model for developing economies like India as per the Gen Y characteristics of the US. If context becomes so important in definition of everything in today’s world, we cannot ignore the influencing factors in determining the characteristics of generations.

One of the most important reasons why we need to have a clear understanding of the characteristics of Gen Y in India is the notion of the ‘demographic dividend’. India is now at an inflection point with a population of 1.2 billion, of which about 0.8 billion is in the working age. By the year 2026, 64.8 percent of India’s population would be in the working age of 15-64 years. The strength of this large pool of employable talent will not only power India’s economic progress, but it should be able to supply enough human capital to the developed nations.

Therefore, irrespective of the location where this generation will be working in, their characteristics would be common since the place of origin that helped in developing these traits were the same. The study on Indian Gen Y thus becomes more relevant, becoming an important guideline across functions, units, and organizations across the globe.

Talent Gaps Expected by 2020 and beyond

Influencing Factors of a Generation 

What determines dominant characteristics in individuals? While some traits are inherent, a real majority is formed by experiences each individual has undergone during their formative years. The same holds true for generations as well. At the end of the day, a generation is also a set of individuals who chronologically share a same location in the history.

The key influencing factors in any generation are:

  • Economics
  • Politics
  • Culture/Social Lifestyle

Influencing Factors leading to characteristics

Economics

The factors that seemed to have affected India most intensely were the opening up of markets post-liberalization in the 1990s and the establishment of MNCs and BPOs. However, this new found abundance was not comparable to the ones seen in the US, and only a small percentage of the population enjoyed this affluence. There was still a large population living in villages and Tier II and Tier III cities where a large segment belonged to the lower income group and was not able to afford a good education–which brings us to delve deeper into perhaps the most important influencing factor which is economic growth.

Indian Income Pyramid

What does this economic difference mean if we look at a level classification of Indian population? The National Council of Applied Economic Research (NCAER) report 2012 describes this as the stratification of the population into deprived, aspirer, middle and upper-middle and high-income household in India. The report highlights only 31 million homes which can be compared to the US. The larger population is still in Aspirer and Deprived class. With economic development, the population in Aspirer category is moving to Middle Class, however, the fundamental experience of this Aspirer class cannot be compared to Gen Y of developed nations by way of their access to disposable income. But it can be compared to Gen X of developed nations because of critical experience encountered by the Gen X of developed nations and Gen Y of developing countries like India is usually the same.

 Characteristics 

Ambitious & Risk takers

  • Looking for growth (Still in formative years if compared to their global cohorts as majority is in Aspirer Category so growth becomes Important)

  • Key experiences and challenging work 

  • Growth opportunities engage them rather than job stability as was true for earlier generation

  • Keen on higher education(Since majority are in Aspirer category, education is still way to do well in life. More focused on education than their global cohorts)

Politics

India has come a long way since 1980.Major political events which impacted our society like Indira Gandhi’s assassination, Mandal Commission, from single party rule to coalition regime, regional parties started major deciding factors for Government at center, increase in terrorist attacks, Bombay blasts, 26/11 to mention a few. All these political factors culminated characteristics in generation which had seen political turmoil but was firming their ground by asking questions and rationale for decision and the same got affirmed more with passing of RTI (Right to Information) Act in India. For the first time in decades, there is a high public demand for accountability in the running of Government.

 Characteristics 

More transparent and less bureaucratic 

  • Readiness to comply with fair reasoning

  • Desire/drive to make a difference

  • Keen sense of competition both regional and global

  • Eager to prove they are not less than their global counterparts

Culture/Social system

The sudden westernization of lifestyles and values with the IT boom propelled India towards a path that was more aggressive in financial growth and homogeneity of culture. This subsequently led to more jobs and more economic independence, and there was exposure to global culture, in a way, not seen after independence of the nation. In India, women who worked and actively pursued a career increased significantly. This shift in social trend began as a result of high influx of population from rural to urban cities which led to nuclear families. The need to support increasing household expenditure and a new sense of freedom and identity, previously uncommon in the social structure led to a number of women joining the workforce in new cities. This led to breaking of social structure connected to family, region and clan. Role modeling which was majorly from large family setups was broken and this generation started identifying itself with workplace and looking for role models and mentors from the professional world.

 Characteristics 

Need for identity & role model 

  • Unlike the earlier generation who had a strong social system to anchor, this generation identifies with work and looks for role model in workplace. This need for identity and role model is peculiar to Indian Gen Y as their global cohorts had not experienced the social and joint family structure from the past as well, so the gap was never felt.

  • The starting working age for Indians is much younger when compared globally, so emotional maturity is not at par with their global cohorts.

Title conscious and peer pressure – Creating a role-based organization structure with quick progression 

Indian Gen Y employees are aware of their designation and prefer to have elaborate designations for an enhanced identity. Partly peer pressure and partly ambitions, these designations are important to them and define who they want to be. Hence, organizations should clearly define the role and designation and state the path to a rewarding role for quick progression. This is connected with the culture where hierarchy is expected coupled with the need for growth. The influencing factors of culture and economics here make Indian Gen Y different from global cohorts.

Create a platform for high awareness and give priority to ethics and moral value system

Indian Gen Y is still in formative years with a younger entry age to workforce and moving away at an even at younger age from their home for technical and higher education. Ethics and moral values start becoming blurred with social peer pressure determining the way of understanding things. Thus the need to create awareness on ethics and values becomes very important for organizations. While their global cohort’s majority of them are independent since younger age and have seen abundance, their personalities are formed by their independent view points and less by social peer pressure.

Establish mentor programs with senior staff

There has been a huge population influx to urban cities and nuclear families are fast replacing the traditional family systems. The desire of belonging to a larger institution is prompting a need to identify socially with work and organization. Mentors from the extended family are now missing and employees are now looking for mentors within organizations to fulfill their need for recognition and development and help them navigate the corporate structure deftly with refinement, often helping in softer issues of grooming and coaching. In the long run, this helps Gen Y develop a stronger connect with the organization.

While as for their global cohorts in developed economies, the social structure was never strong. As per Geert Hofstede’s model, these cultures are individualistic and lesser tied with the society. So the gap was never felt but for Indian context with the migration to major cities and loosening of societal ties, the need for mentoring is strongly felt by Indian Gen Y.

Indian Gen Y vs Developed Nations Gen Y

In conclusion

Majority of Indian millennials are still in formative years vis-a-vis their global cohorts. Education and growth still continue to be the focus of the Indian millennial. Since they identify themselves with workplace vis-a-vis their global cohorts, robust mentoring plans will help in leveraging a lot from them. Organizations should be aware of the potential conflict of Gen X with Gen Y. Millennials are not different but come with extra exposure and confidence which needs to leveraged by organizations by building managerial capability. 

Topics: HR ReadyTechHR 2016Employee EngagementTalent AcquisitionStrategic HR

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Author

Reetu Raina
Reetu Raina

Reetu Raina

Reetu is currently the Head of Talent and Culture at Sterlite Tech.

Article: Connecting the Generations in India — People Matters

Research indicates that all generations want their leaders to be charismatic, team-oriented, participative, and humane

Connecting the Generations in India

Common sense suggests that the generations in India are fundamentally different from one another. Some differences are blatant– such as, how people dress or their preference for a consumer-oriented life style or choices about after-work entertainment. Other differences are subtle and not as easily detected, like ideas about marriage or what one considers as appropriate personal behavior or attitude towards elders or members of the opposite sex.

But as the generational tides shift due to the retirement and replacement of older employees, will there have to be wholesome changes in how leaders must behave? I do not think so.

Let’s start by defining the generations, mainly in the context of India’s urban middle and upper socio-economic classes. Three generations emerge: the Partition generation, born 1944-1963; the Transition generation born 1964-1983; and the Post-Liberalization (Market generation) born 1984 onwards. These generations are roughly equivalent to the Baby Boomers, Gen X, and Gen Y or millennials.

Each generation was raised in unique historical and economic circumstances and so their values are different. The Partition generation aspired for steady jobs and economic stability to buffer themselves and their families against misfortune. They believe that the social customs that they grew up with, are essential for social stability. The Transition generation has experienced a greater range of choices about lifestyles, careers and consumer goods and is more open to different options. However, most want to stick to the family and societal traditions with which they grew up. The Post-Liberalization generation has been brought up in a world with exponentially expanding opportunities. They are inclined to value entrepreneurship and hard work, and regard organizational rules with some skepticism. However, they continue to appreciate their families and traditions.

But when it comes to workplace behavior, our research at the Center for Creative Leadership shows that, what employees want from their leaders, across all three generations, is far more similar than different.

So what do the generations believe about effective leadership? In India, our data indicate that all three generations want their leaders to be charismatic, team-oriented, participative, and humane. And all three generations are not convinced that a hierarchical or autonomous style of leadership is effective.

These six leadership styles were identified by the GLOBE research, which was conceived by Robert House of the Wharton School of Business, University of Pennsylvania. Study participants were asked to think about outstanding leaders who were “exceptionally skilled at motivating, influencing, or enabling you, others, or groups to contribute to the success of the organization or task” and to rate their characteristics. The leadership styles are based on statistical and conceptual analysis of data from 17,300 middle managers from 61 countries, and is one of the most comprehensive recent studies of global leadership,

Let’s delve deeper. What do the descriptions of these six styles tell us about what all three generations want from their leaders?

  1. Charismatic leadership is characterized by strong enthusiasm and by inspiring and motivating others
  2. Team-oriented leadership calls for helping teams to deal with conflict, work together, and develop cohesion
  3. Participative leadership features collaboration and inclusiveness
  4. Humane-oriented leadership is characterized by helping others, generosity and compassion Autonomous leadership features self-reliance, individualism, and working and acting independently Hierarchical leadership places importance on social rank, following tradition, and abiding by the rules.

These descriptions help us understand what all employees want from effective intergenerational leaders. They tell us that an “outstanding leader” will be regarded as outstanding by all generations, and not just one generation of employees! But how does this translate into cross-generational behaviors and workplace interactions between managers and subordinates? Here are my top tips which are time-tested and they work. They may seem obvious, but they are difficult to put into practice. 

  1. Practice charisma. This is simply having enthusiasm for your work and for the people with whom you work. Emotions are contagious. Studies show that leaders who are perceived as positive are also perceived as being more effective.
  2. Help your team to connect with each other. In India, the last decade has created vast opportunities for business growth. But within a company, fierce competition for personal career advancement can turn a team into a collection of maneuvering, ambitious individuals who focus on their own agendas and jockey to claim credit. In this context, it is especially important for you as a leader to build in time in your meetings for team members to learn to support one another. Your team needs to practice tackling challenges together, reflecting on lessons learned, showing mutual appreciation and celebrating achievements.
  3. Be participative when possible. Make it a habit to ask your team for ideas and make sure you implement others’ ideas, not just your own. A leader who educates and empowers subordinates and invites their participation will consistently achieve superior results. Cultural traditions teach Indian subordinates to listen and follow the instructions of their bosses and superiors. Many times, well-qualified employees are treated as peons and scolded for not doing precisely what they were told. But recent insights from neuroscience tell us that by chastising employees frequently, we simply make it more difficult for their brains to absorb new learning and improve. They begin to mistrust their own judgment, lose confidence and the motivation to take initiative or responsibility for achieving team goals. They become under-performers.
  4. Be humane. Really think about what your subordinates and co-workers need and how you can help them to work more effectively and achieve their personal and work-related goals. In India, there are dramatic differences between the socio-economic strata of society. Sometimes, employee performance is significantly impacted by life circumstances and events. Simple actions that recognize others’ personal situation go a long way — for example, inquiring about a sick child or attending an employee’s wedding. The point is that humane leaders consciously take such personal factors into account.

In practice, what employees of all generations want to see in their leaders is consideration for others. All leaders must learn how to be more charismatic, team-oriented, participative, and humane, and less hierarchical and autonomous. This is how to meet the deep and basic needs of employees. A good way to bridge generational gaps is to live up to employee expectations and demonstrate that you want and see value in everyone’s contributions.

Author

Meena Surie Wilson

Meena Surie Wilson

Meena Surie Wilson

Meena Surie Wilson, Senior Faculty, Center for Creative Leadership – Asia Pacific

A Survey of 19 Countries Shows How Generations X, Y, and Z Are — and Aren’t — Different

In the near future, three of the most studied generations will converge on the workplace at the same time: Generation X, the age cohort born before the 1980s but after the Baby Boomers; Generation Y, or Millennials , typically thought of as those born between 1984 and 1996; and […]

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In the near future, three of the most studied generations will converge on the workplace at the same time: Generation X, the age cohort born before the 1980s but after the Baby Boomers; Generation Y, or Millennials, typically thought of as those born between 1984 and 1996; and Generation Z, those born after 1997, who are next to enter the workforce.

In a survey of 18,000 professionals and students across these three generations from 19 countries, we found some important differences in their aspirations and values. We hope that results from this survey, conducted by the INSEAD Emerging Markets Institute, Universum, and the HEAD Foundation, will be useful to companies seeking to retain, develop, and attract employees from these talent pools. However, it’s important to note that our findings are a snapshot of where these employees are at thismoment in time; employees’ needs and expectations often evolve over the course of their careers, and we hope future surveys will update these findings.

Leadership Ambitions

We found that across the globe, becoming a leader was important to 61% of Gen Y, 61% of Gen Z, and 57% of Gen X respondents. But responses varied by country: For example, in the Nordic countries respondents were significantly less likely to covet leadership roles than those in Mexico. Among Gen Y respondents, 76% of Mexicans said attaining a leadership role is important, but only 47% of Norwegians said the same. 77% of American Gen Y professionals said that gaining a leadership position was important to them.

Organizations should keep these preferences in mind. Those in markets lacking enthusiasm for leadership, including Denmark, Sweden, and France, across which only 56% of Gen Y professionals said becoming a leader was important to them, will find their talent pipelines harder to fill; those in countries like Mexico, the U.S., and India will have to find ways to manage expectations and provide leadership experience or other motivation for ambitious workers.

In general, Gen Y and Gen X professionals are more enthusiastic about the coaching and mentoring that comes with management jobs than the higher responsibility. However, Gen Z cites higher levels of responsibility and more freedom as attractive attributes of leadership. Geographically, Gen X respondents in Spain put coaching and mentoring others as what is most attractive about leadership, but this was a lower priority for respondents from Germany, Norway, Denmark, Britain, and the U.S., who all put challenging tasks as the most attractive aspect.

Men and women’s leadership preferences also differed across generational cohorts. For Gen X, 63% of men and 52% of women said becoming a leader was important to them. Among Gen Y and Gen Z professionals, it was 63% of male respondents and 61% of women. (Other research has similarly found that younger women are as ambitious as their male peers but that companies may be draining female employees ambitions.) Our survey respondents gave varying reasons. In general, Gen X women are more likely to enjoy the challenging work involved in leadership, as well as getting to coach and mentor others. Gen Y women also put opportunities to coach others ahead of other activities, while Gen Z women felt that high levels of responsibility was the most attractive thing about leadership. Men across all generations were more interested in future earnings and high levels of responsibility.

When we asked about barriers to leadership, high levels of stress in particular put off Gen Z respondents in countries such as Japan, France, and the U.K. This was the same among Gen Y professionals, with respondents from the U.S., Switzerland, and Finland standing out in terms of citing this concern. Gen Xers in all these countries concurred; German, Swiss, and Emirati Gen X respondents were most worried about achieving work-life balance.

We also found that women, across both geographies and generations, were more likely to be put off by stress, more likely to feel they lack the confidence to lead, and more likely to fear failing than their male colleagues. But women also worried about different things in different countries. In China Millennial women were most concerned about being unable to find the developmental opportunities they need to progress, while Chinese Gen X women worried more about not being able to enjoy their retirement. Both generations feared not finding an alignment between their personalities and the jobs available. In the U.S. female Millennials worried most about not being able to realize their career goals. In Sweden female Millennials were most concerned about being overworked.

It will be crucial for companies to understand the different concerns holding women back in their global workforces. Most multinational companies have globally or regionally defined inclusion initiatives, rather than ones customized to a national level. But what women want in China differs greatly from what those in India want. Leadership development initiatives may have to be tailored by country to address these differences.

Entrepreneurial Ambitions

We found a strong interest in entrepreneurship across all three generations. Our results show that one in four students (Gen Z) is interested in starting their own business. And among those already in the workforce (Gen Y and Gen X professionals), one in three yearned to be entrepreneurs. Gen Y professionals in Mexico (57%) and the UAE (56%) were the most interested in starting their own businesses.

When asked whether they would want to work for an international company or start their own business, respondents in Gen Z favored working for an international company, while Gen Y and Gen X professionals preferred starting their own business. Only 27% of Gen Y professionals in Mexico reported wanting a career at an international company. In India 43% of Gen X wanted to start their own businesses and 25% to work for an international company.

To keep those interested in entrepreneurship close to the firm, leaders might want to consider “intrapraneurship,” giving employees the ability to work on startup projects within the firm.

Relying on Technology

When we asked which technologies are likely to revolutionize work in the coming decade, we learned that Gen Z was most enthusiastic about the potential of virtual reality (VR). This was stronger in certain countries such as Mexico and Singapore and weaker in countries such as India. Gen Y professionals also saw VR as the technology most likely to revolutionize their work in the coming decade, putting it ahead of wearable technology, project management, and audio/video conferencing. Companies may want to consider virtual reality as a tool for recruiting these cohorts.

Gen X, on the other hand, believed virtual reality technologies would have a low impact on their work. They had the most enthusiasm for project management tools, with certain countries, such as Germany, Japan, and Russia, also expressing excitement about cloud computing and e-learning tools.

We also asked whether respondents saw technology as helpful to or hindering their work lives. More older professionals considered technology a hindrance in Britain, Sweden, and Norway. Technology was most viewed as helpful by Gen Xers in Denmark, Sweden, and Mexico. Among Gen Y, respondents in Mexico, Sweden, and Germany perceived technology most favorably. And Gen Z students in Germany, Japan, and Mexico also saw technology as useful, while those in China, the U.S., and Canada were more likely to view technology as a hindrance to their work.

While these cohorts want very different things from technology, both young and older workers agree that their organizations’ digital capabilities are not up to scratch. Over 70% of Gen Y and Gen X professionals thought their employers’ digital capabilities are important, but only around 40% of both generations said their companies’ digital capabilities are high.

Finally, more than 70% of respondents across all generations said flexible working arrangements represent an important opportunity for their work lives in the next 10 years. The Swiss across all generations put flexibility as a top opportunity. So did Singaporeans in Gen Y and X (Gen Z Singaporeans put flexible working locations first). Chinese and Japanese respondents were excited about the international job opportunities and working with clients and colleagues in other countries.

Training

Respondents differed in their preferences for work training. When asked if they would take an online course if offered one by their employer, 70% of Gen Z respondents said yes, while 77% of Gen Y and 78% of Gen X professionals said they would take it.

Given the choice between an online course and an in-person one, 69% of Gen Z chose an in-person program, compared with only 13% choosing an online one. It was the Gen Xers who gravitated most toward online training, with 25% of respondents choosing this option. But 21% of Gen Y professionals also said they preferred online training over in-person teaching.

Fitting In

All generations were concerned about whether their personalities fit with where they work (50% of both Gen Y and Z respondents and 40% of Gen Xers). Japanese Millennials (66%) and Spanish Millennials (57%) were most concerned about fit; this was observed among Japanese Gen Zers (60%) and French Gen Zers (64%), too.

Japanese, Danish, and Indian Gen Xers also put fit as an important priority. But what most bothered Gen X in general was not being able to enjoy retirement, getting stuck with no opportunities, or losing job security. Not being able to enjoy retirement emerged as a top concern in the UK, the U.S., and Spain.

In sum, firms and leaders need to understand the different preferences among these generational cohorts in order to make better decisions about leadership development, technology, training, and culture-building.


Henrik Bresman is an associate professor of organizational professor at INSEAD and fellow of the HEAD Foundation, a Singapore-based education think tank. Follow him on Twitter @HenrikBresman. The INSEAD Emerging Markets Institute is a think tank for the creation and dissemination of information on growth economies. Universum is a global talent research and employer branding firm.


Vinika D. Rao is Executive Director of the INSEAD Emerging Markets Institute.

Generational Differences Between India and the U.S.

I’m often asked if generations share common characteristics around the globe. The answer: to some extent, particularly among younger generations whose members were exposed to many of the same events through cable television and the Internet. But among older generations, the shared elements are much less significant and the national characteristics of the generations become increasingly unique.

By definition, a generation is a group a people who, based on their age, share not only a chronological location in history but also the experiences that accompany it. These common experiences, in turn, prompt the formation of shared beliefs and behaviors. Of course, the commonalities are far from the whole story. Even those of you who grew up in the same country also had unique teen experiences, based on your family’s socioeconomic background, your parents’ philosophies, and a host of other factors. But the prominent events you share – particularly during formative teen years – are what give your generation its defining characteristics.

Let me briefly compare some of the formative experiences – and resulting generational traits – of individuals growing up in the United States and India. I’m hoping you’ll join the discussion to share your experiences.

Traditionalists – Born from 1928 to 1945

Traditionalists were teens in the 1940’s and 1950’s. In the United States, these teens experienced a booming post-War economy – rapid growth of suburbs, increased availability of consumer goods, and a boom in white collar jobs. It would be logical for any teen growing up in this atmosphere of budding opportunity to be excited about the possibilities of joining in. Traditionalists in the U.S. tend to be loyal to institutions and accepting of hierarchy and rules. For many, financial success is an important metric of achievement.

In India, the 1940’s and 1950’s saw the birth of India as an independent nation. Teens would have witnessed Mahatma Gandhi’s non-violent, civil disobedient campaign for independence, the end of the British Raj, and Gandhi’s assassination. Like the U.S., this was a time of patriotic pride, with the resurgence in Indian traditions and the establishment of a democratic republic with elections. But the living conditions in India at the time were difficult – a poor economy, short life expectancies, low rates of literacy, mass impoverishment, stalled industrial development, and destitute farmers. The Indo-Pakistani War of 1947 (also called the First Kashmir War) marked the beginning of a long border conflict.

For individuals in this generation in India, patriotic pride over newly established independent nation blended with loyalty to family and community. The concept of boundaries was an important element of an individual’s mental model – boundaries of new states, local sects/groups, and the individual. Success was defined as obedience to traditional practices, while finding ways to participate in this new India.

Boomers – Born from 1946 to 1960/1964

Teens in the 1960’s and 1970’s, Boomers in the United States were heavily influenced by the Vietnam War, the Civil Rights movement, widespread protests, the assassinations of Kennedy, King, and other idealistic leaders, and, toward the end of their teen years, Watergate and Nixon’s resignation. Most emerged from this era suspicious of authority and idealistic about their role in the world. In addition, Boomers grew up competing for the limited number of seats available to their rapidly expanded cohort. From this, they internalized the message that life would be a perpetual game of musical chairs – Boomers are fundamentally competitive because they grew up in a world in which zero sum rules apply.

India, during these same years, shifted to a socialist economic model under Indira Gandhi’s leadership: nationalization of industries, public works, social reforms, and public investment in education. Political factions grew and the Indian national Congress split into two: Old and New Congress. India signed a 20-year treaty of friendship with the Soviet Union; its first break from non-alignment. Wars around borders continued: Sino-Indian War, Indo-Pakistani War of 1965 (Second Kashmir War), and the Indo-Pakistani War of 1971 (independence of Bangladesh). The rupee was liberalized and underwent severe devaluation. A “Green Revolution” improved agricultural productivity enabling India to feed its population self-sufficiently after two decades of food imports. Toward the end of the period, during the Indian Emergency of 1975-77, Gandhi is accused of corruption, rules by decree, suspends elections and civil liberties, and is removed from power by the opposition.

For teens in India at this time, economic options were limited by the sluggish economy; personal options are heavily influenced by the family, group, or caste into which one was born. For those who are able, success is linked with getting out of India to obtain higher education and work in the U.K. or U.S. Similar to U.S. teens’ experience with Watergate, the Indian Emergency left this generation with skepticism of political leaders.

Generation X – Born from 1961/1965 to 1979

Generation X teens in the United States during the 1980’s and 1990’s lived through a period of extraordinary social change. The economy was poor and many saw important adults in their lives laid off from jobs where they had planned to spend their entire career. They were influenced by the Challenger disaster – the space shuttle that blew up shortly after takeoff, women entering the workforce, rising divorce rates, and the growth of electronic games and of the Internet. The first generation of “latch key kids,” X’ers internalized the possibility that many of the institutions in their lives – whether marriage or corporate employment – could disappear. As a result, it is logical that self-reliance became an important life value – a desire to keep multiple options open if something bad were to happen. X’ers are generally mistrustful of institutions, loyal to their friends, and dedicated to being good parents.

Teens in India saw Indira Gandhi killed by her bodyguards and succeeded by her son Rajiv Gandhi, who instituted a number of important reforms: loosened business regulations, lower restrictions on foreign investment/imports, and reduced bureaucracy. Rajiv also led the country into a major expansion of the telecommunications industry, space program, software industry and information technology sector. Political conflict continued: Rajiv Gandhi’s image as honest politician was shattered by the Bofors scandal and he was later killed by suicide bomber. P.V. Narasimha Rao became Prime Minister and initiated further economic liberalization and reform. Still, over 75% of 1980s Indian Institutes of Technology graduates emigrated to the United States.

Members of Gen X in India developed a mental model patterned on a rich, vibrant democracy – comfortable with many views, perspectives, and voices. The constraints of the caste system were giving way to the power of education, which was increasingly available for the best and brightest. Although success continues be associated with moving outside the country, economic opportunity is growing within India. Diaspora not only take care of and retain close ties with those in India, but are beginning to make investments in the country’s economic future.

Generation Y – Born from 1980 to 1995

Globally, Generation Ys’ immersion in personal technology enabled this generation to experience many of the same events and, as a result, develop as the most globally similar generation yet. Acts of terrorism and school violence were among this generation’s most significant shared formative events. The random nature of terrorism – in which inexplicable things happen unexpectedly to anyone at any time – left many Y’s with the view that it is logical to live life fully now. Around the world, this generation has a sense of immediacy that is often misinterpreted by older co-workers as impatience.

In the U.S., Y’s teen years were marked by an unprecedented bull market and a strong pro-child culture. As a result, they are optimistic, goal-oriented, and very family-centric.

In India, the late 1990’s and 2000’s saw the development of a large middle-class and increased demand for and production of many consumer goods – in many ways, a situation reminiscent of the U.S. Traditionalists’ experience with a rapidly expanding pie. The Indian economy grew under liberalization and reform policies, the country was stable and prosperous, and political power changed hands without incident. India became a prestigious educational powerhouse and respected source of IT talent. By 2008, 34 Indian companies were listed in Forbes Global 2000 ranking.

Y’s in India share the generation’s global sense of immediacy, coupled with the excitement of being part of the country’s first wave of broad economic opportunity. As a result, young employees in India tend to share the rapid tempo of U.S. Y’s ambitions, but with a greater emphasis on financial reward as a desired outcome. They have come of age in an exciting, dynamic country with significant economic opportunity. Most are entrepreneurial and business savvy, as well as technologically capable and connected. Their mental model is heavily influenced by India’s rich, complex democracy – they easily accept diversity of opinion – as well as by the Western heritage of laws and customs left from the old days of British rule, making them strongly suited for global interaction.

So, bottom line: some common traits, particularly among Generation Y, and many differences, certainly in older generations. If you find this discussion helpful, I’ll share my research on generations in other countries in future posts.

And I’d love to hear from you – particularly if you grew up in India. What events were most memorable and influential during your teen years?

* * *

Finally, I’m very excited to share with you that Harvard’s Corporate Learning group has developed a terrific online program based on my work: “Leading Across the Ages.” In this difficult economy, it’s a great way to share insights broadly within your organization – to reduce intergenerational tensions, strengthen relationships among your colleagues, and increase productivity and the likelihood of innovation. I hope you’ll check it out!


Tamara J. Erickson has authored the books Retire RetirementPlugged In, and What’s Next, Gen X? She is the author or co-author of five Harvard Business Review articles and the book Workforce Crisis. Erickson was named one of the top 50 global business thinkers for 2011.