Not All Property Management Companies Are Created Equal
In the summer of 2002, owners that we already managed one property for approached me to manage another property for them—the very same property I briefly talked about in my introduction. The 100-unit building was in a very rough part of town. I went out to the property and was shocked on my initial walk-through. Very rarely had I ever seen a property that was so disastrously managed.
There is no doubt that the property faced challenges given its location, but it seemed as if the manager had given up on the building. I could immediately tell that managing this building was going to be a challenge of the first order. Luckily, I enjoy challenges. Because of my relationship with the owners, I elected to take on the management of the property.
The first problem the owners had was they had signed a property management agreement that was fee-based rather than based on a percentage of the income collected. As I indicated earlier, if you are going to use a third-party management company, you should always make sure they collect their income based on the property’s income. It is just too easy for someone to become complacent if they know the money will come in no matter their performance.
Even though I enjoy a good challenge, I still had huge reservations about taking on the task of managing this property. For over two months, the owners and I went back and forth on negotiating terms that would be fair for me to accept the job. There was such a large amount of outstanding unpaid bills that I made it a condition that the owner bring all accounts up to date before we even stepped foot on the property, which they did. We needed this to happen to even have a fighting chance of fixing the problems the property faced.
When we finally did take over the property in March of 2003, we were shocked at the condition and state at which it was operating. Immediately, we walked each of the 100 units. We found significant deferred maintenance. Nearly every unit on the property required a large amount of renovation work, including the occupied units. Not only that, the deferred maintenance was so significant in about forty units that the previous manager had not been able to rent them. The property was only 60 percent occupied. Many of the vacant units required $2,000-14,000 each just to be rent-ready. In the end, ninety-eight units needed work of one variety or another with a total bill of $106,000!
Because the property was in such a state of disrepair, rents were significantly below market, and once we began to dig into the financials we found some pretty astonishing things. Shockingly, the rent income was about $145,694 below market. Based on a 6 percent capitalization rate, that alone devalued the property by $2.4 million.
Operating expenses were too high as well. The previous manager had not explored any ways to save money. A couple quick phone calls on our part saved about $20,000 annually in operating expenses. Unfortunately, that savings and some others had to go toward expenses to make the property rentable. Even worse, we discovered that the mortgage had been intentionally paid short by about $20,000 by the previous management company, and the lender was threatening foreclosure.
It was the owners’ intention to sell the building since it was such a burden. This, however, was a futile effort. The actual cash flow for the financial year ended up being negative $166,373! That was an operating loss that equated to 4 percent of the entire value of the building. That means that the building was actually unsellable, since as we’ve discussed, value is based on operations. Had they tried, I think the owners would have had a hard time giving the building away.
Once a manager gives up on a property, as the previous manager had, the resident profile will inevitably slip. Such was the case with this property. Desperate to just fill apartments, the manager stopped doing background checks and rented to anyone who came through the door, a last-ditch effort to increase occupancy. Criminal activity got to be so bad on the property that the standard street beat police wouldn’t go there. Instead, they had actually set up a police substation inside the property itself because of the incessant drug activity. Additionally, the police department had rented an apartment and was conducting sting operations on the residents.
As I mentioned in my introduction, one resident was so involved in drug trafficking that he had been paralyzed from one of the many gunfights he had been in and was wheelchair-bound, and he had his wheelchair custom-built so that he could hide an automatic weapon in it. When we first took over the management of the building he was very nice and very interested as to what we were planning on doing to increase security. He was worried how it might affect his business!
We immediately evicted fifteen people when we took over the property because of their involvement in criminal activity. One of my employees went so far as to jokingly suggest we apply for federal funding to become a halfway house for convicted felons. That might have been easier.
We faced a mountainous volume of work when we took over the property. In trying to get the property back to a functioning level, the workload was so intense that I had my corporate office employees keep track of the time they spent on it. The results were astonishing. Following is the actual monthly time and cost of my corporate staff on just this one property:
Let me tell you why this chart is so significant. When I negotiated the property management agreement with the owners, I wanted there to be some safeguards because I knew there would be a lot of work involved. With that in mind, we settled on a management fee of 5 percent of the total income collected, or $2,500 per month, whichever would be greater.
When we took over the property it was generating about $31,000 in total income each month. At 5 percent our monthly fee would have been $1,550. Thankfully, we had a safeguard and collected $2,500. Unfortunately, I still lost money.
Earlier in the book I talked about the things a property’s operating income pays for. One of them is the on-site staff: your manager, maintenance, housekeeping, and leasing agents. It does not pay for the property management’s corporate office staff. Take a look at the chart again. Do you see how on the first month we took over the property the total cost to my office staff was $3,560? That was a direct loss to me of $1,060. From then on it was basically break-even.
All of this was a direct result of the previous manager’s inability to manage the property correctly, and all of this could have been avoided if the owners had done a little more homework and been more prepared in their initial search for a property manager.
In the end we were able to get the building into a much better operating status. The difference was so dramatic that the owners actually changed the name of the building in order to shed the negative stigma of the previous name.
After our hard work, the owners were able to sell the property and even realize a little profit. That would have been unthinkable two years earlier. This is proof positive to me that there is nothing more important to the value of a property than good property management. Think of the stark contrast; one manager had driven the property so far into the ground that it was technically worth nothing, while we took the same property and created value just by implementing sound management principles.
To me there is nothing more tragic that seeing a property’s value destroyed by a manager’s bad performance. Unfortunately, this property’s story is not an isolated case. The responsibility rests on your shoulders to do your homework when hiring a management company. In this chapter we will discuss how you can avoid these mistakes and find a property manager that fits your investment’s needs and manages your property successfully.
First off let me say the simplest definition of a good property management company is this: one that sends you a check and never calls. That is the dream of every real estate investor. One of the major advantages about hiring professional property management is that you no longer have to invest copious amounts of energy and time in your property. When you have a property management company that you trust, you let them take care of your asset and they send you the returns. If you feel the need to control every aspect of the property management process, you should just manage the property yourself. Otherwise, you defeat the purpose of hiring a professional company and you are wasting your money. However, this does not mean you should not be managing the property manager.
Though it is easy to blame a property management company if your property is underperforming, the responsibility ultimately is with you. Even if you are not going to manage your own property, you need to have a fundamental understanding of the work and principles that are needed in order to make your property a success and grow in value. You should choose your management company based on an informed decision.
There are many property management companies out there who are dying for your business. A lot of companies will take on your property, even if they don’t have the manpower or the know-how, because they are more concerned about growing their business than creating value for your investment. Not all property management companies will specialize in managing your type of investment. Later in this chapter we will go into detail about the various types of companies, but for now suffice it to say you shouldn’t hire a company whose expertise is commercial management to run your ten-unit residential building.
The first thing you should do when evaluating which company to hire is to evaluate your property needs. Sit down and think hard about what kind of property you own. Make a list of the needs of the property that will have to be addressed by the management company you hire. Some areas to focus on are:
This doesn’t have to be anything extremely complicated. For example, if you own a 100-unit community, you don’t want to hire a company that doesn’t offer on-site management and trained maintenance technicians. Conversely, if you own a single-family house, you probably don’t want to hire a large company that will find it too easy to let your small property fall through the cracks.
Additionally, your property’s needs will vary depending on the region. You may own a large property that would benefit from a large property management company, but if it is in an area where that company’s presence is small, you could be better served by seeking out a company that knows the market and has a presence.
Something as simple as the climate can create dramatic differences in the needs of comparable properties. A property in Madison, Wisconsin, would need to have ways to manage snow accumulation, icy pipes, and slick sidewalks, something a property owner in Phoenix, Arizona, would never have to worry about. If you own a property in a cold weather climate like Madison, it wouldn’t make sense to hire a property management company that operates primarily in the Southwest. There is such a vast difference between the climates that there is no way the company could be as well versed in managing a property as a company that operates locally or regionally.
A good rule of thumb when evaluating a property management company is to make sure that it belongs to local and national trade organizations. Reputable companies belong to trade associations. Belonging to a trade association is an indication that the company is focused on improving its operations. These associations offer training for employees, networking opportunities, and valuable market research that a company can get nowhere else. You can find a list of prominent property management trade associations on the NAAHQ.org and IREM.org Web sites.
I have been involved in the Arizona Multihousing Association (AMA) for years. Every month I send my employees to any number of the training classes that they offer. These classes are invaluable. Additionally, our involvement in the AMA has created valuable networking opportunities with vendors that we have used to negotiate discounted services. This saves my clients money.
The AMA also keeps all its members up to date on changes and proposed changes in the Arizona legal system that would affect how a property is managed. They provide educational forums and seminars on property management law and help me ensure that my employees are empowered with the knowledge they need to comply with those laws.
Trade organizations also provide certifications based on intensive training.
The National Apartment Association provides a Certified Apartment Manager certification that takes hours of classroom and practical application to obtain. Also important are the crime-free certifications that these organizations provide. In Arizona, all of my properties have obtained five-star certification, a program that has partnered with the state of Arizona to help reduce crime in apartment communities. It is a difficult certification to obtain, and one that I am very proud of.
Types of Property Management Companies
As I mentioned earlier, there are many different types of property management companies. The types of properties you will find companies specialize in are:
There are other types as well, but these are the major ones. Each of these property types has specific needs that require a property management company well versed in those needs.
Beyond specializing in a property type, companies also differ in their operational capacity, each of which will have its pros and cons:
My company specializes in large multifamily management in the Southwest. I get offers all the time to manage outside my specialization. I always say no. In my previous book, The ABCs of Real Estate Investing, I wrote extensively on the importance of setting goals. I believe that “goal power” is the key to success. When it comes to my management company, my goal is to be the most successful property management company in the Southwest.
Earlier in the book I talked about the property that we purchased in Oklahoma City. I had no desire to manage that property so we turned to local professionals. Attempting to manage the property ourselves would also take the focus off my goal of buying property. My Oklahoma City property is part of a different, but complementary, goal to be financially free.
As an investment property owner, you need to begin your search for a property management company by evaluating what type of property your investment is and what its specialized needs are, and then find a property management company that fits well with those criteria. It is an important decision and one that will take a little bit of research on your part. As with all good investments, if managed well, yours will reap great rewards down the road.
