How do property managers help me improve ROI for my rental property?
I love questions that refer to ROI, or return on investment, because that’s where the rubber meets the road. ROI is the engine that drives all economic development! It is the lifeblood of progress, and it’s why you and I have careers doing something other than squatting in front of a mud hut with a home-made spear protecting our families from marauders and wild animals.
Not that there’s anything wrong with that!
Now, more specifically, the question goes to the very heart of the decision to retain a property manager. After all, property managers can’t work for free! Any fees have to be added to the overall expense column of your real estate investment practice – and their fees must be subtracted from any definition of investment return from the properties they manage.
The pressure on property management firms, therefore, to justify their fees in terms of ROI is intense – and it can be a very difficult thing to do!
After all, most good property managers will work hard to get the most possible rent out of a property they manage – but they cannot point to a reliable figure that indicates what the place would have been renting for had the landlord went with the do-it-yourself approach, or even had the landlord engaged a different property manager. None of us can know for certain what would have been in a parallel universe.
But as we shall see, ROI is not the whole picture. There are other important considerations as well.
That said, here are the ways a good property management firm may help a landlord increase his or her overall return on real estate investment activity.
1. Helping price rentals efficiently. Price them too high, and the vacancy rate will be unacceptable. Price them too low, and the landlord leaves money on the table. Either way you mis-price, expected revenues will drop off on either side of an optimal point on a bell curve distribution of possible rent levels.
Somewhere there is an invisible optimal point that maximizes expected revenue from the rental property. (Actually, theoretically, there may be multiple optimal points!). A property manager may be able to help a landlord find that optimal point, or get very close to it, by means of solid market intelligence and experience, which an individual property owner may not have.
2. Marketing. Beyond pricing a rental, a property manager may help with attracting qualified applicants and getting them into a lease quickly. Every day an apartment goes unrented means a higher vacancy rate and lost revenue. A property manager may be able to get applicants in the door faster than an individual landlord working alone.
3. Labor efficiency. Landlords’ time has value. Frequently, this value is much greater than the hourly rate of any of the employees working on property management or maintenance. If the landlord’s time can be productively employed to earn $100 per hour, it does not make much sense for the landlord to run around the property collecting rents and mowing lawns, when it is easy to hire an on-site manager and maintenance person, each working for a fraction of that figure.
4. Economies of scale. An individual landlord would have to do almost all maintenance work using contractors – an expensive process when measured by hourly costs. A property manager responsible for 200 units around the neighborhood can take care of these things with their own employees – frequently saving quite a bit of money. This alone can account for a nice chunk of the management company’s fee.
5. Repairs and upkeep. An experienced property manager should bring far more skills to the table than the average landlord. This may well translate into some preventive inspections and maintenance getting done that many individual landlords wouldn’t think of. A stitch in time, they say, saves nine. Proactive inspections and maintenance saves on more costly and extensive repairs in the long run.
6. Tenant quality and screening. Most landlords have not personally reviewed a thousand credit reports and heard ten thousand sob stories about why the rent can’t be paid on time. Most property managers who’ve been around the block a few times have. This is a skill – and a good property manager will frequently have a nose for potential problems that a landlord trying to go it alone would miss.
7. Evictions. These are time-consuming, complicated processes, and if you don’t follow the law to the letter, you could give the tenant you’re trying to evict enough ammunition to retaliate.
8. Compliance. As any investor knows, returns are only half the equation. You also have to consider possible risks. For landlords, one of the biggest risks is the possibility that you could get sued for something like housing discrimination. If you get into hot water with the Department of Housing and Urban Development, it could cost you tens of thousands of dollars, and it could result in a judgment that potentially strips you of the property altogether.
Property managers can help insulate you from claims by screening tenants carefully and legally, and by keeping records to protect you. In the event the manager screws up, and there is a successful lawsuit against you, the property manager’s errors and omissions insurance company provides a layer of protection you would not otherwise have.
This isn’t the kind of thing that shows up directly in ROI numbers, but it is a vitally important calculation.
Ultimately, the decision to use a property manager comes down to an assessment of value:
- The landlord’s time has value.
- The property manager’s set of core competencies have value. If the landlord is not himself or herself an experienced contractor, this value is somewhat greater.
- The reduction of lawsuit/liability risk that a property manager has value.
- The tax deduction you get from paying a property manager has value itself, as well. Rental income is taxable. Fees paid for property management are deducted directly against rental income (subject to passive activity rules, of course). The dollar you get to keep in rent is “smaller” than the dollar you pay to a property manager.
The landlord ultimately must weigh these factors against the fees charged. In most cases, the advantages are more than worth the fees. If cash flow is tight, you may consider a more limited engagement than a full-service property management contract.
Ultimately, though, successful landlords eventually do tend to invest in property management of some sort. If they don’t contract with an established manager, sooner or later they will do it by hiring their own staff to help them maintain and administer their properties.
The power of delegation
Transferring administrative and maintenance tasks to a property manager that makes these areas their core competency eventually pays off, because the manager gives the investor time. Time to pursue your own core competencies – which hopefully include creating and finding and closing on more profitable real estate deals.
Of course, some people enjoy the daily task of landlording. They find it rewarding in and of itself – and this is fine. But those who eventually generate large amounts of wealth and opportunity for others will tend to realize the power of delegating non-core tasks to property managers and focusing their efforts on replicating the successful strategies that got them their first property.
Writing about personal finance and investments since 1999, Jason Van Steenwyk started as a reporter with Mutual Funds Magazine and served as editor of Investors’ Digest. He now publishes feature articles in many publications including Annuity Selling Guide, Bankrate.com, and more.