“Almost all neglect the properties they manage and take kickbacks from suppliers and subcontractors who overcharge the property manager’s client in order to pay the kickbacks.” – John T. Reed
People selling real estate advice almost always advocate using property management companies. John T. Reed suggests they do this to overcome the objection “I don’t want to get up in the middle of the night to fix a clogged toilet.” “Don’t want to get up in the middle of the night? Me either! Buy my $3,999 program and I’ll teach you how to have the best property managers begging to work for you!!! Let THEM get up in the middle of the night.”
While it may sound great in principle, the reality can be a little less cut-and-dry. You’re usually going to pay 5-10% of the gross rent, plus expenses to hire a property management company. Sometimes they’ll charge extra for filling a vacant unit (for the extra work of advertising, showing and setting up the new tenant). This is all quite reasonable, and if this was the end of the story I’d agree it’s a good way to go.
To get one case out of the way, sometimes real estate agents will offer to be property managers for the owner (or to place tenants for him). They’ll charge a nominal fee, and will typically do a really crappy job (they won’t do their due diligence screening tenants and whatnot). Their job is selling houses (not managing rental properties), so when they’re acting as a manager for the owner, they’re doing it to generate good will so the next time he buys or sells he’ll use them (the same reason they give you a pumpkin). If things work out, they look like a champ for helping, if things blow up, they can just put the blame on the awful tenants (and maybe help the owner sell the place if he’s burnt out).
Genuine property management firms (where that’s what they do exclusively) are an intensively entrepreneurial enterprise. You can be sure whoever started and runs the company loves business, and they’ll be dealing with all the typical challenges of running a business (advertising, employees, customers [owners!], etc). As an entrepreneur, they’ll be constantly looking to maximize profit and minimize costs: for themselves. Property owners will assume that the property management firm will be doing this on their behalf, and in the case of a small number of HIGHLY ethical companies (that will naturally tend to go out of business, we’ll get to that later), they may be right. The majority will sell out the owners in large or small ways. You may think they’re your weasel, but they’re their own weasel.
Greed is one obvious motivation. If a plumbing company offers the management company $20 every time they’re called to be the “sole supplier” for the company’s clients (or some other similar arrangement), do you think the company will refuse? They should. The $20 just gets added onto the cost of the job (and billed to the property owner). If they could afford to pay a $20 kickback, they can afford to lower their price by $20. The manager gets the kickback at the expense of the owner.
The same thing can happen in less obvious ways when a friend or relative of the manager is a plumber, and gets the business out of loyalty. Would the owners want the job to go to the company that does the best job for the best price, or to someone the manager feels loyal to?
Apathy can kick in where greed leaves off. If you’re not paying a bill, it becomes VERY easy to not work too hard to get the price reduced. When I’ve had to rent a car for a business trip, I get whatever model is authorized from the first place I call. When I’m renting for myself, I drive an economy model, use my credit card to cover the insurance, and will track down any deals or the lowest possible price in town. If I can get a lower price to save myself some cash, I do so. If I can save cash for a larger organization that will neither notice or appreciate it, I don’t bother. Which case do you think the PM will be in when the owner is footing the bill?
Property management companies will argue against rent increases. A higher rent means more money for the owner (and a tiny raise for them), but it also increases the amount of work they do (tenants will be more likely to move out after a rent increase, and may be less inclined to complain if they know they’re getting below-market rent).
If someone ethical is running a property management company, acting as a fiduciary for the owner, often customers won’t even realize or appreciate this. They certainly don’t seem to realize how often they’re getting ripped off by property management companies, or you’d hear far more owners grumbling about them (economists call this information asymmetry). The ethical manager will therefore be earning less money (no kickbacks) for more work (hunting for the best deals) and won’t even be getting loyalty from his customers. How is he going to compete in this situation? There will be constant pressure to slack off (both from an ethical and a work-ethic perspective) or give up and move into a more honourable field of work. My reasoning here is (unabashedly) related to the lemon principle (alternative Wikipedia info).
John T. Reed’s advice is “competent real estate investors manage their properties themselves or have in-house salaried employees to do it.” I second this sentiment.
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I have a couple rentals, and I thought about going the property management route, but I declined since one is just half a mile away, and the other is in a rental program while I’m away.
I will say though that after 10 years, and if i’m not close by, I will hire a property manager b/c my time is too precious, and the positive cash flow is large enough.
It’s all about outsourcing your time.
Financial Samurai
When we first became real estate investors, we grappled with this, too. If you are reasonably handy, and only own a handful of units, it is not too onerous to manage your properties yourself. It becomes trickier as you add more properties. We are at the point that if we add more units, it will simply become too time-consuming for us (we also work) but the thought of outsourcing property management duties to a 3rd party company doesn’t sit well with us. I liken it to leaving my kids with a babysitter I don’t know. It feels wrong.
We have decided to try to find an honest, reliable maintenance person to help us with the actual maintenance of the properties and we will continue to do all the administrivia and tenant relations.
It is a challenge finding an honest, reliable maintenance person, too. We have tried several and haven’t found one yet.
Very interesting post. I agree that this is one of those situation where there is a conflict of interest (like real estate agents) and the pm is going to err on the side of his/her own profit.
Long distance property management would probably be the most dangerous situation to be in.
As for people not knowing they are being ripped off – I attribute this to the whole “real estate investing dream/coma” where investors buy rental houses and “have the mortgage paid by the tenants” and basically live in la-la land as far as understanding their investment performance.
If RE prices go up then those people will still do fairly well but in other times they could lose big time (and they still might not be aware of that).
Some property managers even goes as far as skimming off the top. I have seen this first hand with one of my father’s properties where the property manager has been in charge so long he is able to skim off the profits and my father does nothing because he feels it is not worth the time. I guess you just can’t trust some people.
I’m glad you put out this article. I just bought a triplex in October and have since spent many hours fixing up a unit while a house a few doors down was being retrofitted entirely by a PM company. I felt like a idiot doing the work myself, but now I see that I made the right decision. Besides, when I do the work myself, I know exactly what kind of condition the unit is in and can make sure that the work is done soundly. Plus I’m learning something in the process.
i think any the arguements you made against a pm would apply to any business. it could be a dentist, electrician, landscaper, painter. its way to cynical to think that a majority of managers are cheats. my manager calls and provides an estimate before the work is started. i’ll get other estimates or maybe complete the task myself, if i feel the quote is out of line. a pm simply assists with managing my time.
herb: I definitely get where you’re coming from. Growing up, we had a neighbour who is a veterinarian and he was caught performing unnecessary surgery on pets (and lost his license for a period of time). Nice guy, eh? Maybe I am more cynical than average (I’ve been accused of this before). HOWEVER, there are certain groups that pride themselves (and try to hold themselves) to a higher ethical standard. For example, Vets as a profession have put ethical codes into place and try to enforce them (and were successful in the case of my neighbour). Other groups, such as property managers and energy resale marketers, are often unabashedly out to get what they can from whoever they can by whatever means necessary.
The last time I hired a painter, I did so through Sears. My thinking was this has a company that cares about their reputation standing behind the job that is done. I realized that I was paying a premium for this, but I preferred that to taking my chances with some guy who’d recently hung his shingle out as an independant painter and may or may not do a good job.
Good PMs do exists, congrats if you’ve managed to find one (maybe you should get him something nice for the holidays).
Property management is an important factor to consider in buying real estate so you will be convenient when you’re using it already.
Mr. Cheap,
All Sears does is outsource the painting job to a private contractor, that you can hire privately, and charge you a premium for it. They are like Rona\Home Depot etc. They take a cut by being the middle man. Save yourself some money and find out who they hire locally to do the work, hire them privately and negotiate a better deal.
Adam: Yup, I realize that’s what they do and I’m happy to pay for it. The contractor has a vested interested in doing a reasonable job (if they jerk me around and I start complaining to Sears, Sears can get them to do the job: they have more leverage over the contractor in terms of future work).
Some friends got painting done from a private contractor at around the same time and it was a nightmare.
Sometimes it’s worthwhile to have middle men.