The Downsides of Hiring a Third-Party Property Management Company for a Multifamily Property

While hiring a property management (PM) company can offer numerous benefits, there are also potential downsides that need to be understood when choosing to contract such a company. Oftentimes, syndication companies or individual investors don’t have a choice as to whether they should hire a third-party property management company. Additionally, everything becomes even more complicated with scale. It’s common to hear individual small investors with anywhere between 5-20 units to manage a property or a few properties by themselves. In our experience, anything beyond the range I just stated and things get complicated quite quickly. Syndication companies or individual investors in the position to have their own dedicated property management team are very fortunate, but they still have their fair share of work cut out for them. 

We’ve published multiple blog posts talking about our experiences with property management, the benefits of hiring a PM company, and more. However, we have yet to write about the downsides of hiring a third-party PM company and that is what this post is for. Some of the previous posts I alluded can be found here:

1. The Benefits of Hiring a Third-Party Property Management Company 
2. The Importance of Defining Systems and Processes When Managing Multifamily Properties  
3. The Difficulties of Vertically Integrating a Property Management Team into a Multifamily Syndication Company 
4. The Efficiencies of Property Management with Neighboring Properties
5. The Benefits of Having a Vertically Integrated Property Management Team in a Multifamily Syndication Firm

Note – The definitions of the technical terms in any of our posts can be found in the glossary section of our website.

The Downsides

1. Costs: Property management services come at a price, typically a percentage of the rental income or a flat fee. This can and will eat into profits, especially if someone has a small property or a tight budget. For smaller properties, PM companies typically charge anywhere from 8-10% of the effective gross income (rental income – vacancy). This can kill cash flow and in most cases will make the deal no longer worth pursuing, especially after accounting for an increase in taxes and insurance. 

Many smaller investors get caught in the trap of not realizing the costs associated with hiring a third-party property management company and either end up trying to manage their property themselves or facing the harsh reality of the fee. The problem is that most of these people also don’t realize how harsh the property management game can be. Sure things tend to go pretty well if someone invests in a nice area with low crime, but what about if they invest in a not-so-nice area? Also, it’s worth noting here that there is an inverse relationship between the return someone can expect from a property and the demographic factors of the location of the property. In other words, the nicer the area someone invests in, the lower the return they can expect. 

2. Lack of Control: In reality, if someone relies on a PM company to manage the day-to-day operations of their asset(s), they’re giving up control. Keep in mind that control is one of the very reasons why real estate investing is so attractive. Control allows someone to force appreciation so that their property is worth more. Explained differently, investors should aim to be able to increase the value of their property by conducting renovation projects, figuring out ways to increase other income (parking, laundry, etc.), and more. When an investor gives up the keys of their asset to a PM company, they decrease the chances of successfully forcing up value. This last statement is very important and I will explain in the next point why that is so.

3. Quality of Service and Tenant Relations: The truth is that unless an individual investor or syndication company contracts a large number of units to be managed by a single PM company preferably in a small area, the quality of service will usually be low. That low quality is less likely to retain tenants and as a result, the property performance will suffer. The reason for this is that PM companies simply do not make a lot of money on small properties. For example, a building with 2 units that makes $36K in EGI will generate $3600 in fees for a PM company that is charging 10%. Compare that to a building with 100 units that makes $1.8M in EGI, that building will generate $180K for the PM company assuming they charge the same rate. Even at 7%, the 100-unit building will yield the PM company $126K which depending on the market can pay for 2 full-time positions and still have money left over to cover other costs. The point is that it’s easier for PM companies to work with one or a few sophisticated investors or syndication companies. However, large syndication companies face their fair share of PM challenges too. I recently heard of a syndication company that has changed the PM company managing their recently acquired 1000+ unit portfolio over 15 times in the past 12 months! 

4. High Turnover of Staff: The final downside to hiring a PM company is that it is regular in the PM business to experience high turnover. This is especially true if the property being managed is in a rough area, experiencing multiple evictions, etc. As a general rule of thumb, 80% of the trouble at any given property is caused by 20% of the tenants. This 80/20 split is known as the Pareto distribution or more commonly the “80-20 rule.” It can be applied to many natural phenomena and human activities, but I digress. Any person or company who hires a PM company can expect at least some level of turnover in the property managers they work with.

Conclusion

Before hiring a property management company, carefully research and consider these downsides. It’s crucial to choose a reputable and reliable company that aligns with the specific needs and preferences of a given property. A mismatch between a PM company and a property type can lead to months of stress quite quickly. 

If you have any questions regarding the terms and concepts in this post or previous ones, please reach out to either me (tedi.nati@jpacq.com) or someone on our team so we can help explain further. If you’re interested in investing with us at JP Acquisitions, you can contact us via our contact form, by emailing a member of our team, messaging us on LinkedIn, or signing up for our investor portal to set up a meeting.

As always, I hope you enjoyed reading this post as much as I have writing it. Best of luck!