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

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.