July 1993
Vol 16 No 11
The most obvious answer is government. After all, at some level it controls the uses to which property can be put, who can use it, the costs of holding it, the amount of rent that can be collected, the rights of all users of property, how much net profit the owner can keep after taxes, credit required to finance purchases and sales, and finally government can always take the property through condemnation and seizure. So. that's not a wrong answer at all. But, in the private domain, management and managers hold the key. Let's look at the proposition from the standpoint of the owner-manager as well as the professional manager.
Income real estate without management is a lot like a computer without software. No matter how much it costs, it won't work unless someone applies the creative juices to come up with applications programs and operating systems. The hardware alone won't do the job (as IBM is discovering). When you buy real estate to rent out, mine, drill, farm, fish, or graze livestock you're either going to have to manage the property yourself or rely upon others to do it for you.
For some reason or other, everyone thinks they can cut hair, paint and manage, but it just ain't so. Management requires a type of personality that can deal with a range of challenges from the minutia of keeping tabs on every cent that comes in or goes out for tax and investment purposes, to making decisions based upon brand, price and reliability comparisons when buying equipment, to engaging and supervising others, to performing maintenance, to preparing accurate monthly reports for review by bookkeepers, accountants and tax preparers. As discussed last month, qualified property managers are expected to render judgments as to the income feasibility of a particular property as a rental – prior to construction or purchase – then make it perform as predicted.
As you might surmise, this can be a complex and varied field, not really suited to the amateur. That's why real management professionals command high fees and make huge sums of money. One person who lives in my area once managed over 40,000 apartments in Washington DC. He employed sub-managers who in turn hired resident managers for on site management functions. Owners were happy to pay his 6-figure income in order to retain his services. This brings me to my main point: Those who find themselves in need of cash flow should recognize the possibilities of both improving their own management operations and hiring out to others as qualified property managers. Let me tell you how some subscribers have fared doing this.
One fellow we know has a computer with an income tax program which easily calculates landlord tax liability. It has all the programs and worksheets required to complete Schedule E of the Form 1040. He normally charges 10% of gross rents as a management fee, but has discovered that owners readily pay an additional 2% in return for his putting the reports into order so that the bottom line can be easily entered on Schedule E and the reports attached in way of explanation.
This is simplicity itself when an accurate bookkeeping system has been employed throughout the year. On a management portfolio which includes gross rents of $25,000 each month, this adds $6000 per year to his income at a very low marginal cost, and gives him a competitive edge over other managers at the same time. As his business grows, so does his extra 2%. All he uses is a simple computer system that anyone could learn quickly.
There are many such computerized systems. Quicken does a rudimentary job. So does Safeguard. Yardi Systems is the most comprehensive of the group. David Tilney of Keyper Corp can be contacted at (719) 632-7462 for information concerning Yardi Systems. David will be appearing at our Reno management seminar where he'll be able to give a demonstration for those in attendance.
TO MANAGE OR NOT TO MANAGE, THAT IS THE QUESTION . . .
I've been accused of having a 'Type A' personality. Type As are typically hard chargers, assertive, aggressive, controllers not known for their patience. I like management because I like having my own hands on my assets. Over a long period of years I've learned to delegate property management to others, so I think I'm qualified to speak on both sides of the management issue. There are pros and cons on both sides.
Owner/managers save money at the expense of time. A know a guy who does absolutely everything himself. His maintenance costs are minimal. He's able to recycle lots of materials between properties that he owns. He personally supervises all contractors that he has to hire to put on roofs and install septic systems to be certain that he's getting his money's worth. Because he hand-selects his own tenants, he has experienced few collection problems. Furthermore, he has low tenant turnover, and as a result, he experiences high occupancy rates and low refurbishment costs. There's no doubt that he has a good job, but that's exactly what it is, a job not an investment.
In many ways was the same. I managed the properties I own locally in that way with the exception of repairs and maintenance which I routinely contracted out to others after the first few years. I reasoned that I could make better use of my time buying properties than in repairing them. But I wanted to stay on top of the income-producing elements of property management. So I screened all tenants, chased late rents, served the notices and filed suit for evictions. Because I located a dead honest maintenance man with whom I've had a long relationship, I left repairs to him. He could do them better and quicker than I could, leaving me free to pursue opportunities that came my way.
After a time, I began to fracture the management job into pieces in the same way that Henry Ford fractured the making of an automobile. Management is too big a job for most people to learn. When they do learn to do it, they can command such high premiums for their expertise that I can't afford them. Let's face it, for years I charged 50% of the profit to manage other people's properties. So I created a sort of management assembly line full of people who were skilled in only a few tasks. I try, with varying success, get them to communicate with each other. It has worked out pretty well doing business this way.
Let's follow the life cycle of a rental period. Suppose you bought a house today to use as a rental doing all the things we discussed in last month's letter. The first thing you've got to do is to have it cleaned and freshened up so that it will appeal to the tenants you want to attract. In a tight rental market such as I enjoyed through most of the 70's, the incoming tenants did all the clean-up work, but in today's markets, the premises must be clean in order to rent to clean people. One cleaning we contacted had a set price of Five Cents per square foot. Let's see, a 1000 square foot house should cost $50 to clean. Certainly reasonable. She cleaned one of my houses and charged me $175. When I pointed out her printed flyer offering to clean at five cents per square foot, she pointed out that there was 1000 feet of floor space, and another $1000 feet of ceiling space, plus cabinets and fixtures. That's pretty good formula and one which many unemployed people might do well to emulate. One day's work: $175. Not bad.
Next, we have to rent the property up. That's expensive, slow work. Each ad in my paper costs almost $20 and for those prices most people will kill weekends and nights just sitting by the telephone or at the house waiting for calls. One enterprising person started a rent-up service. He combines several rentals into a large 'generic' ad with borders and 14 point print to attract attention on which he lists several addresses in addition to.a telephone number which they can call to get a taped message concerning the whereabouts of the rentals. He mentions that he'll be at an open house at a specific location for one hour for those interested in seeing the house and completing an application. He uses a cellular phone hooked to a call forwarding system to respond to calls while at the rental house location. Each hour he moves to another rental house so it will be open during the appointed time. He leaves flyers at all the houses with maps and information concerning the other houses he has for rent, together with the times that they'll be open for viewing. He gets half the first month's rent for this service.
The economics of this service work well for all concerned. He usually rents a couple of houses up each weekend. If rents were $500, he'd earn that amount less his costs for advertising. Sometimes he makes quite a bit more. The owner's are spared the expense of their cheap ad which might not pull well, and they don't have to kill their weekends waiting for tenants. They can leave their own rental applications and contracts with the rent-up service as well as their qualifying criteria. Once they've the applications and credit checks, have been completed, the service gets applicants to sign the rental contract and pay the first month's charges. The owner is then contacted and given the new tenant's file and collected funds.
Now that the tenants are ensconced in the property, they complete an inspection sheet on which all discrepancies are noted in the same manner that a new home builder gives the occupants a punch list. At that point the new tenants call the Maintenance Coordinator who schedules a time to come in and get things ship shape. The tenants sign off on the condition of the job once the discrepancies are cleared, and are from that point on responsible for all damage to the property using the cleared punch list as the baseline for the original condition. This eliminates lots of squabbles over the damage deposits when the tenants leave.
The tenants are given a financial incentive to do all repairs in the premises up to $50 – $100 based upon about 15% of the monthly rents. If there are no maintenance calls during the month, they get that amount rebated along with a rental reminder mailed out on the 20th of the month. If there are any repair problems they can't or won't do, the tenants call the Maintenance Coordinator who either contracts for needed work or does it himself. He provides quality assurance to be certain the job is done properly. The tenant loses the entire amount of the rebate the first time each month a repair call is made, and this is used to defray the costs of the Maintenance Coordinator. It's amazing how few calls are made under this system.
Next we have rent collections and evictions. Rents are paid in to a central 24 hour private mail facility in which money orders can be bought and deposits made directly into a secure mail box. By having rents delivered in the form of money orders directly to a private mail facility rather than using the U.S.mails per se, 90% of the collection problems are eliminated. Plus, we get the use of the rent money that much quicker without worrying about clearing time and bad checks. When rents don't arrive on time, the rent collector delivers a 'pay or quit' notice immediately and follows up with an eviction service to be certain that eviction is started at the earliest possible date.
Since neither of these services have any contact with the tenants, there's little chance for the non-payer to bend a landlord's sympathetic ear. The collectors get paid $15 for delivering the first notice. The Eviction Service makes all the arrangements for a landlord advocate lawyer to pursue the eviction suit. Voila! You've got your empty house back and the cycle repeats. You'll want your Maintenance Coordinator to be contacted when the eviction starts so needed repairs can be scheduled. Afterwards, the clean-up process starts the cycle over again.
This makes for an extremely efficient process, but at the expense of some cost. But what is the true cost of management? First of all, look within your own family for the people to perform all the management functions. Many an otherwise unemployable teenager or retiree can fulfill these functions to a degree at reasonable cost. Only the rent-up portion of the process requires a real estate license – and then not in all states. You'll also find that, while many of the various functions aren't done as well as you might have done them yourself, others may be done much better, saving you money. The hardest part of all is in giving yourself permission to let others do it.
Suppose you were in jail for life. Would you give up 30% of your income to buy yourself out? That's about what paid management will cost you over time. If you're just starting out, you won't be able to afford professional management, and you'll be glad to do it all yourself. Sooner or later you'll discover how to do the things you do well and either just work on your own property or get others to pay you to work on theirs. Then you can take the money you've earned and pay others to do the things that you don't want to do or can't do well. You may find this works well initially. As your income continues to grow, you'll find that your best advantage lies in backing away from the field of fire and evaluating your overall portfolio performance. At this point you'll want to consider paying for full time management.
MANAGEMENT IS THE CHINESE WALL OF REAL ESTATE . . .
Only a handful of the Fortune 500 companies own performing rental real estate. Why? Because management is more art than science. Look at all the lenders and the RTC. The properties they own epitomize how real estate can lose value simply because they aren't being managed.adequately. Over $20 billion in value has been lost because of actual physical deterioration which capable management could have prevented, but there aren't enough managers to go around. The bad news is that many times there's no one to help you in your personal management effort. The good news is that your management skills can provide a steady income to you when you contract with others to provide management for them.
As in all things, a supply/demand situation enables competent managers to demand and receive high fees. One resident manager was given 30 days paid vacation in Europe as a condition of her contract. Another was made an equal owner with a land developer and a builder in order to be able to syndicate new projects to investors with management guarantees. As mentioned, I routinely received half of the profits just for agreeing to manage investors' property. At one time, I was given an Option on 2% of a $50,000,000 syndicate just for management consulting services. It went broke in the Texas oil slump, but it demonstrates the money that can be earned.
In a few instances, property managers have reaped huge rewards by being in the right place at the right time. One subscriber manages several hundred vacant HUD houses. He receives a flat fee of around $50 each per month for essentially keeping an eye on them and recommending various remedies to prevent vandalism. Multiply 400 by $50 by 12 and you'll see that this opportunity pays better than most executive jobs in any industry.
Another fellow manages 500 houses that were syndicated in the late 70s at the peak of the housing boom. He runs both a rental pool and a maintenance pool which the owners volunteer to participate in. This way, vacancy rates are only small fractions of each property's rents since they're spread over all the properties. The same holds true for repair costs. When an appliance wears out or a roof must be replaced, the costs are spread out so that no one owner gets a bill he can't pay. In return for organizing and running the pools, owners agree that all of the management company's overhead is paid by these pools. In essence, the manager's fee is NET to him, since he has no overhead expense. An equally valuable result of this is that he receives no complaints concerning vacancies or maintenance costs since they don't represent irritating cash drains to his customers. He'll have a management income stream for life because of his creation of pools.
One of the least recognized management opportunities lies in the distress markets. Management distress can be just as real as financial distress. At one point, I got a 3 year Option to buy 3 houses just for providing management during summer vacation for a teacher. He'd been unable to enjoy the benefits of summers off, and one day he just overloaded. I still own those houses and their values have risen by over $100,000 since I first acquired my Option 10 years ago. Many times, there's too much equity for an out of work owner to abandon while he searches for employment elsewhere. Being able to manage/Option enables you to share in the cash flow and be paid management fees too.
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