The Cost of Keeping Property Management In-House

Smaller firms are bringing property management in-house and at least one large firm is offloading its property management to a third party. There continues to be a growing divergence between small and large real estate firms, as I outlined here last month.

This isn’t an insignificant decision. There are huge costs involved. Aside from staffing a property management arm, the biggest cost is time. Smaller firms can’t buy time the way larger firms can. And though property management itself is hardly a profit center, it does create value. Why would a company with enough resources to do it well back off? And why would a small company with far fewer resources—capital and time—look to add more burden?

The Time Problem

Since smaller firms don’t normally make the news, I’m using LinkedIn as my source of information. This past week, a small owner in the Pacific Northwest announced he was bringing management in-house to better control costs. Another small owner in Los Angeles decided to sell his entire portfolio and get out of real estate altogether because property, asset, and construction management became too overwhelming for too little return. Which one is right?

We’re a smaller firm (anything under $1B in AUM is classified as small in institutional circles) and we once self-managed our California portfolio. We did this despite my co-founder’s late grandfather—who owned apartments himself—telling us not to. Property management takes an enormous amount of time. For growing firms, that time is often better spent on asset management and finding new deals.

All of a sudden you’re paying bills, dealing with vendors, leasing units, communicating daily with onsite managers, going to eviction hearings, producing monthly financials, posting on social media, buying ads, and playing general contractor. This is only a partial list. Self-management gives you deep insight into your investment and better control over everything. Yet it pulls your time away from growing the business. Most companies wait until they own a critical mass of units before hiring someone internal to run it—that’s the typical path to self-management.

But isn’t this basically the same as third-party management? Now you’re back to asset management and meeting with your property management team. That sounds a lot like just hiring a third-party.

What Scale Buys You

That’s exactly what some bigger firms think. Security Properties owns 22,000 apartment units and recently announced it was transitioning to Bozzuto for third-party management. “As the industry evolves, we believe the best way to scale our impact is to partner with best-in-class operators while concentrating our internal resources on market-rate acquisitions, affordable housing and investment management,” said Security Properties CEO Dan Byrnes in a statement. They’re telling us that another company can manage just as well as they can, if not better, and that their time is better spent growing their assets. Security Properties is a big client for Bozzuto. Let’s assume the average rent is $2,000/month. Across 22,000 units, that generates $528 million in annual property revenue. Assuming a 2% property management fee, that’s $10.56M in annual property management fees. I think Security Properties can get their manager’s attention. And this is the dilemma smaller firms face.

It’s difficult for smaller firms to get attention from their third-party manager. With a one-off property in a new market, or even a couple of assets, that’s not enough to get true institutional-level alignment. We’ve been fortunate at times to have incredible onsite staff and management who want to see our properties succeed and think like owners. At other times, when the environment became difficult, scrutiny increased around how profitable a client we were. That incredible staff suddenly gets reassigned to another asset and different owner, and more excuses surface.

Smaller firms are stuck in a tough place. Self-manage to gain better cost and operating control, or find a like-minded management company and grow assets.

Finding the Right Partner

Finding the right third-party manager is difficult. We’ve hired across the spectrum trying to find that one. From small firms to the largest in the US, and everything in between. There’s no right answer. It’s a cliché, but it all comes down to the people you’re working with. Great people are largely company-independent, but a management company’s culture can dictate the type of people you end up working with.

I’m unsure if we’ll ever go back to self-managing. Two major things would have to happen. First, we’d have to consolidate our portfolio in the Bay Area and grow it. It has to make financial sense. Second, the properties would have to line up with our time expectations. A rent-controlled property in Mountain View with very little resident turnover is a different kind of time commitment than a traditional property with normal turnover (e.g., 40%+ annually). If we could cobble these together and include a technology stack to make the work more efficient, then I can see a scenario where we go back to self-management.
In the interim, third-party management is the only way to go.