Real Estate 038: Self Management vs. Hiring a Third-Party Property Manager

It’s been a while since I've written a blog post, mainly due to focusing more on acquisitions, managing the rehab, and stabilizing my portfolio. A question I receive often from my readers is whether or not they should hire a property manager (PM) or self-manager their properties. So I decided to reflect on my past two years of rental property ownership and share my thoughts below.

Should I self-manager or hire a property manager?

Investors understand the importance of buying below market in good locations with enough cash flow to pay its debts, expenses, and whether market cycles. However, all of these assumptions and proformas are only on paper, and a rental property is only good as its executed properly. Like Gary Keller describes in part 3 of his book "Millionaire Real Estate Investor", owning a million, landlords must keep the property in good condition (no slumlording) as well as find quality tenants to live in your rentals. A subset of those two functions is understanding the local markets (e.g. landlord laws, market rents, tenant demographics) as well as efficiencies of a sole proprietor vs leveraging a team (e.g. contractor discounts through volume, bookkeeping, and other administrative functions).

Hiring a Third-Party Property Manager

I have made a conscious decision on day one to hire a third party property manager to manage my rental properties and here are the reasons why:

  • Cost efficiency: Each property manager is different, but based on the number of doors they manager (e.g. 100 -> 1000), they may work with designated teams of handyman, or even have in-house contractors that save you time and money when dealing with rent ready repairs and/or maintenance calls.

  • Scalability: In addition to maintenance repairs, the process of searching for tenants, marketing, answering calls, collecting rents and bookkeeping takes time and effort. You may be able to handle the administrative functions easily when you are at a handful of single family properties, but as you scale up to 10, 20, 50 doors, you may end up finding yourself becoming overwhelmed with the tasks at hand.

  • Liability protection: With my properties, the leases are between the tenant and the property management company, and the property management companies carry legal liability insurance in case there are issues that arise during showings, open houses, and maintenance visits. Furthermore, experienced PMs should be able to advise their clients on understanding local laws and regulations that can be a potential liability.

  • Increased profit: You may have heard the advertisement "We've seen a thing or two, so we know how to deal with these claims". Its spoken from a large insurance company who have been in the industry for many years and have dealt with issues and challenges day in and day out. Unless you are fully confident in your ability to manage rental properties with maximum efficiencies, you may be leaving money on the table. For example, not pricing your rental rates appropriately, not using the right lease agreement, and understanding what type of rehab is needed for what tenant demographic and type of property. If you are paying your PM $100/door, but through reduced maintenance, longer term tenants, and increased rental rates you are able to recoup even half of that ($50/month), isn't it worth saving yourself hours of labor you can use to buy more cash flowing assets?

Self Managing your Rentals

Although I have made a personal choice to let a third party PM to manage my rental properties, there may be exceptions where others may choose to manage their own rental properties. Here are some of the scenarios I have found with other fellow investors who choose to self-manage their rentals:

  • Active Real Estate Investor: There are folks who choose to be a real estate investor full-time and have the bandwidth to screen tenants, handle maintenance calls/repairs, and maintain the bookkeeping.

  • Close proximity: If you invest locally in your backyard (generally <1 hour away), it may be easier for an investor to tour with prospective tenants, handle emergency issues, and keep a close eye on the property.

  • Low number of rentals: If you are not looking to scale to a large portfolio, it may be easier to self manage your properties from both a economic and time-commitment perspective.

  • Real World Education: It may not be a "cheap" education, but it may be worthwhile to see first hand how rental property management operates. Especially if you are a newbie investor just starting out, it may be possible to self-manage for a couple years (or months) and then hand it off to a third party PM if it does not work out. However, its important to note that sometimes bad PM work may be harder to unravel than starting from ground zero.

In summary, I plan to continue using my third party PMs for all of my rental properties for the aforementioned reasons above. I have rental properties in three different cities, mostly over 2,000 miles away, and do not have the bandwidth to find tenants, field maintenance calls, and do the bookkeeping. As it is with any professional services such as CPAs and Attorneys, my mantra is "you get what you pay for".

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

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Real Estate 020: Purchasing Rentals All Cash vs Financing

One of the greatest advantages of investing in real estate is the ability use leverage, in other words, other people's money (e.g. bank, private investors, credit unions, etc.) to build your portfolio. When asking yourself the question of paying all cash vs financing a rental property, you have to consider the return on investment (ROI) and the risk involved in deploying your hard earned cash. Lets take a deeper look into the pros and cons into the two different strategies below:

Assuming that you have a lead on a $100,000 property, paying all cash for this deal may initially cost less as there are no financing fees (points), interest charges, appraisals, and additional closing costs. However, by deploying all $100,000 into one deal, you are essentially placing all of your eggs in one basket (e.g. one market, one home, one tenant, one rehab). When performing a "stress test" or "what could go wrong" analysis, you may be opening yourself up to potentially massive losses in this one deal. On the other hand, if you leverage your cash and purchase 4 financed properties ($20,000 downpayment + $5,000 closing costs), you will be spreading your risk across 4 different properties. Assuming both financed and all cash deals are expected to produce a 20% return, the financed option provides $60,000 more profit that the all cash method.

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This analysis isn’t as black as white as stated above, as we all know quality beats quantity when it comes to investments. By purchasing 4 properties instead of 1, you may also be purchasing a handful of properties that are below your standards or have increased risks due to the volume of activity (e.g. multiple rehabs, tenants, property managers, and markets). Having one project may allow you to give more careful attention to the project and leave less room for error. Of course, this is also dependent on the strength of your team and the speed and timing of the market when you decide to scale. After analyzing the cash flow, deducting the debt service and other fees/costs involved in purchasing the home, you will note that your cash on cash return will be higher than the cap rate, as you are utilizing other people's money to purchase a bigger piece of the pie. 

There are also other hybrid ways to reduce risk when determining how to finance your rental properties:

  1. Using short term loans to use the Delayed Financing Exception (DFE). The DFE is a Fannie Mae product where investors are allowed to purchase a home all cash and cash-out refinance their home within 180 days of first taking title on the property. The cash out portion is limited to the lower of the purchase price and closing costs of the new loan or 75% of the after repair value (ARV). This strategy may allow an investor to purchase a home off market at a deep discount all cash, and with a little bit of cosmetic upgrades command a higher appraisal value and cash out refinance before the tradition 6 months seasoning requirement for a BRRRR (Buy, Rehab, Rent, Refinance, Repeat) strategy. In this strategy, you increase your ROI by using leverage, but also decrease risk as you have less money in the deal through forced appreciation. 

For example: An investor purchases a rental property all cash for $50,000 that needs about $3-5,000 in paint, carpet, and finishings. The home is expected to appraise for $65-70,000 and cash flow $300/month after obtaining a mortgage. The investor is able to purchase this home at nearly 70% of ARV as it is an off-market deal from a motivated seller that does not want to invest the time or money to make upgrades and sell for a higher profit. After the cash closing, the investor is all in at $57,000 (purchase, light rehab, closing costs), and requests a DFE cash out refi 1 month after closing. The property appraises at $70,000 which means the investor is able to take a loan of $52,500 (lower of purchase price and closing cost of new loan vs 75% of ARV). As the investor recoups $52,500 of her initial $57,000 investment, she now only has $4,500 into a property that cash flows $300/month and her return on investment is 45%. 

Note: These numbers are taken from an actual deal of mine where I purchased an off-market deal through my property manager's contact from a retiring out of state investor. These types of deals are not easy to find, but if you do, will produce high yield, so network with people in your REI meetup groups, facebook, real estate forums, and let your brokers/property managers know you have cash to purchase. If they have a good experience working with you, they will be more likely to send you warm leads. Please remember that there are nuances with the DFE and specific requirements, so consult with your lender before deciding to pursue this strategy.

  1. Snowball debt strategy. This is a method that is covered by Chad Carson in his book "Retire Early with Real Estate." By creating passive income through rental properties you are able to take the cash flow and start tackling the smallest amount of debt or debt with highest interest. This is the same strategy financial experts such as Dave Ramsey preaches when teaching his students how to eliminate consumer debt. 

For example: An investor has a $52,500 loan on a rental property (example above), that provides $300/month in cash flow after all expenses and debt service. Instead of using the cash flow for other expenses, the investor decides to re-invest that money into the same property to reduce the principal amount of debt and save on the overall interest. (Note: some investors may want to only do this when deciding to de-leverage their portfolio or when they cannot find a good investment during a downturn in the market. If you have a 30 year fixed interest at 5%, by chipping away at the loan, you will be slowly giving yourself back a chance to keep the 5% interest that would have gone to the financial institution). Now if you continue to do this over time, as well as start bringing the excess cash flow from your W-2, business, and/or other rental properties, the velocity of this money will be much quickly and you will have multiple paid off properties that are less impacted by market risk.

In summary, when personally looking at using cash or leverage to buy properties, financing investment properties appear to be less risky than paying all cash. Financing puts more risk on the lender (assuming 80% LTV) than the investor, since the lending institution picks up the higher loan to value portion of the deal. By using leverage, you would gain essential investor experience in working with a financial lender, and have them as a second pair of eyes on underwriting the strength of your deal. While working with a lender may require more paperwork and time commitment, there are significant rewards as you continue to gain experience and pick up additional rentals.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!


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