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 007: Rental Property Criteria

Now that you have identified a market, its important to start developing a criteria (again, a ship with no clear direction is sailing towards nowhere) and analyzing properties.

So how does an investor analyze properties? Below are some metrics that I use to evaluate rental properties. Remember to subscribe to my blog to receive updates as well as gain access to my free cash flow calculator and rental property criteria.

1. Cash on Cash (Used when financing a property)

To calculate the cash on cash return percentage, I take the net monthly income after all mortgage, insurance, property taxes, property management fees, vacancy and maintenance expenses are included, and annualize the amount. That amount is divided by your total cash invested into the property.

Below is a property analysis using real numbers of a sample investment in the midwest, USA.

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Net Cash flow of $174.13 * 12 months = $2,089.56 divided by total out of pocket cash $13,600 down payment + $3,400 estimated costing cost 5% = $17,000.00

  • Cash on Cash %: Net Annualized Cash Flow / Total Cash Invested

  • 12.29% (rounded): $2,089.56/$17,000.00

2. Cap Rate (Used when paying all cash)

The Cap Rate is used to make comparisons between similar rental properties. By taking the Net Annualized Cash flow / Purchase Price, you arrive at the Cap Rate of a rental property. This method is more meaningful when an investor pays for a property all cash thereby calculating their annual return on their lump sum of money. Please refer to the picture above that illustrates the Cap Rate calculation on this property

  • Cap Rate %: Net Annualized Cash Flow (no mortgage) / Purchase Price

  • 8.30% (rounded): $5,643.96/$68,000.00

3. Rent to Value Ratio

Another quick measure of relative costs of buying and renting across different markets is the rent to value ratio. As mentioned in my previous post of cyclical and linear markets, I have generally observed that cyclical markets tend to have a lower rent to value ratio, meaning you will make less by renting out of property relative to its purchase price, compared to linear markets with a higher rent to value ratio meaning its a better market for investors looking to cash flow on their investment properties. The rent to value ratio is calculated simply by taking the gross rent divided by the purchase price of the property

  • RTV %: Gross Monthly Rent / Purchase Price

  • 1.21% (rounded): $825/$68,000

4. Debt Coverage Ratio

The debt coverage ratio is not often used by all investors, but I like to use it to gauge the cash flow that is generated to pay my mortgage on the property. It is calculated by taking the Net Annualized Cash Flow / Total Debt Service owed to the lender. A debt coverage ratio of less than 1% means that the buyer will not be able to pay the current mortgage without using their own funds (i.e. negative cash flow). A ratio greater than 1% means that the buyer can use cash flow from the investment property to pay the mortgage.

  • Debt Coverage Ratio %: Net Annualized Cash Flow (no mortgage) / Annualized Mortgage Payment

  • 1.59% (rounded): $470.33 * 12 months / $296.20 * 12 months

So what do I look for when analyzing rental properties?

Great question. As I mentioned previously, I am a buy and hold investor primarily focusing on single family homes in strong working class (blue collar) neighborhoods for positive cash flow. Note that this criteria is quite fluid and used as a basis to narrow down my search from a pool of 50+ properties at any given time. Note: these are my "rules of thumb" as of writing date, and can change any time.

  • When Financing a property: Net monthly cash flow (after all expenses)> $200 per unit

    • Assumptions used: 5% closing costs, 8% vacancy reserves, 8% maintenance reserves

  • Neighborhood Rating: B- or above (Note that each investor may rate neighborhood's differently). For example, some investors rate A/B/C based on ratio of owners/renters, crime stats, schools, other statistics and demographics.

  • Property Type: Single Family 3 bedroom 1 bath (or more), ideally with a Garage in markets such as Kansas City, where there is heavy snow and hail. Note: Some markets (i.e. Memphis), it is common to have a carport instead of a garage. Further, 2 bedroom homes are more difficult to lease. 3 bedroom houses are most common, thereby increasing the tenant candidate pool.

  • Size of home: Ideally 1,000 - 1650 sq ft. Not too large, nor too small. Note: I do this on purposes as the extra sq ft. of ~800 (ex: 2,400 sq ft. homes) do not necessarily correlate to the same ratio of increased rent. Also, replacing a roof/flooring on a 2,400 sq ft. home is significantly higher than a 1,200 sq. ft. home.

  • Low Crime Areas

  • No HOA fees. The HOA fees are unpredictable and can kill your projected cash flow.

  • Cash on Cash: 12-15% or higher (Depends on market, type of property, location, etc.)

  • Rehab including updates to CapEx items 5 years life or less (Water Heater, HVAC, etc.) 10 years life or less (roof)Note: The amount of rehab (after reviewing scope of work) may result in a lower or higher maintenance reserve from base of 8%.

  • Rent to Value Ratio: At least 1% or higher, ideally 1.30% or higher

Please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision. 

Good Luck!

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Real Estate 005: Questions to ask your Turn-Key Provider

Below is a list of questions that I typically ask when interviewing a turn-key provider. A good/experienced turn-key will be able to answer all of these questions and feel comfortable sharing information with you, as they have a vested interested in your success. 

General Questions:

  1. How long have you been in business? 

  2. How many properties do you sell to investors a month? 

  3. Can you walk me through the purchasing process from beginning to end?

  4. How many investors (clients) do you have? How many are from out-of-state, or out-of-country?

  5. How many properties do your typical investors have on average?

  6. Do you have any references?

  7. Why did you choose this market?

  8. What price ranges are your properties?

  9. Do you offer any rent income guarantees (first or second year)?

  10. Do you own the homes? Are you a full Turnkey or a Marketer?

Market Specific Questions:

  1. Is the market tenant friendly or landlord friendly? What is the eviction process like? Have you had to evict any tenants?

  2. How are rent prices determined?

  3. What neighborhoods do you invest in and why (A/B/C, can you define them)?

Rehab Questions:

  1. What major cap-ex items (roof, hvac, furnace, plumbing, electrical, etc.) are repaired or replaced? How do you determine whether items are replaced or serviced only?

  2. Do you provide a full scope of work for each rehab? 

  3. What appliances come with purchase of the property?

Financing Questions:

  1. How do your lenders obtain financing? Who are your preferred lenders?

  2. How do you deal with properties that do not appraise for the purchase price?

  3. Do you require earnest money?

Closing Questions:

  1. If a third party inspection report uncovers additional repairs, how do you handle them (Will I get photos)?

  2. When are the timing of the additional repairs (before or after closing/are they included in an updated contract)

  3. Do you provide warranty on the rehab? 

Owner Communication Questions:

  1. How do I get paid?

  2. Do you utilize an owner online portal?

  3. How often is the communication on accounting/issues on maintenance/in general?

Tenant Related Questions:

  1. What does your tenant background check consist of? What are the requirements of a tenant?

  2. How long is the tenant lease agreements? What is the current turnover rate?

  3. Do you rent properties to Section 8 tenants?

  4. What is the typical "get rent ready" costs when a tenant leaves?

  5. If tenant destroys a property in excess of the security deposit, what is the procedure?

Property Management Questions:

  1. How many units/doors do you currently manage in this market?

  2. What is your current and historical vacancy rate?

  3. How long does it take to find a new tenant?

  4. Do you utilize a checklist when a new tenant is leased?

  5. What is the property management fee?

  6. When are rents due from the tenant? Do you charge a late fee?

  7. What are the fees involved (lease up fee, marketing fee, renewal fee)?

  8. What are the markup fees for maintenance costs (cost + markup % or cost + hourly rate)?

Remember not to make it a interrogation session, because no one wants to work with an "askhole". Put yourself in their shoes, working with hundreds of out of state/local investors. Please be respectful and remember that relationships a built over time. Make every effort to fly/drive to the market you are interested in and meet with the team who will be your "boots on the ground". Please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision. 

Good Luck!

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