JF1144: How To Work With 3rd Party Management Companies #FollowAlongFriday
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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless and this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any of that fluff.
Today is Follow Along Friday, and we’re actually officially recording it today, on a Friday. It’s the first time ever we’ve actually recorded the episode on the day it airs; that was due to some technical difficulties we had yesterday… But here we are, and we’re looking forward to bringing this to you.
We have some listener questions on third-party management companies, how we work with them as apartment investors, and we also have some updates… So how do we wanna approach it?
Theo Hicks: I’d say we dive right into the questions today. As you said, we’ve got — we actually were submitted a long list of apartment syndication questions from a gentleman named Tim. He has recently transitioned to syndication; he’s done a 102-unit and a 145-unit deal.
Joe Fairless: Congrats, Tim.
Theo Hicks: Yeah, that’s awesome.
Joe Fairless: Tim from Wisconsin.
Theo Hicks: Tim from Wisconsin, yes.
Joe Fairless: Okay.
Theo Hicks: And he sent this 13, very detail, great syndication questions, and we’re gonna try to break them up into categories and tackle them that way. Today we’re gonna answer four questions, most of them being related to how to work with third-party management companies.
His first question isn’t related to that, but he asks, “How do syndicators deal with investors’ questions regarding payouts, since each payout will be different and it is rather a complicated calculation?”
Joe Fairless: I think the payouts aren’t different every month, assuming that you take the same approach that we take. Let’s talk about the approach that we take. We have an 8% preferred return on all of our deals, and we pay monthly distribution. Some do quarterly, some do annually, we do monthly. So we do monthly distributions on an 8% preferred return, otherwise known as a pref; so 8% pref, and we do that for most of our projects for 11 months, and then in the 12th month of that project, that’s where we identify how much additional cash can be distributed above and beyond the 8%.
That allows us to be incredibly conservative and make sure we have a healthy operating account should something unexpected take place with our properties in months one through eleven. Now, some properties we’re able to do distributions above and beyond that, and when that takes place, we simply notify investors and everyone’s really happy about that.
So the distributions in that scenario where it’s simply the 8% on track for 11 months, and in the 12th month you take a look at what can you do above and beyond. Let’s say the total equity was a million dollars in the deal, then 8% of that is $80,000, divide that by 11, and that’s the monthly distribution that is sent out to all the investors, proportionate to whatever they put in. If one person put in 100k, then they get one-tenth of that distribution.
That’s who we do it, and certain investors don’t get different return percentage than others, everyone gets the same percent return, but the amounts are different based on how much they invested. If one person invested a dollar and another person invested $20, then obviously the $20 investment person would get a higher chunk of money, but it would be the same percent of their month.
Theo Hicks: Okay. And at each month is that calculation done by you guys, or the property management company does that calculation?
Joe Fairless: The property management company does the calculation after the first month, because we just tell them “Hey, this is our plan for months one through eleven”, and then in the 12th month then we take a look at it… But it’s really just a simple calculation – a million dollars, “Okay, we can distribute X% more. Okay, what is that percent applied to all the investors in the 12 months?”
Theo Hicks: And even in your underwriting process you’re kind of already starting to understand that projected returns and how the 8% preferred return is gonna work, and then if you’re projecting above and beyond that, how that split is gonna work… And even planning out your exit strategies in five years, you’re planning out how much money you’re projecting to make at exit and how much of that may go to investors [unintelligible [00:05:38].14] somewhere else. So you’re doing the calculations upfront, too.
Joe Fairless: Yeah. Ultimately, we buy the property, we have projections, but it’s how is it performing today and where do we see the market headed. But all roads lead back to capital preservation, and that’s the most important thing with any investment (ask Warren Buffet). So we want to err on the side of caution when we do deals, and this is one component of that, where we err on the side of caution, but then end the 12th month, we’ll distribute the excess above and beyond 8%. Because in reality, our deals have a higher projection in year one than 8%, so all of them have been able to hit or exceed that.
Theo Hicks: Okay. Let’s move to the next question. He asked “Do syndicators use third-party management, or do they have their own management companies?”
Joe Fairless: Both, because it’s a general question. This is a question of scale and desirability… Because with single-families — let’s talk about single-families real quick. With single-family property management companies if you ask a single-family property management company that has less than 500 homes that they oversee how is business, they might say it’s okay, they might say it’s good, but they won’t say it’s incredibly profitable. And until you get to approximately 500 doors as a single-family property management company, you’re not gonna achieve the level of scale that you need.
Well, the same principle applies for apartment third-party property management companies. However, instead of 500, it’s 3,000. As a property management company you don’t have 3,000 doors (for apartments), then you’re really not making much money. You might be making some, but you’re not gonna be able to take your kids on vacation and be okay with splurging on some all-exclusive or all VIP Disney passes. I know you like Disney.
Theo Hicks: I like Disney.
Joe Fairless: So the question with third-party or your own is if it’s your own, you’re not gonna be making any money, and it’s gonna detract you from doing deals as an apartment syndicator, until you get to scale of about 3,000 units.
However, as with any generalization, there’s some caveats, and one of them is maybe your skillset is getting your hands dirty or GC-ing projects, being the general contractor on projects. Maybe that’s how you differentiate yourself from the competition; you know the ins and outs, you know when you go look at a boiler room exactly what to look for. You know when you look at the different mechanicals of a property, you know what to look for and you have the current team in place to do the work. Well, in that case, it makes more sense for you to have your own management company, because that’s part of your special sauce, that’s part of what differentiates you and your company, and I believe you must be local in that scenario. If you are local and you have that skillset, then it makes more sense.
However, for most apartment syndicators and most apartment investors, it is not a primary skillset, so that’s why third-party management companies make more sense, and that’s why we have a phenomenal third-party management company in Dallas-Fort Worth that we work with.
To summarize, when you look at if you should hire a third-party or you should create your own – because believe me, when I had my first deal, I thought about creating my own. I was interviewing people, and thank goodness I didn’t.
Take a look at what is your skillset and are you ready to develop a separate business – because it is a separate company – from what you’re looking to do with asset management and acquiring properties, working with investors etc. We haven’t found that that makes sense for us at Ashcroft Capital, therefore we continue to work with a third-party, even though in about a month we’ll be approaching 3,000 units.
Theo Hicks: The next question – a two-part question… I just realized I’ve asked the second part of the question, so let’s stick with the first one… “If a syndicator is using a third-party management, what is a monthly fee and is that fee negotiable?”
Joe Fairless: Everything’s negotiable. It depends on the amount of units that you have, and where they’re at in proximity to each other, because that allows scalability from a property management side if they’re all close together. The fee ranges between 2,5% to 5,5%… I think I’ve seen 6%, but I’ve certainly seen 5,5%, so 2,5% to 5,5%. It depends on the age of the property too, so that’s another variable; what is the business plan with the property, so much heavy lifting is there, literally and figuratively… Those are variables that go into the fee, and when I say the percent, I mean the percent of collected income. It’s 2,5% to 5,5%, maybe even 6% of collected monthly income, that is the property management company’s fee.
Please make the distinction between their fee, the payroll, the insurance and the healthcare or other aspects that the property management company will have on your balance sheet for that property, because they have employees who are being deployed at your property. Coming from my single-family home background, I thought (incorrectly) that the fee was inclusive of having people there, staffing the property, but it’s separate. You’ve got to pay payroll, you’ve got to pay for the people to be at the property, you’ve gotta pay for the maintenance people, and you’ve got to pay the related costs to having those people on the staff of the property management company, and that needs to be taken into account.
On top of that, you pay a fee, which is 2,5% to 5,5%, maybe 6%. So it is negotiable, and those are the variables that are involved.
Theo Hicks: Those expenses on top of property management are important, because again, I thought incorrectly too that “Oh, I just pay someone 5% and they just take care of everything. Maintenance costs are in the 5% and all that stuff”, but obviously, that’s not true.
Joe Fairless: And with single-family homes I believe – I have three, and I believe I pay 8%; it’s been a long time since I revisited that, like 3-4 years. They do a phenomenal job, but with single-family homes you might see anywhere between 7% upwards to 10%. The thing you wanna watch out for there is what additional fees are they charging? Are they charging a lease fee to lease the unit, and what is that fee? Are they charging maintenance costs to handle the maintenance costs? Are they padding those numbers? But everything is negotiable.
Theo Hicks: Would the fee be different if that property management company had equity in the deal?
Joe Fairless: It could, certainly. Everything’s negotiable. They might choose to have a lower fee. It’s unlikely they’re going to have a fee that loses money or even breaks even; they’re probably gonna make some money on it, as I would as a businessperson, even if I was in the deal, because otherwise it’s a pass-through and I’ve got my staff working on stuff that they could be working on in other places that would actually make my company money. But anything’s negotiable, it’s certainly something that — it wouldn’t be unacceptable to at least ask that to a management company. They could say “Heck no!”, but you could still ask.
Theo Hicks: Okay. And then a final question is “How do syndicators work with a third-party management on being proactive versus reactive on things like property upkeep, updates, remodeling the units and direction for achieving specific goals?”
Joe Fairless: Well, let’s take it into two parts – proactive and reactive. We’ll start with reactive. Reactive would be making sure that you have a weekly status call at minimum with your management company. That is to go over all the items that you need to be aware of; how are the cap-ex projects going? Are you still on budget with each of those projects? How does your business plan look? In particular, are you getting the renovated amounts for the units that you are renovating, or is that above what you projected? Is it below what you projected? Why or why not? How are you doing on the one-bedrooms, the two-bedrooms, the three-bedrooms? What are we leasing more? What are we leasing less? What are some differentiating features of your property that you should be highlighting? Are they highlighting it? For example, no other property in the area has garages – we’re highlighting that.
With your property it’s important to identify how are you differentiated from the competition and then making sure the management company is highlighting that. How many down units, if any, do you have? When are they going to be live and ready to be rented out? How many leads came in? How many applications came in this week? All these things and about 50 more are metrics that need to be tracked on a weekly basis, and if the management company does not have a software program that easily allows you to track this and you have access to, then you need to create your own spreadsheet, and have a spreadsheet that they fill out on a weekly basis with those things I mentioned, and then a whole lot more. So that’s more reactive.
From a proactive standpoint, before you even buy the deal, it’s important to provide your management company with your proforma and your business plan so that they’re aware and aligned with you on what the expectations are for the performance of the property. That’s where they would either push back or shake their head in agreement that “Yes, we’re onboard with this plan and we are confident we can hit these projections based on our expertise in the area.” So before you even have the deal, you need to be lock-step with them.
Then once you have the deal, it’s important to secret shop the property. A Best Ever listener reached out to me. He’s in Dallas, and he said “I’d like to help you out. I don’t know what I can do”, I said “I’m not sure either. Actually, yes, there’s one thing… You can go secret shop our nine properties in Dallas-Fort Worth and write up what you saw, what you experienced.” That primarily helped us have reassurance that things are handled incredibly well. But then there’s also opportunities for improvement. So that helps us stay on top of things that we can improve, and then consistently improve by doing that secret shopping on a consistent basis, whether it’s you call up the properties, how many times does the phone ring, how is the demeanor of the people answering? What type of questions they ask? Do they get your contact information so that they can build a database for future outreach or don’t they?
Then also have people on the ground if you’re not local do that and experience the walkthrough. Additionally, from a more reactive standpoint, we visit the market, we visit Dallas-Fort Worth. My business partner and I visit at least once a month, between the two of us. We might not overlap or we might not go at the same time, but one of us is there at least once a month. So we’re touring the properties ourselves and being with the staff.
Theo Hicks: Here’s one thing to add about that weekly performance template or checking in with the property management company once a week is very important, especially early on, if you have some sort of renovations planned or develop the rents, because the longer it takes to bump those rents up or the longer it takes to actually rehab the project, the lower your bottom line or project returns are going to be. So you wanna make sure that — as you said, be proactive in the beginning to create that project plan, but then make sure you’re also being proactive and once a week making sure they’re on track and you’re meeting your projections.
Joe Fairless: Yeah, that’s one thing that’s mission critical for sure in the first 12 to 24 months, and even more specific in the first six months, to make sure that there wasn’t any major assumption that has gone sideways. When you do that and they’re aligned at the beginning, then likely you will have things covered. It’s just when you surprise the management company or they lie to you and you’re totally missing something major going into it, too. So you’ve got your safety net of the management company looking at it and you messed up – when both of those things combine, then it’s a perfect storm of disaster.
I’d say with your management company – Frank and I were visiting our properties I think two weeks ago, and we were touring it with our largest investor, a couple of our properties, and we asked the management company “Hey, where are we at with this budget item in terms of expenditure?” and they knew it. That’s a level of attention and expertise that is needed for a value-add deal, especially in the 6 to 12 month range, but just in general.
You’ve gotta have on the ground management partners who know it at that moment in time. We knew it the previous week, but where are we at at that moment in time?
Theo Hicks: Yeah. So that conclude Tim from Wisconsin’s first batch of questions. We’ve got 13 of them, and we’re gonna be addressing them in the Follow Along Fridays moving forwards, so thanks again for sending us that really detailed list of questions.
Moving on to business updates and observations… I know you just got back from Baltimore, and then you also had something about protesting taxes you wanted to discuss as well…
Joe Fairless: Yeah, one tip for everyone who has an opportunity to protest taxes on a property – this is on the acquisition side. When you have it under contract, make sure that you have something in the contract — so I guess right before you put it under contract, make sure you have something in the contract that allows you to protest taxes if you’re within that timeframe for protesting the taxes in your particular county. Because that’s what we have done on properties, and I’ll give you a specific example…
It cost us approximately $8,000 to protest taxes while we had a property under contract, and the result was a savings of $28,000, so we netted $20,000. That’s good. The big win though is that lowers the tax basis for future years, and that helps us basically save more money for future years, plus perhaps it sets us up for an opportunity to protest in future years, too. So make sure that that’s something that you have in your contract before you sign on the dotted line, because that has potential to save you a whole lot of money.
Theo Hicks: Good advice.
Joe Fairless: And separately, I was in Baltimore last weekend with Colleen, I met up with a couple people in my consulting program, as well as an investor who was in Baltimore. It was the most impressive experience I’ve ever had based on my expectations of the city. I didn’t have as high of expectations of Baltimore, but holy cow, I’m in love with that city. A top five city to visit in the U.S., by far. It’s a combination of Boston, because it’s got a beautiful harbor; it’s a combination of New Orleans because of the row houses, and it’s a combination of Cincinnati, because everything’s really old, but they keep it up really nice… At least in certain areas in Baltimore, areas we were at.
I was just really impressed, so if you haven’t visited Baltimore, I recommend taking a weekend trip to Baltimore. We also went to DC, it’s 45 minutes away Uber. We went to the Holocaust Museum, which is very powerful, and went to a couple other places. So a Baltimore trip is kind of a fun fact for the week. I recommend that everyone go.
Theo Hicks: Awesome. What about business-related updates?
Joe Fairless: Do I have another…? We did this yesterday, and that’s why we’re doing it again, because there were technical difficulties. Did I mentioned the…?
Theo Hicks: I don’t think so.
Joe Fairless: Okay, then we’re good. What about you?
Theo Hicks: So again, I’ve got three four-unit properties and I’ve been having some issues with the boilers, and yesterday I had them repairing the radiators and the boiler in the other two buildings, and unfortunately the cost for the two buildings was lower than the cost for the one building that was in really rough shape… [unintelligible [00:23:14].12] they have these self-bleeding valves, so if air gets in the system, it will automatically squirt the air out, because we have a closed system with all water in there… But what will happen is it will squirt out some water with it too, and the water will get on the metal and if you don’t look at it, it will completely rust and corrode. So they were all rusted, so they all had to be replaced.
Luckily, only one radiator had to be replaced this time though… And again, that’s $1,200 I think, or something like that.
And I have a funny story about one of the boilers in one property that I’m not even gonna talk about, but I guess the lessons that I’ve learned…
Joe Fairless: You can’t ever say “I have a funny story” and then say “I’m not gonna talk about it…”
Theo Hicks: Well, I’ll mention it briefly, because I kind of want to. So one of the boilers had never worked before apparently, because all the tenants were saying how their windows would frost up in the winter… So that was the one I was very worried about. I thought I’m gonna replace the entire boiler, and they had to rebuild a lot of portions of the actual boiler. But it was funny, because once it finally was on and running hot, they were saying how that water temperature was like 50 degrees higher than what it was when they initially turned it on, after repairing all the radiators and doing all the other repairs.
We finally turned it on, and I got a call saying that the boiler is just making insanely loud noise, and I’m just like “Oh man, I spent all this money on this boiler, I had it replaced and it’s not gonna work.” So I’m expecting like a [unintelligible [00:24:32].02]…”
Joe Fairless: Yeah, I’ve heard those.
Theo Hicks: …that type of noise. I call the guy who owns the boiler company that was fixing it and I tell him about it, and he’s worried, too. He’s like “I’ll go over there right now [unintelligible [00:24:44].16].
So I’m driving over there – it’s like a ten-minute drive – and I’m just like panicking the entire time. And I get there and he’s sitting on the front porch. I walk up to him and I’m like “So what’s the deal? Are we gonna do something?” He goes, “Just wait until you hear this…” I’m like “Oh, this could be loud…” So we go down there, and literally the boiler sounds like [unintelligible [00:25:03].01]
Joe Fairless: Barely audible?
Theo Hicks: Barely audible. We’re standing right next to it, leaning on it, having a normal conversation… So I thought that was kind of funny. It was like “Man, now they finally have heat, and now the noise of the boiler is an issue.” So that’s just a funny story, but lessons moving forward – number one…
Joe Fairless: So it was just…
Theo Hicks: No, it wasn’t loud at all.
Joe Fairless: It wasn’t loud at all, okay.
Theo Hicks: I think it was just because it had never been on before, that they just weren’t used to it. And it’s always gonna be on, and all the other boilers are actually louder than this one. None of the other residents complained. The boiler is even quieter than the [unintelligible [00:25:32].14] where I live, in my personal residence. So I just think it was an unexpected thing that they’ll just have to be used to, unfortunately. But the lessons learned – I think I’ve mentioned before that if you have boiler on the property or radiators, the inspector most likely will not inspect them if he doesn’t know how to inspect the radiators or boilers. So if you’re getting the inspection and you’re with the inspector, ask him if he knows how to inspect the boiler or radiator.
My inspector told me he didn’t upfront, so I should have obviously had someone else come look at it. But moving forward, whenever I buy a property with a boiler I’m gonna have some people come through and look at [unintelligible [00:26:05].20] There’s probably four or five radiators per unit, depending on how many rooms are in there. Then look at all of them and get an estimate of what it will cost to get it up and running.
I also wanted to actually test the system too, because another problem that we had is that one of the boilers was leaking, so I asked to have it fixed in the inspection contract, and they started making the fixes but they didn’t fix it all the way, and it didn’t get fixed until after I actually bought the property, which is another really bad mistake. And once they actually fixed that portion, they realized all the other problems that there were, which I would have caught upfront…
It’s mostly just inspecting the units, more because again, even while I was doing these radiator repairs, I’d walk through the units and they’ll seem to be leaking that I didn’t see before… One of the tubs was leaking and was leaking water down the wall, into the garage, into the basement… So I’ve gotta address all those issues, too.
So just spending more time on the inspection when you’re buying a property, especially one that’s a little older. I think ours were built in the ’50s or ’60s. Focusing on the inspection period upfront, not kind of just ignoring it like “Oh, it’s fine, I’ll just deal with it when I buy the property”, because those things add up very quickly – a hundred bucks here, a thousand bucks here add up quickly and the next thing you know you’re not making any money for the year.
Joe Fairless: And also casually asking residents that you see during the inspection process, “Oh, do you enjoy living here? Have you got any maintenance requests that I should tell the owner about?”, just a couple questions like that. If they say “No, no”, “Okay, do you know anyone who might? Because I can let the owner know…” Because you will. You will let the owner know during the process of renegotiating the contract.
Theo Hicks: And they will tell you, too. At least my residents. I remember when I was doing the inspections I saw a couple of them, and they were more curious what’s happening, who’s buying the property, who are you…?
Joe Fairless: I thought they didn’t tell you.
Theo Hicks: No, they didn’t tell me initially. When I was first looking at the property I met a couple of them. They were just asking me questions about myself, and “Are you buying the property? Do you represent the owners?”, things like that. And then once I actually bought them and I went in there, they’re like “This is messed up. You need to fix this and this…”
Joe Fairless: But it’s getting that information before you buy.
Theo Hicks: Yeah. I think a great question is “Is there any upsetting maintenance that I need to tell the owner about?” It lets them know that you’re probably proactive, because — again, it’s really strange, because the conversations I’ve had with residents now, they make it… I mean, [unintelligible [00:28:21].11] I need to address that, but they’ll say things like “I told you to fix this months ago.” I’m just like, “Wait, I bought this property a couple weeks ago, so tell me what your issue is and who did you talk to and what did they do? Did they patch it up? Did they say anything? What’s going on here?” Because they totally understand they’re living there, and if they’ve got leaks and issues all the time, they’re gonna be mad, and I’ll just take it.
Joe Fairless: Yeah, the number one reason people move out – maintenance issues. Cool.
Theo Hicks: And then I’m getting married this weekend, too.
Joe Fairless: Oh yeah, you’re getting married on Sunday. Early congratulations. You’re already wearing your ring…
Theo Hicks: I am already wearing my ring.
Joe Fairless: …bucking the trend. Congrats!
Theo Hicks: Thank you. So that’s all I’ve got. There’s a couple of other miscellaneous things – Best Ever Conference, you can still get $100 off your ticket probably for about a week or two, by Halloween… So make sure you go to BestEverConference.com to get your ticket for that.
Joe Fairless: And check out all the speakers who are gonna speaking there. You’re gonna be impressed by the speakers. This will be an even larger conference than the last year, but the quality of attendees will be just as high. What I mean by that is last year I’d say 90% of people there had purchased multiple deals, and it was a more high-level conversation, not necessarily “How do you fix and flip?”, it’s the step above that – “How do you scale your business? How do you do asset protection?”, that sort of thing.
Theo Hicks: I don’t remember meeting anyone who hadn’t done at least a single deal.
Joe Fairless: Yeah.
Theo Hicks: And then finally, this week we’re gonna do another review of the week. Make sure you subscribe to the podcast on iTunes and leave a review for your opportunity to be mentioned on our next Follow Along Friday.
This week we’ve got Carl Meyers Jr., and he said that he’s been involved in real estate for 30 years, and he learns something new from the podcast every day. Great source of information.
Joe Fairless: Well, that means a lot, certainly coming from you, Carl, based on your 30 years of experience. I think we could all learn something from you based on your 30 years of experience, so I would love to interview you and learn more about your journey and lessons learned along the way. If you wanna reach out to our team, we’ll set up that interview.
Thanks, everyone! Theo, enjoy yourself this weekend! Theo is gonna be doing his honeymoon thing next week, we won’t be doing Follow Along Friday because of that. Damn you and your weddings, and honeymoons…! [laughter] But we’ll be back on Follow Along Friday two weeks from now. Of course, we’ll be doing daily episodes every day, and we’ll keep on doing it, so talk to you tomorrow.