Buy and hold real estate is, in my humble opinion, the best investment there is. That said, it comes with a very noteworthy challenge: You have to manage the properties you purchase.
As such, that leads to a bigger question: Should you choose in-house property management or outsource property management? This question, while important, does not come with a cut-and-dry answer for every property investor. Here’s what you should know about both sides of this coin.
Should you hire a third-party property manager?
Of course, there is no “right” answer to this question. Whether or not you should hire a third-party property manager highly depends on what your goals are.
Are you looking to grow a large company and become a full-time real estate investor? In that case, it probably makes more sense to manage your properties yourself.
Do you want to invest passively and grow a nest egg while doing another job? Then it would make sense to hire a manager.
Do you like getting your hands dirty and doing the rehab and maintenance on your properties yourself? If so, I would lean toward managing your own properties.
Do you dread the challenging interactions and the occasional hostility that can come from tenant interactions? In that case, it likely makes more sense to hire a third-party manager.
In-house vs. third-party management
As with most things in life, there are trade-offs to each approach. Right off the bat, managing properties yourself saves the money it would cost to hire a property manager. Most property management companies charge about 10% of collected rent for their services, as well as all of the late fees collected and the first month’s rent for each new tenant.
That said, every business book will tell you that time is money, and hiring a property management company saves you time. You can use this extra time at your job, to find more motivated sellers and value-add opportunities, or to do anything else that interest you or needs your attention.
But while hiring a property manager can save you time and money, the reality is that there are more aspects than just money involved in property management. Managing your properties yourself reduces the possibility of being taken advantage of by your employees or contractors.
Potential issue #1: Fraud or commission pay structures
If you hire employees or use contractors, you run a higher chance of being defrauded because someone else is handling the day-to-day financials related to your properties. In fact, I’ve heard of property managers getting kickbacks from contractors or leasing units but not telling their clients about it. They simply pocket the rent from this “vacant” unit instead. That’s the worst-case scenario, of course, but it happens.
When you’re managing the properties yourself, however, you are closer to the action. As such, it’s easier to monitor what is going on with the properties and the tenants—and make sure that everything is happening above board.
Furthermore, your incentives aren’t perfectly aligned. As noted above, property managers usually get the full first month’s rent for a new tenant. While this covers the cost of their leasing agents, those costs are often fixed. That said, some leasing agents are paid a commission.
One of the issues to stem from a property manager working on commission is that it’s actually in the manager’s interest to turn over the property more often. When a property has a high turnover of tenants, the property manager has more opportunities to lease it and collect the full first month’s rent and commission. But higher turnover is, of course, contrary to the interests of the property owner.
So, fraud doesn’t necessarily need to occur for a property manager’s commission structure to be a problem. Bad incentives alone can lead to less effort, and, in turn, worse outcomes in certain areas. Either way, though, no one will ever care more about the outcome of your properties than you do.
Potential issue #2: Managing the property effectively
But while you will always have more of a vested in your properties than other people will, it isn’t necessarily easy to manage your own properties. There are a lot of moving parts when managing a property—which means there are specific components you need to have in place in order to manage your properties effectively.
For starters, you need to make sure you are in compliance with the Fair Housing Act—which is one of the most important factors, if not the most important, at play. Otherwise, you can get into serious legal trouble.
But to adhere to the Fair Housing Act takes time and energy. Certain systems are critical in this process—and they won’t appear overnight.
Third-party property managers will, or at least should, have the systems in place to adhere to the requirements of these laws. This includes having access to the right templates for leases, applications, deposits, and pay-or-quit templates on hand. It also includes knowing the policies and procedures that should be followed for leasing, collections, maintenance, and other day-to-day property management duties.
As such, the built-in structures that property managers have in place can be a major advantage. On the other hand, if you want to manage your own properties, you will likely have to build these systems over time.
Potential issue #3: Problem tenants
Using a third-party manager to oversee your property will also allow you to offload a lot of headaches. Most tenants are good, but a few can be tough to deal with. Whether the issue stems from the tenants chronically paying their rent late, getting constant noise complaints about their unit, or other tenant-related issues, dealing with the issues that problem tenants cause can be a big headache.
By using a third-party manager, you add a layer of insulation between you and the issues with tenants, which will make decisions on those matters less stressful. In turn, it will make your life easier because someone else is handling the communications with these tenants. But don’t be fooled by the idea of offloading the tenant headache to someone else. There is no such thing as “hassle-free” property ownership, unfortunately—so while using a third-party manager can alleviate some of that stress, you’ll still be involved with it at certain points.
Managing the manager: A requirement with a third-party property manager
If you choose to hire a third-party manager, you’ll still need to manage the manager—which includes looking over monthly income, vacancy, and receivables reports. If properties aren’t getting leased or delinquency is high, make sure to question them about it. Be a bit of a pest. The squeaky wheel gets the grease.
And if the manager isn’t improving, do not be afraid to switch. Just be thorough about vetting the replacement or you’ll run the risk of ending up in the same boat you were in with the last one.
That also leads to one last key advantage of managing your property yourself: You gain experience doing it. Even if you decide to eventually hire a property manager, it’s a lot easier to tell when someone is pulling your chain if you have some experience in the role.
Third-party property manager or self-management: Which should you choose?
So, which option should you choose? Well, whether or not you choose to have someone else manage your properties depends on what your needs and goals are. That said, you can often narrow down the options by evaluating the size and location of your property portfolio.
If you only have one or two rentals in your portfolio, it often makes sense to do it yourself—especially if you are house hacking. With so few properties, you are not going to be a high-value customer for a property management company—and as long as you find a maintenance company to do the maintenance (assuming you don’t want to do it yourself), managing the properties in your portfolio should not require a significant amount of time.
If you have a decent number of rentals—between five and 20 or more—then a property management company makes more sense. Such a portfolio will require you to devote a good amount of time to managing, but will rarely generate enough income for you to quit your job unless you own them debt-free or are also flipping or wholesaling. As such, you will likely not have enough time to properly manage it.
If you are going big and want to build a sizeable real estate company with a large number of rentals, then it could be worth building your own property management company. This will give you a lot more control over the quality and your brand—and allow you to take advantage of some economies of scale.
If you are buying properties out of state, then you effectively need to hire a third-party management company. Still, you should do so carefully, as investing out-of-state comes with an assortment of risks and challenges.
Or, if you work for a corporate fund or REIT, these companies typically do not specialize in property management. As such, it would be wise to hire a property management company to handle the management side of the equation.
Final thoughts on property management tactics
While each side of the property management coin has its own pros and cons, remember that the decision you make for your portfolio should ultimately be based on the many factors that are unique to your situation. It’s up to you to look at your goals, situation, and the advantages and disadvantages of each option in order to decide the best option for you.