The Problem With Property Management

by Mr. Cheap

“Almost all neglect the properties they manage and take kickbacks from suppliers and subcontractors who overcharge the property manager’s client in order to pay the kickbacks.” – John T. Reed

People selling real estate advice almost always advocate using property management companies.  John T. Reed suggests they do this to overcome the objection “I don’t want to get up in the middle of the night to fix a clogged toilet.”  “Don’t want to get up in the middle of the night?  Me either!  Buy my $3,999 program and I’ll teach you how to have the best property managers begging to work for you!!!  Let THEM get up in the middle of the night.”

While it may sound great in principle, the reality can be a little less cut-and-dry.  You’re usually going to pay 5-10% of the gross rent, plus expenses to hire a property management company.  Sometimes they’ll charge extra for filling a vacant unit (for the extra work of advertising, showing and setting up the new tenant).  This is all quite reasonable, and if this was the end of the story I’d agree it’s a good way to go.

To get one case out of the way, sometimes real estate agents will offer to be property managers for the owner (or to place tenants for him).  They’ll charge a nominal fee, and will typically do a really crappy job (they won’t do their due diligence screening tenants and whatnot).  Their job is selling houses (not managing rental properties), so when they’re acting as a manager for the owner, they’re doing it to generate good will so the next time he buys or sells he’ll use them (the same reason they give you a pumpkin).  If things work out, they look like a champ for helping, if things blow up, they can just put the blame on the awful tenants (and maybe help the owner sell the place if he’s burnt out).

Genuine property management firms (where that’s what they do exclusively) are an intensively entrepreneurial enterprise.  You can be sure whoever started and runs the company loves business, and they’ll be dealing with all the typical challenges of running a business (advertising, employees, customers [owners!], etc).  As an entrepreneur, they’ll be constantly looking to maximize profit and minimize costs:  for themselves.  Property owners will assume that the property management firm will be doing this on their behalf, and in the case of a small number of HIGHLY ethical companies (that will naturally tend to go out of business, we’ll get to that later), they may be right.  The majority will sell out the owners in large or small ways.  You may think they’re your weasel, but they’re their own weasel.

Greed is one obvious motivation.  If a plumbing company offers the management company $20 every time they’re called to be the “sole supplier” for the company’s clients (or some other similar arrangement), do you think the company will refuse?  They should.  The $20 just gets added onto the cost of the job (and billed to the property owner).  If they could afford to pay a $20 kickback, they can afford to lower their price by $20.  The manager gets the kickback at the expense of the owner.

The same thing can happen in less obvious ways when a friend or relative of the manager is a plumber, and gets the business out of loyalty.  Would the owners want the job to go to the company that does the best job for the best price, or to someone the manager feels loyal to?

Apathy can kick in where greed leaves off.  If you’re not paying a bill, it becomes VERY easy to not work too hard to get the price reduced.  When I’ve had to rent a car for a business trip, I get whatever model is authorized from the first place I call.  When I’m renting for myself, I drive an economy model, use my credit card to cover the insurance, and will track down any deals or the lowest possible price in town.  If I can get a lower price to save myself some cash, I do so.  If I can save cash for a larger organization that will neither notice or appreciate it, I don’t bother.  Which case do you think the PM will be in when the owner is footing the bill?

Property management companies will argue against rent increases.  A higher rent means more money for the owner (and a tiny raise for them), but it also increases the amount of work they do (tenants will be more likely to move out after a rent increase, and may be less inclined to complain if they know they’re getting below-market rent).

If someone ethical is running a property management company, acting as a fiduciary for the owner, often customers won’t even realize or appreciate this.  They certainly don’t seem to realize how often they’re getting ripped off by property management companies, or you’d hear far more owners grumbling about them (economists call this information asymmetry).  The ethical manager will therefore be earning less money (no kickbacks) for more work (hunting for the best deals) and won’t even be getting loyalty from his customers.  How is he going to compete in this situation?  There will be constant pressure to slack off (both from an ethical and a work-ethic perspective) or give up and move into a more honourable field of work.  My reasoning here is (unabashedly) related to the lemon principle (alternative Wikipedia info).

John T. Reed’s advice is “competent real estate investors manage their properties themselves or have in-house salaried employees to do it.” I second this sentiment.

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