Vertical Integration - Savior to Multifamily (MF) Investing?

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Vertical Integration - Savior to Multifamily (MF) Investing?

You have to be living under a rock (if you are a MF investor) to not know the challenges MF is facing right now. Interest rates, insurance hikes, rise in real estate taxes, eviction delays, rising expenses and delinquency are just a few problems investors are encountering. Owners/Operators have to identify new and innovative ways to offset these expenses just to survive.

One of the most common solutions I keep hearing is bringing property management in-house (aka vertical integration). On paper this may look like an obvious solution, however, in practice it can cause more challenges (cost) than it saves for most situations. Before jumping to the challenges, let's talk about some of the positives.

The most obvious positive is the PM fee. The industry average is 3% for large properties, not including add-on fees. Through vertical integration a company can have one in-house PM manage multiple properties, when maybe only 1-2 properties need to off-set that expense.

Another benefit is the higher visibility in the day-to-day operational spend. Most 3rd party PM companies have a spend limit that they are allowed to spend without ownership's approval to avoid delays in operations. Bringing the management in-house would allow real time decision making on the validity of the spend.

While there are other benefits, for brevity this post is just going to focus on the expense.

Looking at the opposite side, there are quite a few challenges to starting a new business, which in essence is what is being done here. For those of you who think it is the same, I would argue that they are similar but not the same. One of the most important roles your PM company provides is knowledge on the legal side of leasing at a national, state and local level. I can guarantee that most owner/operators are not aware of these details.

Clearly there are companies who are thriving with in-house management. I would suspect that these companies did not decide to go vertical when they were cash-strapped, but in a position of financial security to take on this new risk.

PM teams should be adding incredible value to your overall business plan. If they are not, then it might be time to switch companies, or even, dare I say, self-reflect as your team might actually be to blame. If it is the latter, then no new PM company, nor vertical integration will solve your challenges.

Ultimately there are some investment companies that vertical integration is going to be a key part of their success, while others vary from no impact to being the downfall. Regardless of what you decide, I do not believe it is the only action someone will need to take to "survive to '25". Operations is a game of keeping a lot of balls in the air. If you relied on the wind to keep a few of those balls in the air these past years, it then becomes very difficult to figure out how to juggle even if you add an extra set of hands.

Arn Cenedella · Answer

@Ashley Wilson

Systems and structures have value and can be excellent.

Over 46 years in the industry, it’s the people that count the most. Their ability, character, and work ethic matter most.

The answer between 3rd party PM and VI comes down to in part to:

Who is actually filling those roles whether 3rd party or VI?

We do sub 100 MF syndications and we are vertically integrated and WE LOVE IT.

But that’s because my partner who acts as PM is fabulous at what he does.  If he sucked our VI would suck.

Who is the human in the command and control seat?

That will make or break an operation.

People matter.

Ashley Wilson · Answer

@Gino Barbaro I agree without knowing all of the details I think it is impossible to create a blanket approach to anything within mf, vertical integration included. The takeaway point of what I was trying to say is that being motivated to bring management in-house due to cash position isn't typically a good reason. I am guessing when you and your company brought your pm in-house you were in a position that if something did not go right, you had the resources to support the change (financially speaking). The majority of cases I am hearing for bringing pm in-house today are actually due to the contrary. In other words, if it were to fail, there is no fall back.

Gino Barbaro · Answer

@Ashley Wilson

It really depends upon an investors goals. If there goal is to grow at a rapid pace, then 3rd party is the way to go. We're vertically integrated, and every time we add another deal, that means hiring staff, and possibly growing the back office.

If the focus is on equity and PPU (profit per unit), then self managing woud be ideal.  You can implement your own systems, decisions can be made in hours rather than weeks, and tyou can focus on your deals, not the otters 1000s of units third party has to manage.

To say one is better than the other is difficult if you dont have all the facts. I would challenge everyone to read Small Giants by Bo Burlingham, excellent book on growing a company with culture and core values.

Buy Right Manage Right Finance Right

Great post Ashley

Gino

Chris Seveney · Answer

I agree with you, those that are struggling are trying to do a "hail mary" by bringing it in house and they are in for a rude awakening. I have worked for two large MF operators and one had it in house and one did not and the one who had it in house always second guessed why they were doing it, it was costing them more than what it would cost it to outsource it, but they were stuck in their ways (and liked the "fees") they were generating even though they could have done it for less outsourcing it.

Chris Seveney · Answer

Always the great debate. While you definitely have more control, its a different set of headaches. Turnover in the PM space has been skyrocketing the past few years, so if you are a smaller operator and you only have one leasing agent and they leave, that can be detrimental to the business. As a larger operator it makes absolute sense to do this in house, but there needs to be some level of scale to the business in order to have it streamlined and running as efficient as possible.

Ashley Wilson · Answer

@Arn Cendedella 100% agree with you! I have always said when people look to invest they typically look at returns first, market second, the team third, when in reality it is the team that can make or break a deal, market second and the returns last.

Gino Barbaro · Answer

@Ashley Wilson

We weren't that smart. We bought our first 25 units and started to self manage out the gate, and have been since then, with over 2,200 units.

Interestingly, A lot of our members in the J&G community start out with third party, and when they've achieved some scale, decide to bring in house. They want more control.

Gino

Ashley Wilson · Answer

@Gino Barbaro I would argue in some ways you were smarter:) You got the difficult aspects out of the way first!

Ashley Wilson · Answer

@Evan Polaski excellent points!

Evan Polaski · Answer

From the LPs perspective, it comes back to pros and cons, just like talking from the GP/Operator side.

Since in-house property management really thrives at scale, when your GP has an in-house management team, it MIGHT create a conflict of interest.  It might be in the best interest of the LPs to sell a deal, but that means the Property Management team is losing units and reducing their profitability.

Alternatively, the standard third party manager is incentivized to increase revenue and only control expenses to the level of NOT being fired.  And we have probably all worked with co-workers who work to the level of not being fired.  In my limited experiences, when an owner brings PM in house it tends to have a net benefit to the NOI of the asset through both tighter control of revenue drivers and expenses.

Vertical Integration - Savior to Multifamily (MF) Investing?

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