Does property management blow the budget for small MFAs?

Question

I'm a new investor living in/looking in the Cleveland market, interested in cutting my teeth on small multi-family apartment buildings (<10 units). I've been crunching numbers on some of the deals I've seen offered here just to get confident with the relationships between purchase price, NOI, CAP, and cash-on-cash returns - to begin to understand what I could afford and what it might result in for me. Everything makes sense until I add in a line item for property management. Then, the budget is blown, dropping any cash-on-cash return into the 0-2% range. With Cleveland CAPs hanging around 8% in the ideal investment neighborhoods, is it reasonable to think professional property management is even an option on a small apartment building? Or am I missing something in the math? Curious for the experience of others...

Thanks for any insights!

Adam P · Answer

Sounds like you are looking at average deals on the MLS and Loopnet.  You can find good investments on the MLS, but they don't hang around for long (usually less than a week).  In these days of low interest rates, there are a lot of stupid investors out there paying crazy money for properties which will never make money.

If the property won't make money with property management, don't buy it.  The point of a business is to be able to scale, to the point where you eventually retire.  Without the ability to outsource everything, you aren't building a business, you are building a job.

I have been finding the best deals lately are primarily due to poorly maintained buildings, buildings with tenant issues, and being sold by utterly incompetent agents who make seeing the building and making an offer a nightmare.  You need to search out buildings with these types of "issues" which can cheaply and easily be overcome, generating great cash flow.

Derek Gendig · Answer

You may want to reconsider the purchase.  **Please note I am a PM**.  If the numbers are tight to begin with, I can say with almost certainty that once you own the homes they will get even tighter.  Things will come up.  They always do.  Regarding a PM, depending on whom you work with, a PM should be your greatest resource once you own the home.  They should work for you to gather estimates, communicate with tenants to ensure timely payments, have your back in following city/state law in terms of proper communications and timely communications in time of eviction and much much more!  Life is busy.  PM must be handled as a full time job.

Now, with that being said, only you know what is best for you but there are some good points in this thread so take time to read and comprehend.  Think things through for a bit.  Don't hang your hat on what 1 or 2 people say because again, only you know what is best for you.  Best of Luck to you!  Trust your intuition!

Anthony Gayden · Answer

I always calculate a property management cost. If the property can't cash flow with management, what happens if for some reason you can't self manage? I recently found out I am relocating 1200+ miles away from my two properties here in Arizona. Fortunately I bought the properties and did all equations as though I would always use management.

Timothy Murphy III · Answer

@Carrie Giordano

The most important thing is to make sure your consistent in how you apply different expenses to different properties. A cap rate only has informational value if it's allowing you to compare projected returns of several properties and if you're comparing properties that take different sets of expenses into account then there's no real basis for the comparison. That said, I would include ALL expenses in my cap rate calculations, including capex, vacancy, management, etc. Do so even if you intend to self-manage because your time is valuable and you may eventually want to remove yourself from the system and hire outside management.

I imagine many sellers intentionally understate or omit certain expenses on their pro formas because it makes the paper returns look better. At the most extreme, I even see some properties cash flow calculated as Gross Rent - PITI = Cash Flow. Obviously, this omits many key expenses that will come up. Don't just blindly accept a seller's stated figures, always do your own due diligence. Make sure you know how a given cap rate is calculated so you can determine if you think the calculations are correct and take all relevant information into account.

Carrie Giordano · Answer

@Jeremy Janszen I have looked at some small apartments 15and under in ohio in b-C areas and have found similar issues. When I add property management (10%), vacancy (8%) and cap ex (10%) I am barely cash flowing after the debt service. Most of these deals are listed to be 9-13cap rates but don't account for vacancy or any cap ex. @Mark Mosch should cap ex be deducted from the no I to calculate cap rate?

Account Closed · Answer

NO - property management should not blow-up your deal. The issue is what are you getting from the Property Management group. Under about 60 units you usually can do without onsite management. For small projects <10 units, your biggest cost is leasing, bookkeeping, maintenance, and other cost can be done relatively cheap and there are many ways to get those done at very competitive rates. As for leasing, with smaller projects, you may be best serve by doing that yourself and saving that cost. Lastly, whether you self manage or use a third party, the time involved is always a concern and should be consider as a cost before evaluating strict return on investment.

Please feel free to contact me if you want suggestions on how to streamline your management and save on property management cost.

Michael Worley · Answer

Yes, Property Management should be a line item normal operating expense. As for the amount, historically PM for MF properties is in the 3-5% range. On smaller properties it runs a little higher, but should not exceed 7-8% (or else you're getting a bad deal from the property manager).

Jeremy Janszen · Answer

Great conversation, all.  This gets me back on track with good advice.  Really appreciate this forum and the contributions.

Steve Smith · Answer

@Jeremy JanszenI look at it this way , what if something happened to me I feel better knowing that even with property management my family will still be okay even if the cash flow is lower

Anthony Gayden · Answer

A lot of sellers either think the end buyers are idiots, or they themselves are idiots. A small multifamily property is an investment, period. Investors need 100% of the information before they can make any sort of deal. These sellers are omitting information and trying to hide cheat and scam the buyer into overpaying.  They use proforma numbers that are 100% BS.

The best thing that an investor can do is know their market up and down. If you know your market, you will never fall for one of these unscrupulous sellers trying to rip you off.

Does property management blow the budget for small MFAs?

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