Why is my Memphis investment property losing money?

[Jackson Long]

Hey @Bob Beach and @Xiao Xiao here is the post I promised.  I am happy to talk more about any of this at any time.  I am traveling at the moment though so you can also fee free to reach out to Ken Klingler or Jack Inman.

Also I am making up ALL OF THESE NUMBERS because I am typing from a Motel 6 in the middle of nowhere.  They are representative though.

Why is my Memphis investment property losing money?

Answer, you are probably using the wrong property manager. Let me give you a quick breakdown of the problem. The traditional property management business model is inherently broken. For a successful partnership (client/provider) you want synergy. You want aligned interests. This is exactly how traditional PMs do-not-work.

Ideally it should look like this- you have a 1k a month rental and they charge you 10% a month. In a year the property earns 12k. Property manager takes 1.2k and you keep 10.8k. Great. But sometimes you lose tenants and putting in a new tenant requires work and the PM should get paid for this- they usually charge half a month's rent. So if the property turns once a year and you lose a month of occupancy (best case) it looks like this instead property earns 11k. PM makes 1.1k but PM also makes 500 for the lease up so now their annual take goes from 1.2k to 1.6k 30% increase!!! And the owner profit goes to 9.4k (1k*11-10%-500) a reduction of 13%.

This is just the tip of the iceberg but shows how right from the start a traditional PM wants a different set of things than the owner.

Now the PM is ALSO going to manage the rent ready. And say that rent ready might cost a local owner with his own team something like 500 paint, 250 carpet cleaning, 250 in miscellaneous repairs. The PM will say something like “we use our own people to get the best cost”. Instead of 500, 250, 250 it will be 475, 225, 225! Except that they will charge a 10% service fee so instead of 1k total you pay 1,018. Now wait- the property was vacant for a month- so it needs the lawn cut twice and a visit from pest control. And with every transaction the owner’s profit goes down and the PM profit goes up. It gets hairier too! Previous tenant never reported a leak issue. On the walk through mold is noticed. (btw this is a true story) so a remediation specialist is called out. Well they make their money selling moisture barriers and whatever else. You may get lucky and they say nothing needs doing- but in all probability they will come up with 3k in work that should be done. A PM should be the one to say “hey wait, do we really need to spend that money?” except that if you agree to that work- they just made another 300 dollars. 300 dollars is 25% of what they would make in a regular year in our ideal scenario.

At this point the property manager has increased their revenue on the property by 100% and the owner has lost about 35%.

So, YES it is important to think about “how much does it cost to paint” and “how often do you need to replace the flapper in the toilet”, but what is far far more important to consider is who is making money off of what transactions. A property doesn’t go from 2% cash on cash return to a loser because the paint cost 20% too much. It goes from 2% Cash on Cash to a loser from a thousand conflict of interest cuts.

[Account Closed]

The solution? A few years ago, I spent two years looking into the Memphis market when I could buy 20 homes 100% occupied for $40,000 per home. I was ecstatic and ready to jump on an airplane buy 80 rental units. The problem I found with Memphis is everyone tells me it is the Eviction Capital of the World because the income is so low that when the average tenant loses his job he doesn't have enough money in the bank to pay the next month's rent.

So, I did the math over and over and realized that even if the tenants had the money to pay their rent the monthly rent they paid would not cover the cost for a management company and maintenance. So, the story your told is absolutely true, proves my math was correct and confirms my belief that properties are cheap in Memphis, but there is a reason.

In 2004, I turned down a 108-unit property in Klammath Falls Oregon. The property was beautiful. It was on 5 acres, came with 5 beautiful townhomes built with Oregon-style beams inside and it came with an additional 5 acres that I could build units on. The entire property was for sale for $3.2 million. I offered $2.8 million and the seller accepted, but I backed out. In California at the time that property was worth about $6 million.

This is why I backed out and the same is true for Memphis. The property was cheap and 100% occupied, but the problems with the math is when a tenant moves out of a unit in California, I collect $1800 per month for rent and the I can re-paint, install carpets and I will still have a little cash in my pocket. When a tenant moves out of a unit in Memphis and the rent is $950 per month it takes almost two months of rent to clean, paint and carpet an apartment. So, when the rents are half as much that always makes the operating costs twice as much and that is why Klammath Falls and Memphis are not good places to invest with the exception of when properties appreciate in value. 

If your Memphis properties appreciate in value then you can bite the bullet, lose money that results from your expenses and maybe the appreciation and depreciation on your taxes will earn a profits, but when you have low-income tenants and cannot raise the rents than you cannot earn a profit in Memphis.

You will never get rich from buying properties and living of the cashflow from rental income because rental income barely keeps up with inflation. You get rich from buying properties that appreciate in value. I don't watch Memphis any more and I will guess that this housing epidemic has caused properties to increase, significantly, but you still need to do the math to see how much more you can increase rents because rental income determine the value of multi-unit properties and how much banks will loan when you want to sell your properties and capitalize on appreciation.

What would I do in your case. I would manage the properties myself to save not only the management fees, but to save from the mistakes management companies make e.g. paying too much to contractors and vendors.

If you can't manage the properties yourself then I would sell them before your management company digs you into a hole you can't get our of, meaning bankruptcy.