The Property Management Fee that can actually make you MORE Money
Property Managers and their fees are an almost unavoidable part of building a real estate portfolio. But what if I told you that your property manager can charge you a fee that will actually make you MORE money in the long term?
One of the most common complaints I heard from my Real Estate Investor clients was that they couldn’t find a reliable property manager. Before I had started my own brokerage/property management company, clients would purchase a property with me and then shop around for a property manager. After working with these property managers, the complaints I heard were common: “fees are too high, the contractors they hire for renovation/repair are too expensive, they’re not responsive when I call/text, they don’t DO anything, they’ve NEVER BEEN to the property, etc.”
So in 2022, I got my full broker’s license in Florida and started my own property management company. Now most of the complaints were pretty easy to fix; contractors are too expensive? Shop around for quotes or draw from my already established network of reasonably priced quality contractors. Previous property manager slow to respond? I respond and answer my phone always. They’ve never been to the property? I make sure to inspect every unit as soon as I take over a property. This is all customer service 101 and frankly NONE of these items should even be in question when hiring a property manager.
But then I got to the fees, and this was an area where I needed to give more thought. A Google search of typical property management fees shows fees ranging from anywhere from 6% to 12% of gross rents plus a placement fee of anywhere from ½ month to 1 and ½ months rent for placing a new tenant. And it was this fee in particular that got me to thinking perhaps the landlord and the property manager’s interests aren’t exactly aligned. Let me give you an example:
Let’s say we have an apartment on a 12 month lease at $1,000 per month. Landlord Joe hires Property Manager Ed to manage the property. And for the sake of this argument let’s ignore all other expenses (taxes, utilities, lawn service, etc.) Property Manager Ed charges Landlord Joe 8% of gross rents as a property management fee, and he charges a ½ months rent for placement fees on a new lease. And let’s look at this in terms of an apartment available starting January 1st for a term of 1 year ending on December 31st 12 months later.
So let’s say Property Manager Ed finds a tenant and moves them in on day 1. Out of that first $1,000 rent payment:
Month 1:
Ed Receives: Placement fee: $500
Property Management Fee: $80
Total Fees: $580
Joe Receives: Balance: $420
Now let’s say over the next 11 months, everything stays stable, there are no other expenses. In that time frame, each party will receive the following:
Month 2 – 12:
Ed Receives: 11 Months Prop Mang fees $880
Joe Receives: Net Rent Balance: $10,120
So at the end of year 1 their totals are as follows:
Year 1 Totals:
Ed (Property Manager: $1,460
Joe (Landlord) $10,540
Ok so not terrible so far. Ed has brought in some income for managing the property, Joe has received his net rents, everything looks good. But now that the lease is up, Property Manager Ed and Landlord Joe’s interests start to diverge. And it’s all based on whether the tenant decides to RENEW.
There are many factors that affect whether a tenant will renew: Pricing/lease increases, current job/life situations, satisfaction with their rental, etc. Pricing we have control over through negotiating rent, however our pricing strategies will always be based around market conditions. Landlord’s obviously want the maximum return on investment so we want rents to be as high as they can be while maintaining low vacancy. The tenant’s job/life situation we have no control over. However there is a massive area that we can influence to help a tenant decide whether to renew, and that is TENANT SATISFACTION.
Are their maintenance requests addressed in a timely manner? Does management ensure their quiet enjoyment of the property? Does the trash get picked up on time? Heck, what is their relationship like with the property manager.
The way I view it, is the customer service portion property management is actually SALES in disguise. I am year round SELLING my tenants on the prospect of renewing. Making sure they have everything they need and addressing issues as soon as they come up. I’m establishing an ongoing relationship with them because I WANT them to renew. The reason I want them to renew is because keeping vacancy low is in my Landlord’s best interest. But is it in my best interest as a property manager? Let’s look again at the example of Property Manager Ed and Landlord Joe and see what happens at the renewal point.
Let’s assume a simple renewal at an increase of $100 per month, bringing gross rent to $1,100 per month.
Year 2 Lease at $1,100 per month
Ed Receives: 12 months Prop Mang fees: $1,056
Joe Receives: 12 Months Net Rents: $12,144
In this simple renewal, things are pretty straightforward. Joe makes nearly 13% more in year 2 between a combination of higher rent and not having to pay a placement fee. However, Ed makes 28% LESS in year 2 because he didn’t have a placement fee. That is not an insignificant amount, Ed is missing out on almost a third of his income because he RETAINED a tenant. This is a clear conflict of interest financially when a property manager stands to lose a third of their income when acting in the best interest of the landlord.
Now let’s look at what happens if the tenant decides not to renew and the unit is going to be vacant for some time. Maybe Ed is not that great of a property manager and doesn’t answer his phone when a service request comes in. Maybe he’s rude and gruff with the tenants. Maybe he’s more interested in larger properties that he manages for other clients. Either way, Ed has done a poor job and is at least partially responsible for the tenant moving out. Let’s assume a 45 day vacancy period before Ed finds a new tenant.
Year 2 Lease at $1,100 per month
Vacancy: 45 Days
Month 1: No Income, unit is vacant
Month 2: 15 days pro rated – Gross Rent = $550 collected
Ed Receives:
Placement Fee: $550
Property Mang Fee: ($44) Insufficient balance will need to be collected the following month
Joe Receives : Net Rent Balance: $0
Month 3
Ed Receives:
Balance of Prop Man Fees Due: $44
Prop Man Fees: $88
Joe Receives:
Net Rent Balance: $968
Month 4 – 12
Ed Receives:
Prop Mang Fees: $792
Joe Receives:
Net Rent Balance: $9,108
Year 2 Totals:
Ed Receives: $1,474
Joe Receives: $10,076
Look at the difference in the numbers based on these two scenarios:
With Renewal:
Ed Makes: $1,056
Joe Makes: $12,144
Without Renewal:
Ed Makes: $1,474
Joe Makes: $10,076
Do you see the problem here? The property manager makes 40% MORE per year if a tenant moves out. And the landlord makes nearly 20% LESS over that same time period due to the vacancy expense. The property manager is actually INCENTIVISED to get tenants to move out which causes the landlord to lose money.
So what is the solution to this? As crazy as it may sound, a property manager charging an additional fee might actually benefit both them AND the landlord and align their financial interests. We call this a “renewal fee”. Essentially it’s a financial incentive for the property manager to retain the tenant. Let’s look at the same renewal example again except in this case the property manager charges 20% of one months rent as a fee for renewing a lease.
Year 2: Lease Renewal at $1,100 per month
Month 1:
Ed Receives:
Renewal Fee: $220
Property Management Fee: $88
Joe Receives:
Net Rent balance: $792
Month 2 – 12
Ed Receives:
Property Management Fee: $968
Joe Receives:
Net Rent Balances: $11,132
Total Year 2 Income:
Ed: $1,276
Joe: 11,924
Now in this situation, Ed has made $200 less than he would have made if he had to place a new tenant, BUT he also didn’t have to do the work of placing a new tenant, he simply had to negotiate and draw up a lease renewal. Joe on the other hand, made $1,800+ more than he would have if they had to place a new tenant. And the fee that incentivized Ed only cost him $220, which is only 1.6% of the annual gross income from the apartment. This should be a very MINOR expense for a landlord. But for Property Manager Ed, $220 is a nearly 20% boost to his income and is a significant motivator. If you knew you could get a 20% bonus on your salary every year, how hard would you work for it?
Under many property management agreements, the property manager can actually makes MORE money year over year by placing new tenants, even if it isn’t in the best interest of the landlord. Even losing 45 days worth of property management fees, they still make more that year because they placed a new tenant.
By utilizing a renewal fee, the interests of a landlord and a property manager in line. The property manager makes slightly less money renewing a lease than if they placed a new tenant, however a lease renewal is far less labor intensive than placing a new tenant. There’s no showings, no background/credit checks. It’s simply a negotiation on price and then drawing up a new lease.
Vacancies and new tenants are an unavoidable part of property management, but every landlord should be asking themselves whether their property management contract has them setup to minimize vacancy expense. The best way to do it, is to incentivize your property manager to retain tenants.