Investor · Walnut Creek, CA · Member since 2016 · 17 posts · 21 votes
Hello - Wondering if any investors have experience working with a property management company that charges their fee based on a percentage of net income (after operating expenses) instead of a percentage of gross rents. If so, was it beneficial? I assume it would incentivize the PM to keep expenses down in addition to increasing the rental income as much as possible. Appreciate your input.
So As a Property Manager this is a no go for me. I get the feeling you think the property manager some how has control on things such as late payments or your AC or hot water heater breaking down. There are ways for the PM to assist the owner in keeping the cost down. Have a reliable low cost vendor is one. We send all AC service orders to the same company. Because we have 600 doors we get great service and lower cost than you as a regular owner would get just calling this vendor because you found them on Google. Why, because he knows with me there is a lot of repeat business. In your scenario if the AC goes out and cost you $5,000 to replace and the rent is $1,000 per month I would get no management fees for 5 months until you start making money again? Does not really make sense for the PM.
When the property management fee is 100% determined by the total rents received, the property manager's only incentive is to increase the rent (so the fee they collect increases as well). When the PM fee is based on net income, the property manager's fee collected increases when the rents increase, and when the operating expenses decrease.
So As a Property Manager this is a no go for me. I get the feeling you think the property manager some how has control on things such as late payments or your AC or hot water heater breaking down. There are ways for the PM to assist the owner in keeping the cost down. Have a reliable low cost vendor is one. We send all AC service orders to the same company. Because we have 600 doors we get great service and lower cost than you as a regular owner would get just calling this vendor because you found them on Google. Why, because he knows with me there is a lot of repeat business. In your scenario if the AC goes out and cost you $5,000 to replace and the rent is $1,000 per month I would get no management fees for 5 months until you start making money again? Does not really make sense for the PM.
I appreciate the input and totally agree for SFR. I'm more so thinking of commercial multi-family properties where the gross rents are $10,000+ each month.
@Thomas Loretz We may come from the land of unicorns, but I have not seen anything like this yet. Please let me know if you find one.
If I understand you correctly, your concern is in making sure that your property manager is incentivized to keep your operating expenses low. I share your concern. I believe I may have once pondered upon the possibility of paying my PM like that. That mental exercise would have been some years ago, though, and short-lived.
I don’t know what your numbers look like, but am imagining this scenario: today your $10,000/mo gross rental income commercial property may cost $3,000/mo in loan interest and another $3,000/mo in property tax, insurance, utilities, and beauty upkeep. (Specific numbers used for simplicity’s sake.)
If you are able to find a PM to be paid off of your net income, I’d guess they’d want ~15%. In the above scenario, they’d make $900/mo in months with no issues. That may appeal to someone. Or you could have found someone for 6%-8% gross ($600-$800/mo.) Perhaps you can find a “net PM” for 10%, which, in this scenario, would equal a 6% “gross PM.”
But I don’t think the numbers really matter in the end, because two potential outcomes appear to me right away:
1 - Unless you will have a way into the PM’s maintenace request system or for the tenants to communicate with you directly, you may soon start to have higher vacancy due to tenants who may have leaky plumbing appliances that keep them up at night, tree branches that hit their windows in light breeze, garbage piled up around the dumpster, broken irrigation sprinklers, and the like. I think each of these is not a habitability issue that absolutely must be fixed, like no heat, etc. But some of this may also lead to violation notices and, over time, to still-higher maintenace/repair costs. And - most importantly - the appeal of the property is likely to suffer.
2 - (You said commercial multi-family.) Do you have a balloon due in four-five years? What is to stop you (except for bad market conditions) from further leveraging this property, which would almost certainly immediately result in lower income to the PM? You’ll likely be needing to renegotiate/find a new one. And what if your property then is not as easy to manage as it had been initially?
3 (I know I said two potential outcomes, but I am also seeing a rather predictable outcome from the first one that would affect the second, or make it impossible) - Given that the property is likely to deteriorate before you have to refi, its worth would be lower. What loan terms would you be able to get then? Would you be able to sell it in time for at least what you paid for it?
I am not all-seeing. If you can think of some way to keep your PM fee down - while making sure that your property does not suffer - in paying off of net, please explain. I’d love to give it another thought.
Thank you, Al. Fortunately or unfortunately I am thinking about this hypothetically at the moment and more so from the perspective of opening a net fee property management company. Although I would not want to include the loan/interest payments in the NOI calculation similar to calculating CAP rates.
@Thomas Loretz so what's normal? I'm starting to work with A PM. He's asking for 1st whole months rent and then 10% on each rent thereafter. Is this normal?
@Chad Vineyard - I would think normal depends on the market and asset. A 200 unit building is obviously going to have a different fee structure than a single family rental.