Peter Lohmann's Mailing List - Issue #8

October 05, 2021

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Property Management Company Valuation

I just published a brand-new piece on how to think about property management company valuation. You can read it here. I'm including a short except below:

Transaction Types

Property management companies (like many small businesses) can be purchased in one of two ways:

Stock sale. The buyer purchases shares of the business and steps into the shoes of the seller. In this way, the buyer is assuming all the past liabilities of the current business owner. However, this might be the preferred option if the buyer wants to retain the existing brand, existing contracts & vendor relationships. Depreciation of long-lived assets is not reset.

Asset sale. The buyer purchases a “book of business” from the seller. Also known as Goodwill. In essence, the buyer is paying for the property management agreements (contracts). Ideally the existing contracts are assignable, otherwise the seller needs to get agreement from each individual client. Deprecation does reset (goodwill is typically depreciated over 15 years).

Valuation Factors:

Factors affecting property management company value:

* (Article continues, go read it here!)

Re-convene

Tomorrow morning I'm flying to LA for Moses Kagan's Re-convene, the real estate private equity "un-conference". I couldn't be more excited. If you're going to be there too, be sure to say hi! I won't have much of an agenda, just looking forward to making connections and learning.

Podcast Appearance: Notorious Rob

I was a guest on the Notorious POD podcast episode 25 with Rob Hahn. We discuss problems with realtor compensation. This is a wide-ranging conversation about Peter, property management, reatlors, NAR, Zillow, etc.

Property Management Fee Structures

I wrote another blog post recently on the importance of how property management fees are structured. This was a shorter post so I'm including the full piece here for your convenience:

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What’s the right way to compensate a property manager?

Percentage of Collected Rents

The traditional structure is a percentage of collected rent (somewhere around 6 to 10%), plus a leasing fee (usually around 1/2 to 1 month’s rent).

In theory, this arrangement incentivizes the property management company to do a great job collecting rents, maximizing rent amounts for a given property, and leasing up units. But in reality, there are multiple problems with this setup.

First, the percentage of collected rents doesn’t work to the property owner’s advantage. Say the market rent for an apartment is $1,000 and the PM charges 9% of rents. If the unit leases at market rate, the PM stands to make $90/month. Come renewal time, you might be thinking the PM is incentivized to extract the maximum possible rent because they stand to benefit as well. You would be wrong. If the market rent increases by $100 (to $1,100), and the PM manages to get the unit renewed for that price, that’s only an extra $9/month for the property manager. It’s just not enough to move the needle in terms of leasing effort. You may recognize this as the Principal-Agent Problem. Obtaining the best possible rent and maintaining high occupancy for the property should be part of the property manager’s SOP, and they should be able to articulate to you how they do this. It’s not rocket science.

And just in general, charging a percentage of rent makes absolutely zero sense. Generally speaking, the higher the rent, the easier the property is to manage. Why should a property manager charge lower management fees for lower-rent units, which are MUCH more operationally intensive? Some PM companies solve this by having a “floor” on management fees — you’ll occasionally see this as “6% of rent, minimum $85/mo” or similar. But that really doesn’t solve the whole problem, because from the perspective of the owner of a higher-rent building, your fees are very high. Why should they pay more in management fees for a higher-rent property?

Flat-Rate Pricing

The right answer, in my opinion, is a flat rate per-unit fee. The property manager should determine their overall cost on a per-unit basis, add a bit for margin, and set their fees somewhere around this figure. In this way, the property manager is profitable on all unit types. Property owners with lower-rent units will naturally self-select out, because for them the management fee appears high. This is as it should be, because there is a simply a minimum cost to managing property that does not change regardless of the rent amount. Sooner or later, a property manager who is charging below this amount is either going to sacrifice quality/service, or go out of business.

Flat-rate pricing has the advantage of being logical, simple, and predictable both for the property owner and the property manager. We have chosen to use this model at RL Property Management and have operated with it for over six years. Flat-rate pricing applies to all units regardless of occupancy, because vacant units require, if anything, more effort to manage than occupied units.

No Leasing Fees

I also believe the leasing fee should be abolished.

For one, the property manager makes a hefty chunk of change (maybe up to a year’s worth of monthly fees) every time they lease up a vacant unit, from the leasing fee. In other words, you’ve inadvertently incentivized turnover. And tenant turnover is the most expensive and destructive part of owning real estate.

We have never charged leasing fees. It sets up a horrible incentive whereby the PM is incentivized to fill units quickly (because they stand to make a large one-time fee), without regard to tenant quality/screening. Whereas without the leasing fee, the PM is incentivized to place outstanding tenants and keep them in the property as long as possible — because they are responsible to fill any vacancy at their own cost.

Have a great week!

Thought for the day...