When you’re evaluating whether to outsource property management in multifamily or commercial real estate, you will want to first consider the incentive structure of both methods. Most third-party property management firms charge real estate owners a percentage of revenue generated by the property. For institutional property managers of commercial or multifamily real estate, you will rarely see this percentage reach above single digits. Most charge 3-5% of gross receipts.
Why do property managers get compensated on revenues? Why not on net income? Or even net operating income?
One word: incentives.
Outsourced Property Management Incentive Structure
As a real estate owner, the most important metric to you is net operating income. You want to ensure that your property management team maximizes NOI. However, property management has little control over many of the large operating expenses, such as taxes and insurance. Utilities costs often have more to do with the physical equipment than management of the property’s systems.
The only line item that a property manager has full control over is rental income. Therefore, the best way to incentivize them to maximize NOI is by paying them a percentage of rental income. Many owners also add bonuses for achieving a targeted occupancy rate. To ensure that the property management team focuses on renewals in addition to new leases, owners typically offer those bonuses to the full team, including maintenance staff. Many owners require their written approval of expenses above a certain dollar threshold. That ensures the management team minimizes property costs as well.
Real estate owners may choose to hire property managers in-house (aka vertically integrate) as opposed to hiring a third-party property manager.
Benefits of Hiring Property Managers Internally
Benefits of hiring property managers internally include:
- Greater control of operations, including oversight of all expenses
- Cost savings on personnel, as a percentage of revenue charge may be expensive for a particular property
Benefits of Outsourcing Property Management
Benefits of hiring external property managers include:
- No need to worry about turnover of property management staff, as the third-party management firm runs hiring and retention
- Brand-name management, which matters to many commercial real estate buyers when you decide to sell
- Cost savings on technology, as management firms can often negotiate more favorable software prices
For your property, you may encounter many other pros and cons of hiring internal or external property management. Each situation is unique. You should consider the importance of local market knowledge, superb people skills, strong accounting (and accountability), and operational expertise. If you can find the right team that encompasses those skills in-house, then you may experience efficiencies from vertically integrating. That said, many of the largest real estate owners in the world outsource property management.
The choice is yours.
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