Achieving Economies Of Scale
There are many benefits to operating and investing in real estate at scale, which doesn’t require increasing the size of your investment, but using syndications or partnerships to invest in deals with a higher unit count or across multiple assets (i.e. properties) to achieve economies of scale.
A guest on one of our favorite podcasts recently observed that scale, being an absolute value, brings economies across several benefits such as property management, purchase price, legal costs, marketing costs, and renovation costs. Below, we dissect property management fees to shed light on why economies of scale (EoS) is so important.
Let’s take “Property Management Fees”. Let’s say we have two hypothetical properties we’re considering buying: 1) a 20-unit deal; and 2) a 200-unit deal. Both deal opportunities are exactly the same in every conceivable way except for the unit count; same neighborhood, same price per unit, same number of LP investors, same everything. The 20 unit deal has an annual total Income of $50,000 and the 200-unit deal’s is $500,000. All things considered, are identical in all but one aspect - unit count. Yes, the 20-unit deal makes 10x less income than the 200-unit deal, but one would’ve also paid 10x less for it. The cost structure on a per unit basis is significantly different for these two properties due to EoS, allowing the 200-unit property to lower overall costs on property management, legal costs, etc. In describing above, we assumed that expenses at both properties were also the same (relatively). In reality, however, this would never be the case as a property manager would never charge the same % fee for managing the 20-unit deal as the 200-unit. Likely, the 200-unit deal would be able to negotiate a 3% to 5% fee to the management company, while the 20-unit would likely have to go at least 5%+. The rationale for the fee delta is simple – property management companies appreciate economies of scale, and are able to lower their pricing to accommodate a larger property. They know that 3% of $500,000 is $15,000 compared to 3% of 50,000 is only $1,500, 10 times less. This would be fine in an ideal scenario where the 20-unit deal was 10 times less work to manage, but that’s rarely the case. A larger property requires more work and more personnel, but property management has the ability to outsource staff fully dedicated to these properties, versus smaller projects having to manage time and effort across multiple properties, which create inefficient, that are passed along to property owners as labor cost allocations with a mark up.. Yes, each property requires the same monthly reporting, resident management capabilities and communication with ownership however earning $15,000 is much more lucrative than $1,500, so they adjust their fees based on the size of the properties to balance out this dynamic.
There are other benefits to EoS, such as vacancy risk. For example, 5 vacant units on a 20 unit property, represents a physical occupancy of 75%, whereas at a 200 unit, this represents 97.5%. If our break-even point for a property is 80%, scale can make all the difference. More on this in a future blog!
