Why Managing Real Estate is So Challenging

Today’s Thesis Driven is a guest letter by Eric Edelman and explores the difficulties of managing real estate assets. Eric is a partner at Mana Tree Properties, a value-add multifamily owner and developer focused on the Northeast. Eric was formerly the VP Platform at Common.

I asked Midjourney to convince me not to go into property management

Property management has a certain conceptual simplicity that’s unmatched by most other industries. People pay property owners money—usually on a recurring basis—to use their space for shelter or commercial enterprise. Owners must 1) find tenants, 2) collect rent, and 3) maintain the space. Easy, right?

Given the conceptual simplicity, it’s easy for an LP investor, a prospective proptech entrepreneur, or even a seasoned real estate finance professional to underestimate how hard it is to execute those three tasks day-in and day-out. Anyone who’s been in the property management industry for a few years can rattle off horror stories about fraudulent tenants, criminal staff members, never-ending capex projects with ever-expanding budgets, vindictive local officials, and cooked books.

Being good at the whack-a-mole that is property management requires the ability to solve an almost unlimited range of problems spanning accounting, construction, mechanical engineering, finance, law, marketing, psychology, recruiting, and unregistered social work. And while new technology has certainly improved aspects of managing real estate, especially around the leasing funnel and access control, managing real estate today remains incredibly people-intensive and challenging.

In the good times, the bloated expenses from mismanagement can often be papered over thanks to rising rents and steadily declining interest rates. But when the winds shift as they have in the last 18 months, it becomes essential to understand the fundamental challenges of managing real estate and how to intelligently make decisions about tradeoffs to optimize outcomes.

Today’s letter will articulate those challenges and how they shape the key decisions that anyone buying or managing real estate will face.

The Fundamental Challenges of Managing Real Estate

For many LPs and prospective proptech entrepreneurs, a major draw of real estate is that it’s tangible; buildings located in the physical world providing indispensable services.

But because real estate operates in the world of atoms, it faces some inescapable challenges.

Real estate is about people

Most tasks in real estate require a person on-site to physically execute them. Air conditioners don’t get fixed, hallways don’t get cleaned, and walls don’t get painted without humans to do the work. Likewise, people are needed to tour prospective tenants and walk properties routinely to spot issues.

The problem with people is that they’re imperfect and sometimes unreliable, particularly at the most inopportune times.

As a recent example, at one of the three-family buildings we own, a tenant reported that a boiler was malfunctioning, causing temperatures to swing wildly between too hot and too cold. Eventually, an HVAC contractor deduced that the single boiler for the building had a faulty thermometer. To fix the issue, the boiler needed a new thermometer and all the tenants needed new valves on their radiators so they could modulate the heat in their units. After doing all the work to diagnose the issue and order the necessary parts, the HVAC contractor disconnected his phone and stopped returning emails for weeks indefinitely. Restarting with a new contractor naturally took more time, leaving the tenant distraught over the faulty heat and demanding a refund on her rent.

People need to move around

Managing real estate requires maintenance, leasing, and management staff to frequently travel to the properties. Time spent in transit becomes a critical variable to track in order to optimize margins.

You can easily imagine how this becomes a problem when a portfolio is broadly distributed. A dedicated technician for a single family home portfolio scattered across an MSA can spend half their time just in transit alone.

People are expensive and hard to divide

Wages for these workers were rising steadily even prior to the pandemic, and they’ve only accelerated since. To illustrate, a maintenance technician with only 1-year experience in Dallas now costs $21.58/hr or $55,000 including benefits, while a seasoned maintenance supervisor costs north of $110,000 including benefits.

As we’ll discuss below, once you have a full-time employee hired and fully utilized, it’s not obvious what to do if your portfolio grows incrementally. If a small multifamily or SFR property manager’s portfolio grows by 10%, do they have the existing employee work overtime to manage the additional units? If so, the manager’s cost per marginal hour of maintenance has gone up by 50% thanks to overtime costs. Does the manager hire another full-time person? In that case, the manager now has someone who’s 90% underutilized on the payroll and needs to quickly find more units to cover the cost. Does the manager hire a part-time person? Now your property managers and back-office staff are strained with another employee to support.

Before-and-after renovation at a Mana Tree property

Tenants are unforgiving and unreliable narrators

When people live and work in a building, imperfections with the product are taken much more personally. A broken Amazon delivery is an inconvenience. A malfunctioning heating system in your apartment is an affront. Tenants understandably expect everything to work all the time in the buildings they pay for and when something breaks they want it fixed immediately regardless of the issue’s complexity.

What tenants don’t realize is the product they’re paying for isn’t typically priced for instant service. Everyone wants their non-emergency issue fixed the second it occurs, but no one wants to pay the premium rents needed to cover a roving maintenance team that has the slack in their schedule to instantly be available for minor service calls.

Tenants also don’t understand how much property managers rely on them to be their eyes and ears. Tenants frequently wait too long to report critical issues, report non-issues as five-alarm emergencies, and everything in between. For example, I’ve walked into units where a tenant hasn’t reported an issue in 30 years only to find a hazardous unit that would make Chernobyl first-responders blush. On the other end of the spectrum, I’ve seen tenants threaten to withhold their monthly rent in a newly-renovated apartment because their mailbox key was delayed a week.

Property management is a high stress, low margin business

Most real estate assets operate between 45% and 65% gross margins (net operating income / revenue). Payroll is the largest expense after taxes and insurance, often eating up between 5-10% of a property’s revenue.

While the popular characterization is that everyone in real estate is getting rich, it’s not from the cash flows of the assets. This means buildings almost never have the funds to invest in improvements to operating processes or pay their property managers handsomely. As a result, property managers are constantly trying to solve high-stakes issues for their tenants with teams stretched too thin across a growing portfolio.

How it all comes together (or doesn’t)

To illustrate how all of these fundamental challenges come together and make a seemingly mundane issue difficult, let’s take a simple toilet leak as an example. In the best case scenario:

1. The tenant uncovers the issue

2. The tenant files an accurate maintenance request that conveys what the issue is

3. The ticket is speedily sent (either directly or via intermediary) to the right maintenance technician

4. That technician is fortuitously a) available, b) nearby, c) equipped with the exact part needed, and d) knows how to fix the issue

But after understanding the above fundamental characteristics of property management, it’s easy to see how quickly this sequence can go off the rails. A tenant might not report the issue promptly, the description will be inaccurate leading to the technician appearing with the wrong part, the coordinator dispatching tickets might be out sick, the technician will be busy elsewhere fixing another issue, the technician is new and unfamiliar with this model of low-flow toilet, et cetera.

What do these challenges mean?

Until robots can start replacing humans and flying from point A to B, there’s no way to escape the fundamental challenges of operating real estate. Instead, property managers will constant ly grapple with these challenges–and the implications for their businesses.

The tradeoff between in-house staff and contractors

Given that the people required for most tasks are expensive and sometimes unreliable, managers must maximize the impact of their dedicated staff across their portfolios. While it’d certainly be a better customer experience for the tenant with a leak if their manager had a dedicated plumber on staff to instantly fix challenging toilet issues, hiring an $80,000/year specialist may not pay off for the management company.

For most management firms (and self-managing owners) under 1,000 units, the answer is likely that they’re better off hiring a contractor when a complex plumbing issue arises. The advantage of hiring a contractor is that firms are freed from the burden of ongoing payroll carry. However, they now have to deal with a healthy markup on the hourly cost of a plumber and the vicissitudes of third-party contractors’ scheduling constraints.

The decision of hire vs. contract out extends beyond maintenance to accounting, leasing, and even legal. Whenever a firm decides to contract out a service, they give up a little bit of predictability and control. While that seems undesirable, the alternative option of an entirely verticalized approach would put many firms out of business and cut them off from top specialists who run their own businesses.

As firms grow, they constantly need to evaluate which tasks should be brought in-house vs. which should continue to be handled by contractors.

The benefits of operational density

Many management firms and owners religiously preach the benefits of scaling a portfolio. In theory, managers should be able to afford to bring more specialized roles in-house and gain greater control over their resources as they grow.

In practice, not all scale is created equal. 500 units in the same building is not the same as 500 units across 15 buildings in a neighborhood, which is not the same as 500 single family homes in a MSA.

The number of different roofs, heating systems, wiring types, access systems, and building code quirks all impact how efficiently managers can scale operations and how repeatable their processes will be. Portfolios also get harder to manage the further apart assets are from each other as transportation, coordination, and switching costs all drag on productivity.

Property managers find time and time again that their largest buildings (200+ units) are much easier to run than an equivalently sized scattered-site portfolio because the large buildings have dedicated staff and senior on-site managers that can identify and address issues quickly without needing centralized support.

In contrast, managers of scattered-site portfolios are constantly trying to balance unit count growth and staffing. People are hired in a step-function pattern while portfolios grow incrementally. The more distributed a portfolio, the more managers run the risk of decreased performance and deteriorating margins.

These issues particularly plague single family rental and small multifamily management portfolios. With the wrong portfolio construction, an in-house maintenance technician or leasing person can easily spend 50% of their time just traveling between homes. If tenants fail to report an issue, it could be weeks or months until someone discovers it as part of a routine inspection.

The Path Forward

For managers struggling with these issues, technology can help in a few ways.

Field service management software ServiceTitan or Salesforce’s FieldService can help optimize technicians’ routes to cut down on time lost to travel. Real estate-specific maintenance solutions like HappyCo also have task-specific checklists and tutorials that make it easier for field staff to resolve tickets correctly the first time.

Meanwhile, marketplace platforms like Lessen and VendorPM are trying to help property managers source vetted contractors more easily.

For non-repair work issues, advances in customer service software also allow property managers to better answer tenant questions. For example, Salesforce offers an AI-powered help center product that can surface relevant FAQ articles to tenants based on their questions.

But the interpersonal aspect of running a property management business can’t be fixed by technology. Enduring property management companies like Greystar have learned that they need to put people at the center of everything they do. They relentlessly focus on attracting, training, and retaining talent because they know it is the lifeblood of their business. They also invest in their vendor relationships knowing that the closer they are with outside firms, the more likely they are to get quality service when an issue can’t be solved in-house.

As long as real estate operations involves humans managing properties for human tenants, it will never be as predictable as manufacturing on an assembly line or fulfilling ecommerce orders. But property managers who take the time to study the fundamental challenges of real estate operations and design strategies aligned to the specific context of their portfolio can make operations smoother and reduce the number of five-alarm emergencies.

—Eric Edelman