There are many financial indicators to help you benchmark a real estate deal and its investment’s potential; calculations like cash on cash return, internal rate of return, loan to value ratio, capitalization rate, and many others. But one crucial factor for your CRE investment, especially as a LP, will be the management fees.
Let’s elaborate on what management fees are exactly, what they include, what’s considered a good property management fee, and what to look out for.
Property management services are provided by many companies and serve the real estate sector, both residential and commercial.
Their purpose is to insure smooth operations, like onboarding and evicting tenants, facilitating their needs, ensuring timely repairs, and allow you to take your hands off the property and focus on other ventures — all for a certain fee.
As a limited partner, your aim is to let your money work for you, and that also means delegating managerial responsibilities. Hiring a team to manage your commercial properties is a must for any serious investor.
What’s included in the property management fee?
We mentioned it briefly earlier, but it’s time to dive deeper.
The scope of property management services offered directly affects how much they’ll charge, and the types of services can vary. However, typical services include:
- Maintaining the property (they may hire external contractors)
- Onboarding new tenants, and evicting non paying/problematic tenants
- Ensuring the property’s vacancy rate is low.
Sometimes, firms can take more responsibilities, like finding the best insurance companies and negotiating the best rates for their services.
Property management cost – what it includes and what to know
You can find firms who’ll accept a flat fee to maintain your property, but it’s often advised to pay them a percentage of the total rent, which makes them have skin in the game — acting as an incentive to avoid having your property vacant.
It’s also common for such firms to make money from other venues while being employed by you. For example, they might charge a tenant directly for renewing their lease.
What to expect from a property management firm to take care of, and what to look out for:
- Evictions – as mentioned earlier. Sometimes, tenants don’t hold up their end of the agreement. It could be constant late payments, or disturbance and nuisance at a property. Your property management firm will charge a fee to go through the tedious process of evicting a tenant – typically around $400 per eviction, plus any court costs.
- Late payments – there’s often a penalty for a late payment. How much depends on the contract signed with the tenant, with the average being 7% of their monthly rent.
- Maintenance – done in-house or by a 3rd party contractor. Commonly, firms charge a maintenance mark-up fee, which is often an additional 7-10% of the maintenance costs for the property, like plumbing or HVAC.
Note: You’ll find companies who retain their own maintenance crews. In such a case, negotiate what routine maintenance services are included for what you pay, and what isn’t and may be considered as extras. It’s likely they’ll try to apply labor and material charges. Make sure you aren’t blindsided, and that your agreement entails a set limit for how much they’re allowed to charge.
- Advertising – will be a serious cost consideration and a crucial factor. Some firms may approach this topic differently than others. Some can include advertising costs in their flat fee or percentage rate, while others may split it with you. Some may avoid handling this aspect altogether, and not offer it as a service. Either way, this one will affect vacancy rates, making it paramount to nail down.
- New tenant placement – some firms charge for new tenant placements, or will demand a bonus for getting a tenant into a lease. 50% of the first month’s rent for any new tenant placed is not unusual.
- Tenant occupied unit – some managers will only charge if there’s a tenant in the property. If a whole office building floor is vacant, or a certain number of condos in an apartment building are empty, they may charge a reduced fee.
- Vacancy fee – you might encounter firms asking you to put 1-3 months rent up front, or a part of it. They do so in order to cover the costs of advertising, paying the real estate agent’s commission, and for all paperwork and escrow involved.
Some owners like doing much of these themselves, and just delegate the tenant screening process.These are areas of delegation, and you should pick which ones you do according to your managerial style. Some want to delegate certain tasks entirely to a management firm; others may want to stay very ‘hands-on’.
As a LP, it’s unlikely you’ll want to take care of any of these on your own.
Now, what should you pay a property management firm?
What is a typical property management fee?
A fair industry rate property management firms charge is 5-8% of the monthly rental value for the property, plus any expenses agreed upon in your contract.
What is a good property management fee?
Good property management fee will be between 4-5% of the total monthly rent for a commercial property. However, remember that factors like location, size, the property’s condition, the amount, type and quality of the tenants, and the agreed upon services the management firm will perform will severely affect the price. It’s good to check the common management fees in the area and compare your property to one of similar size and use.
Property management contract – what to look out for
Your contract is important and its terminology is definitive to your investment’s performance.
For example: does the contract state you’ll be paying the firm out of “rental value” or “rent due”? Or, will you be paying them out of “rent collected”? Obviously, there’s a big difference.
As stated earlier, a property management company that only gets paid a percentage of rent collected has a big incentive to do its job. On the other hand, a manager who gets paid based on “rent due” wants to get paid regardless of your tenant situation, which could mean negative cashflow for you.
The scenario you’d like to create should be an advantageous one — where you pay your management out of collected rent only.
Our take: in reality, communication and quality of service precede fees. So, paying extra for a top-tier property manager can be a wise investment. This is a partnership, and finding a high-performance partner with quality and integrity is more important in the long run. The right firm can help you retain quality tenants, get rid of difficult ones, and boost property earnings with great maintenance and superb advertising. Finding a cheaper firm can cause the exact opposite.
Are property management fees tax deductible?
If you manage your own property, you’ll be able to deduct many operations and lower your tax bill. If you delegate the job to a management firm, all expenses related to paying them are usually deductible.
You’ve learned about management fees as a whole, what to expect when paying a management firm, what to watch out for, and what it’ll be like to possibly do it on your own. We also covered the importance of reading your contract, what you choose to delegate – depending on your personality and managerial style – and what’s considered a fair rate for hiring a property management firm.
Investing in commercial real estate can be risky. It is not a fit for everyone. While we aim to provide general information to help you better understand CRE investments, we are neither providing any investment advice nor advising for or against any particular investment.