Blog | Real Estate

[CASE STUDY] Real Estate Lessons in Property Management Responsibilities

When you own rental properties, you also own property management responsibilities — learn how to protect your asset

If you read my recent blog on how to get rich in real estate with infinite returns, then you may be feeling especially motivated to begin your foray into investing. And that thrills me. Before you do so, I’d like to share a story with you — a lesson I learned the hard way — that could help you get out of a jam someday.

You see, one of the hallmarks of a seasoned real estate investor is being able to bounce back from a bump in the road. Not every investment deal is going to go as planned, no matter how much research you did prior to signing on the dotted line. And this holds especially true for managing properties — such as rental houses or apartment buildings. In order to succeed in investing, you must have the ability to problem solve an issue that’s costing you money, and turn a liability into a nicely performing asset.

Real estate case study: Property management in Phoenix

In 1995, I purchased an 18-unit apartment building in the heart of Scottsdale, Arizona, and hired on-site staff to oversee the operations. Things ran swimmingly for many years, and the cash flow was top-notch, so eventually I began to divert my attention elsewhere. I assumed I could take my eye off the ball and the property could pretty much run itself. The property manager was the same woman who had managed the property from the beginning. “What could go wrong?” I asked myself.

To stay in touch with the operation of this apartment building, I asked Teresa, a woman who worked with us, to be my liaison between the on-site manager, the maintenance man, our bookkeeper and me. She had never managed a property, so what happened next had nothing to do with her capabilities or intellect. I was the stupid one.

Do you know when you feel something is out of whack, but you can’t put your finger on it? Your gut is telling you one thing, but you have no proof to back up your feeling. Well, every month, I reviewed the profit-and-loss and cash-flow statements on this property. At some point, I noticed an unusual increase in repair expenses. The explanation I received was that most of the units needed quite a bit of updating and the manager and maintenance man were doing that one unit at a time.

What was driving me crazy was that our cash flow on this property went from a nice healthy return to a negative number that we had to feed every month. This broke my number-one rule of property investing — and I couldn’t live with that!

Real estate lesson: Analyze the numbers

Finally, after many frustrating months, I asked Ken — our investment partner and owner of a very large and successful property management company — for his help. This property, with only 18 units, was too small for this company to handle, but as a favor he jumped in to help.

After analyzing the numbers, here are the four things they found:

1. Revenue: Economic losses were 36%, most of which related to vacancy rate with the remainder tied to rent discounts off each month’s rent. The occupancy rate was 67%, so six of the 18 units were vacant.

2. Operating expenses: Payroll, utilities, and maintenance expenses were eating all the profits — we calculated that the property would have to be at 150% occupancy just to break even. You may ask yourself, “Is this even possible?” Well, no — not unless you can build another nine occupied units!

3. Capital improvement expenses: Buried deep in the general ledger, we discovered high levels of replacement expenses related to carpentry, flooring and appliances.

4. Rent study: When comparing rents within a two-mile radius, we found that occupancy in the area was well above 90% (compared to our 67%).

Real estate lesson: Visit the site

Once we’d completed this forensic financial analysis and market data, we set off to visit the site. If you’ve been following my recent blogs, you’ll know that being able to visit your investment properties is one of the five reasons to stay close to home in real estate investing.

We discovered that four of the six vacant units were entirely uninhabitable — due to equipment storage and long-term maintenance issues. The other two units were in the process of being renovated with wood flooring, new cabinets, granite countertops and new appliances — at the cost of a whopping $7,000 per unit!

Our inspection continued based on our next priority: operating expenses. We wanted to find out why payroll was way out of proportion for a property of this size.

Apparently, the on-site manager, who has been with us since we first owned the property, was getting older and she did not feel up to handling all of the everyday tasks that went along with managing the 18 units. She had turned most of the duties over to a new maintenance man — her son, Pete. Her son had been unemployed up to that point.

Pete, it turns out, was overcharging us for just about every job he did. But that wasn’t even the biggest expense. When a tenant moved out, Pete would not look for a new tenant. Instead, he would just use the empty unit as a storage unit.

What was he storing, you ask? Dishwashers, microwave ovens, handyman tools, and carpeting that he was charging to us to update the apartments. But he wasn’t renovating the units with these items. No, he was buying them for himself, either to use in his own house or to sell for cash. No wonder there was no cash flow.

That is the cost of bad property management. I took my attention off managing the property, and it didn’t take long for the income to go down, expenses to go up, and the cash flow to disappear.

Real estate lesson: Turning problems into profits

Needless to say, we stepped in to take over management of the asset. We brought in new staff to get all the vacant units ready for rent, choosing to embrace the “vintage” feel of living in a historic district and forgo more renovation expenses. Once the units were leased, we began charging for ancillary services (like pet rent fees, utility billing and application fees) to gain additional revenue streams. Combined with the expense savings, the overall cash flow increased 350 percent. Problem solved, and then some. What a relief! We continue to manage this asset today.

Now, you may be asking yourself, “How does this happen to a building owned by Kim Kiyosaki?” The truth is, this mistake could have happened to any investor. I took my eye off the ball because the property had been running smoothly and profitably for a long time. I made a huge error in judgment. It’s also another reason why it makes sense to start small when you first begin investing.

But the important thing is that once I realized my mistake, I quickly took action to course correct that sinking ship. I wasn’t afraid to seek help from trusted experts, even if it was a bit embarrassing. I learned an important real estate lesson from that experience — but the most important of all was how to turn a problem into a profit. With a little investigating into the financials and quick action, you too could reverse an investment that’s gone south.