Profiting From Mismanaged Properties
Real estate investors instinctively pass on deals presented to them simply because the numbers don’t work. This is quite understandable; however, sometimes, a little more digging can uncover a simple reason for the property’s lack of cash flow. This issue often comes down to incompetent ownership, which results in mismanaged properties. Mismanaged properties or properties which are “underperforming” can be a virtual goldmine if you know how to identify and capitalize on the true potential another investor simply is not realizing.
Owner incompetence typically comes down to six major issues. In most cases, these issues can be remedied simply with a combination of good management practices, an understanding of fair market value pricing and rents in your neighborhood, and of course, injecting a little cash. The following examples generally pertain to smaller multi-families (2 -20 units) however the principles can be applied to larger multi-families.
Below market value rents
This common faux pas stems from a lack of knowledge of fair market value in the area, resulting in a cash flow issue. If a property is at +/- breakeven cash flow at 100% occupancy, any vacancy results in the property owner having to cover any shortfall. The solution is clear. Raising the rents even $100.00 per unit (depending on the number of units) can turn an apparent cash flow issue around. However, this can be a more difficult process based on which province the property is in and the Landlord/Tenant board guidelines of the particular province.
As the new buyer of a property, you have the option of requesting vacant possession. This allows you to reset the rental amounts at whatever the market will bear. It is not until you have set the rental amount that you are bound by most provincial Landlord & Tenant guidelines as to how much of an annual rental increase you are allowed. However, it does need to be said that by requesting vacant possession, you must abide by provincial laws, which clearly state you must be either move into the property yourself (or a family member) or you intend to do significant renovations.
Absence of good property management
Lack of this skill is one of the biggest downfalls of any would-be investor. This encompasses everything from improper screening during the tenant interview process to the daily aspects of running the property. Neglecting any of these areas will result in an underperforming property.
Without a rigid system to screen the tenants, owners subject themselves to delinquent rents, frequent vacancies, and potentially large repair bills. Lack of initial tenant qualification, the absence of urgency in collecting rents, and not having proper eviction procedures in place are common characteristics of a mismanaged property.
Using property management or self – managing is another factor to consider. The novice investor often self-manages to save money. However, the lack of efficiency is typically equated with the lack of time the investor has to dedicate to property management, and ultimately, the property suffers and becomes an underperformer.
Hiring an incapable property management company can also create an underperforming property. Property managers have been known to have poor screening procedures because they only get paid when a unit is tenanted. This is more common than you may expect. The bottom line is low rents and high turnover.
Often property managers also outsource repairs and “pad” the bills as extra income. If the owner were in control of the management, they would know exactly what the repair was, the cost of materials and labor necessary to fix the repair, not to mention the name and number of people in their database to repair.
If the property you are looking at is part of a condo corporation or strata, there could also be mismanagement of reserve funds. This is common and results in excessive monthly fees. Being on the condo/strata board and having a hand in how money is spent can potentially bring down the monthly fees, thus enhancing the bottom line.
Ultimately by leaving the management to someone else or not managing the manager will often lead to underperformance. Negative results stemming from poor property management are also why many incompetent investors get out of property ownership.
Lack of routine maintenance
Lack of response to tenant requests of routine maintenance is the number one reason for turnover and vacancy. This obviously results in negative cash flow, which contributes to underperformance. However, this issue is straightforward and inexpensive to correct. Hiring a caretaker instead of a property manager who has handyman skills allows for an hourly wage instead of an overall percentage rate and “padded” repair costs.