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How Fee Managers are Treating Margin Cuts

Property Management Margin Cut
March 2018

Rents have been rising nationally on a consistent basis since 2010. For rental housing fee-management companies, it stands to reason that those increases have led to steady profits, because most management companies work off of a percentage of their collected income, whether it is 2, 3 or 4 percent.

When things are going well, management companies say that some owners attribute their profits to market conditions, and discount their management company’s solid performance.

When rents decline, however, owners do an about-face. They sometimes place blame on the management company, ignoring the aforementioned cycle of market conditions. Feeling the need to respond, owners then consider changing management firms or renegotiating their contract terms.

With shrinking rent growth on the horizon in 2018 in many markets, savvy management companies are continuously trying to stay in front of the trend and boost their reputation. They look for alternative ways to bolster performance by leveraging technological innovation, assessing staffing and senior management experience and implementing more mobile-based platforms that can increase efficiencies, such as maintenance work-orders and marketing or human resource functions.

Live and Learn

So rent growth turned positive seven years ago. Since then, it has ranged from 2.1 percent (Q3 2010) to 5.3 percent (Q3 2015), according to RealPage.

Rick Graf, President and Chief Executive Officer of Pinnacle, says, “From our perspective, our margins today continue to improve. Yes, a lot of that has to do with rents increasing, because we typically get paid as a derivative of collected revenue.”

“[During the Great Recession], we made some cost-cutting measures like most people did,” Graf says. “We saw our revenue stream cut by whatever rate the rent had dropped.”

At that time, Graf took on the risky strategy of investing in his operations, despite the downward trend. He began pumping resources into Pinnacle’s management platform by upgrading technology, marketing and its human resources group.

“By utilizing different banking software and integration software, we lowered our costs of providing service, which obviously increases our margins and allows us to provide more services to our clients,” Graf says. “For example, if technology allows you to lower your cost of client reporting and accounting by a dime per unit per month or a quarter per unit per month and you apply that over 165,000 or 170,000 units, it brings in a lot of money.”

Graf says this investment strategy aimed to double-down and invest for the future.

“This has paid huge dividends today. Our company has seen a dramatic increase in institutional client bookings. Our position in the marketplace has grown very nicely.”

Another example of adjusting for recent shrinking margins is Washington, D.C.-based developer Kettler. Chairman & CEO Bob Kettler’s recent overhaul of his organization shows how seriously apartment firms are dealing with margin compression in all segments of real estate.

Kettler’s business touches single-family and rental housing, office and retail. He has continued to see his margins pressured in all areas during the past half-decade. A declining labor pool, steadily rising land costs and the D.C. region’s costly development process cut into revenue, forcing him to make business-changing decisions.

“When margins [profits] could be 15 to 50 percent on real estate deals, you could run a big volume of business through your shop — for-sale housing land development, tax credits, management and Class A apartments — and all would rise and fall with different market cycles,” Kettler says. “We could always scale up and scale down and move onsite staff members back and forth as it made sense.”

But the changing economy, which required more technology investment in his portfolio that saw increased competition for land, labor and management contracts, made it more difficult for Kettler to justify each business unit.

To get a fresh, holistic appraisal of his organization, Kettler turned to proven management leaders Greg Parseghian, former Chief Executive Officer of Freddie Mac; and Usha Chaudhary, former Vice President, Finance and Administration and Chief Financial Officer with The Washington Post.

The two looked at “every molecule of the business,” helping Kettler realize that there existed duplication of efforts within each business division’s back-office functions, such as human resources and accounting. In response, the company reconfigured its staffing by creating one “shared services group” that would be used by all of its business units. Kettler says this reduced head-count improved margins.

Fee-Management Pricing Wars

Flat rental markets can also provide fertile ground for pricing wars between owners and management companies during the selection process.

“With flat rents, everybody is throwing out one company and bringing in another,” Kettler says. “There is a lot of transition. Everyone is selling against each other.”

Management companies such as WinnResidential used the past year to take a harder look at its clients.

“We made a conscious decision to focus on tactical growth and to position the resources of the organization to best serve our clients,” Patrick M. Appleby, President of WinnResidential, says. “Our priority is quality performance, not quantity of units. We evaluate new business opportunities based on whether we believe we can deliver sustained success for the client, as well as our own margin.”

If something about the potential management-owner relationship does not fit, Appleby turns down the opportunity.

“The test is whether the operational and economic factors will produce mutually beneficial outcomes,” he says. “Using that formula, we have reduced the number of properties in our portfolio over the past year and aligned our key resources to best serve our clients and to pursue new strategic opportunities.”

Dennis Treadaway, President and CEO of FPI Management, says that last year, for the first time in his career, he fired clients who became “inefficient” for his company to manage.

“[Some owners] become so active in the management process that it becomes the managing of the client and not the management of the property,” Treadaway says. “It is not effective for property management companies to operate in that environment. With remorse, I will move away from an account because it doesn’t fit our efficiencies.”

Treadaway, who manages more than 100,000 units, is emphatic when he says finding a compatible client is not dependent on the size of their portfolio. Additionally, he relies on what he calls “organics,” or new business, to offset operating expense increases in areas, such as labor or overhead.

“As overhead goes up and rents soften, there is no room to increase margins if organics don’t come in like we think they would,” he says.

Technology Breeds Efficiency

Kettler is using a relatively new business intelligence unit to help sell owners on the value of its management company and the importance of hiring the best onsite talent. The unit computes things such as how greater NOI can be had from a community because it is employing highly qualified, proven managers.

“There is a real disconnect between owners getting the lowest cost from their third-party contract and managers hiring people who are best for the job,” Kettler says. “Getting a management company that can run a community with 1.5-percent greater NOI, manage a capable sales staff, execute a strong lease-up, choose the right amenities and provide excellent customer service can squeeze $100,000 NOI out of a 300-unit project. That creates value for the owner.”

Like Pinnacle, WinnResidential is deploying cost-saving software, such as mobile maintenance technology, paperless hiring, apps that allow employees to access employment and payment information and video conferencing solutions that allow people to meet remotely versus in person.

“We are trying to find every opportunity to shave costs so we can make sure we have better margins,” Appleby says.

FPI is also evaluating back-office technology to trim costs and protect margins, including employing a peer-to-peer system that automates the electronic processing of paperwork.

“This frees up our accountants to handle more properties than they would have been able to previously,” Treadaway says. “Business Intelligence provides real-time, in-depth property analytics on a macro and micro level, which helps us to evaluate properties more quickly and with more efficiency.”

The Market is 'Flat'

After enjoying 3- to 5-percent revenue and NOI growth during the past four to five years, Mark Fogelman, President of Fogelman Management Group, sees signs of cooling.

“The market has been flat for the past four or five months,” Fogelman says. “I think people are becoming more cautious. Our industry can’t expect 3 or 4 percent year-over-year revenue growth forever.”

He adds, “It is interesting: When the markets are strong, everyone is focused on market selection and job growth and the feeling is that management is not necessarily driving the success. When everything slows, management becomes a much greater focus and there is a deeper dive into cutting expenses and aggregating costs.”

Fogelman sees a tighter market as an opportunity to sell his company’s value. During good times, he feels that apartment owners believe management can be a “necessary evil,” one that commoditizes the administrative function, collects the rent, markets the property and performs maintenance.

“When the market is strong, these owners figure their management company has kind of been on auto-pilot,” he says.

If the market turns this year, Fogelman says the focus will go back to seeking high-performing management companies like his.

“When things slow, everyone looks under the hood again and management companies will need to step up their game,” Fogelman says. “I believe there will be more value and emphasis placed on management and there will be an opportunity for strong, hands-on, locally focused operators to rise to the top and differentiate their skill sets. This basically de-commoditizes the idea of what management services are about.”

Fogelman advises that management companies should step up their knowledge on local submarkets.

“They need to know where the jobs and employers are to help improve their targeted marketing efforts, as opposed to operating with blinders on like many have done for the past few years during these good times we’ve recently experienced,” he says.

Les Shaver, Senior Manager of Content for NAA