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Small Properties, Big Challenges

CIRE’s survey looks at the small side of property management.

by Sara Drummond

Investors who manage their own small properties have only three small problems: tenants, money, and time. And for professional third-party property managers who handle small properties, add landlords to that list.

Those challenges cropped up most frequently in an informal survey of CCIM members who are owners/managers or third-party managers of properties under 20,000 square feet or, in the case of multifamily, fewer than 50 units. While not comprehensive, the anecdotal, self-reported survey provides a snapshot of the landscape small-property owners and managers occupy in a still-struggling economy.

The Personal Touch

Tenants are a necessary evil, but property managers and owners work hard to find good ones and keep them happy so they’ll renew. For the last few years, nonresidential property managers and landlords have struggled to fill their spaces. In some markets, office, retail, and industrial tenants have a plethora of space to choose from, and landlords have been offering shorter leases and concessions to keep tenants in place to reach full occupancy. “Up to now, I include a rent abatement period and a tenant improvement allowance and try to get a higher rent per square foot, an annual increase of 3 percent to 4 percent, and minimum terms of four years with options,” says the owner of two small retail plazas. While the strategy has worked, it has affected cash flow, which has not fully recovered yet, he adds.

Nonresidential property managers also seem to have the most difficulty with local tenants that may have limited business experience. “Especially on small properties, tenants are unsophisticated and need to be educated about HVAC systems, electrical usage, lease terms and conditions, and more,” says the owner/manager of retail, industrial, and office properties. “Sometimes they modify the space, run wiring, install equipment without the owner’s knowledge (and are not compliant to the lease terms or local codes). If they get caught, they usually want the ownership to pick up these costs as it ‘should have been included’ in the rental cost of the space.”

Mom and pop tenants are also a risk when they fall behind on rents: Just one default can put the whole property at risk. “These tenants are sometimes working with very little operating capital so a couple of months where business is slow can affect their ability to pay rent,” says an owner/manager of retail/office and industrial properties with fewer than 10 units each. “[They] have the ability to move quickly and at a low cost if they find a more attractive building in the market. If a small tenant like this gets too far behind in rent, it can be very difficult for them to catch up, so you may be faced with the possibility of having to forgive back rent just so the tenant will stay in the building or making the decision to evict.”

Most property managers try to avoid these problems by qualifying tenants upfront, through credit, criminal, and financial checks. “I ask for a business plan for new businesses and also contact personal references in some cases,” says the owner of two small industrial properties. Other managers conduct their own Google searches to help determine tenants’ personal financial stability.

“Typically we review their financials and do credit checks on any tenant asking for substantial tenant improvements,” says the owner of retail, office, and industrial properties. “If it’s a one-off location for them we seek personal guarantees. If they are unwilling to do the personal guarantee, we are suspicious and less likely to do a deal.”

“There are business people and there are nonbusiness people,” comments one owner of a five-unit retail plaza. In addition to a good credit rating, “I try to qualify the best business person,” she says.

Tracking Expenses

Of course even creditworthy national tenants can be a challenge, says a property manager who oversees small retail centers. “National tenants are always finding ways to re-analyze their [common area maintenance] and amount owed,” she says.

Good record keeping helps support the case for CAM expenses. “We budget each year and present a reconciled CAM budget based on actual expenses and projections at the beginning of the year and charge a monthly estimated fee. It is reconciled based on actual expenses at year-end,” says an owner of retail and office properties.

Recording expenses also helps small-property managers keep their maintenance costs in line. In fact, few respondents list maintenance as a problem, indicating that small-property managers and owners seem to have maintenance issues figured out — thanks in part to the ability to track expenses more consistently year to year with accounting and property management software.

“Using real estate management software gives us the benefit of being able to evaluate the maintenance costs of a specific property and compare that to its income,” says an owner who manages 650,000 sf of industrial space in small buildings. Of course, he adds, “Every day there is an emergency for someone. We have a perspective on [the problem’s] severity and a willingness to step up and make the repairs. The worst thing to do is to put off building maintenance.”

Owners and managers of class B and C properties often cite maintenance as their biggest challenge, particularly for multifamily properties. “The size [of these properties] makes the economies of scale, particularly for labor, disadvantageous. It’s very difficult to hire good people based on the budgets these smaller buildings have,” says a property manager of a 33-unit class C multifamily property.

The cost of in-house maintenance staff is a tough one for landlords to swallow in the current economy. “Currently, we are experiencing some growing pains where we could have a substantial cost savings by bringing a maintenance technician in house,” says a third-party property manager. “But justifying taking on a fixed expense to the property owners has been difficult. We have done cost studies showing the savings benefit, but due to economic uncertainty, the partners have not wanted to add additional fixed overhead.”

In most cases, owners and managers refer to the last three to five years of maintenance expenses. “We take previous years’ expenses, estimate what work we want to do on the property the next year, adjust for expected inflation on uncontrollable costs, and set a budget for the next year. We typically try to keep annual increases capped at 5 percent if possible,” says the owner/manager of 14-building portfolio.

Some have reserves set aside for unexpected expenses, but with longer hold periods and better scheduled maintenance, unexpected expenses are less of a problem. Also, more careful acquisition strategies play into better maintenance, particularly for those investors who are building a long-term portfolio of properties.

Time on Your Side

While many owners and property managers are time-challenged on a daily basis with all the details of managing buildings, small-property owners’ clear preference for long-term holds puts time on their side in terms of investment. Most consider value-add as part of a buy-and-hold strategy. “By the time I find and buy a property, finance it, take care of the management, maintenance, and repairs it needs so it’s operating well, I’ve done most of the work — why sell it?” asks an owner who admits to buying more properties than he has sold.

Others figure investing in the known is better than the unknown. “As a family-owned business there is an aversion to the risk required to buy transient properties and invest in the unknown,” says the manager of a large mixed portfolio.

Most owners cite a 10-year to 20-year hold period, although clearly the rewards of property ownership and management go beyond investment dollars. Many respondents indicate a pride of ownership as well as an immense satisfaction that they are able to master the challenges of property management. “When I bought my first property with two mortgages and all my cash down, I was quite discouraged to find that I had a leaking roof and no money,” says the owner of several multifamily properties. “But then I found a roofer willing to do the job for payments of $200 a month. It was then that I realized there were no problems — only solutions to improve situations.”

Sara Drummond is executive editor of Commercial Investment Real Estate magazine. Thanks to the CCIM members who participated in the property management survey.