Management Philosophies
I find that there are two common management philosophies when it comes to dealing with rental properties: the Cash Cow Model and the Healthy Company Model. I’ll discuss both below and make a case for why the Healthy Company Model serves you better in the long run.
- Cash Cow Model:
People who treat their rental properties (or other investments) as a cash cow try to pull the maximum amount of money out of their property as they possibly can. When you have a cash cow, you’re probably going to delay maintenance and make repairs in waves rather than fixing something immediately. Typically, an owner following the Cash Cow Model in rental property focuses on the profit he or she can make today and tends to lose sight of what his or her property can be worth in the long-term. Ultimately, this model tends to run properties into the ground.
- Healthy Company Model:
People operating out of the Healthy Company Model choose an ethos of fairness to customers, vendors and bankers, property maintenance/other responsibilities, and themselves. A healthy company recognizes the importance of service over greed and arranges their priorities in a way that reflects this recognition. A healthy company owner in rental property, for example, may prioritize like this:
- Customers
- Vendors and Bankers
- Property Maintenance/Other Responsibilities
- Themselves (if there is money left over)
In a healthy company, you won’t realize the immediate cash return, but your property will be worth exponentially more 20 years down the road. In the meantime, you will enjoy the benefits of repeat customers, a good reputation in the community, and nicely-maintained properties.
I think following the Healthy Company Model is the better plan of action in rental property, especially when planning for long-term success. Within this model, it’s important for you to acknowledge that while you may not get any money out of your rental property for the first 5 years or so, you’re building toward a long-term asset that will pay off in the future. With this being said, if you make a good deal, you should definitely benefit profit along the way, but you also need to be willing to put yourself last in any value proposition.
Setting Rent Rates
I’ve had several people ask me how to set the rates for rental properties. As someone who tries to operate out of the Healthy Company Model, I look at a few different guidelines to help me determine rent rates.
- What Will the Market Bear?
I personally believe in a free market economy, and I think the market will set rates based on supply and demand. As a landlord, you need to understand the market’s perspective and not just your own. I would suggest visiting the neighborhood you’re interested in and looking at what other rental properties are going for before you set your own rates or even buy your own property. Part of your due diligence is doing your research to understand what your margin expectations on a property should be when you build a pro forma.
- Are Your Obligations Taken Care Of?
Some landlords will perform their due diligence on a property at the beginning and fail to continually evaluate fair market rent value over time. Oftentimes, this can lead to undervalued rent rates and neglected obligations, so it’s important that you maintain a continual awareness of market conditions to make sure your rent rates are reasonable and fair, both to your customer and your business. A side effect of low rent rates is typically the inability to maintain a property well. When rates run below the market value, it’s difficult to have enough money to make adequate repairs on the unit. The longer the rates remain low, the more likely it is for the property to fall into disrepair and start to go downhill. Keeping up with your rent rates, on the other hand, allows you the profit margins to regularly service the property to prevent it from losing value. If you’re able to hire a property manager, he or she can be extremely helpful and monitor market values for you.
- What Is Fair?
I think it’s important to be fair to your customers when setting rent rates. Personally, I would recommend charging a little less than full market value (about 95%). By being a smidge below what everything else is renting, you’re able to offer your customers more value. At the same time, you also need to make sure you have enough money in the property that you’re always able to cover your obligations. This way, you can continue to treat your customers fairly by performing immediate repairs and avoiding outstanding issues on your property. A fair attitude will likely encourage your tenants to stay and continue to rent from you.
- What Are You Content Making?
I think this question relates back to management philosophies. If you’re interested in following a Cash Cow Model, you may set rent rates in a way that best benefits you, but you’ll need to realize the long term consequences of doing so. If you’d like to establish a healthy company, you will need to set rent rates with your priorities in mind, putting your customer first, your bank and vendors second, your property third, and yourself last.
In Summary:
- A Healthy Company management philosophy leads to long-term success and fairness for all involved parties, whereas a Cash Cow Model may provide short-term profit, but will ultimately lead to a decline in property value and function.
- When setting rent rates, you need to consider (1) what the market will bear, (2) what your obligations are as a landlord, (3) what is fair to your customer and your business, and (4) what you are content making.