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5 Thoughts on Critical Mass

One of the wonderful things about my job as a commercial and investment Realtor and as an investor is the conversations I get to have with incredible people. One thing that came up over coffee with a fellow agent and investor is the idea of critical mass in building a portfolio. She made an off the cuff remark while discussing another investor we know:

Really, you need about a hundred (multi-family) units to establish a critical mass, to really get some economies of scale, to make it worth hiring someone yourself.

I’ve got to agree. You can do perfectly fine using property managers, but you often need to have a decent portfolio to really get their attention. But it’s cheaper to do it yourself, especially if you’re using a good system. At about a hundred units you can hire someone to do things like maintence, cleaning, snow, landscaping, renovations, rent pickups and showing suite. You’ll still have the less interesting parts like book keeping, tenant screening, marketing, acquisition and disposition – many of which you can inexpensively send out to a virtual assistant. That’s another blog post though.

This already got me thinking about other critical masses when I got to page 44 of Malcom Gladwell’s David and Goliath . He goes into detail about things like deminshing returns, but it brings me to a couple other things which I’m going to list in no particular order:

2. Single Family Rentals. I think you need 30-50 doors before you get real cost savings and enough going on that you can hire someone just for you full time. Less if they’re larger properties, more if they’re lots of singles or condos. At 50 doors and $100/month you’ve got $5,000/month in cash flow which is enough to pay someone full time. You still get the benefit of appreciation and mortgage pay down, so if you were to hire someone with all that cash flow you’d still be able to do other things, or you can pay your self.

3. Property Managers. My experience is a good manager handling a mix of apartments and singles can handle 200-400 doors with admin support. If they’re making 6% on 200 doors with an average rent of $800, that’s a fee of $9,600, and half that is out the door as overhead and admin costs. It’s not a big money business – you make your money $50 at a time.

4. Dinner Time. Planning, shopping and cooking for just yourself sucks. It got easier once I was married but it wasn’t until my wife and I had our second son that we really got a critical mass for cooking.

5. Income. Gladwell quotes some other researches that more money stops bringing happiness at about $75,000 per year and I have to agree. Technically speaking, I think that the diminishing returns are for the short run, because if you invest and defer the satisfaction of the money beyond that for the future you’ll do better in the long run. In writing this, I just remembered that when Brent and I started the Davies Real Estate Group Ltd I said “really, I’d be happy if our business would throw off $100,000/year and we’d just bank or use the rest to buy buildings.”

What about you folks? Any industries or situations you can think of?

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    { 2 comments… add one }
    • Jeff Gunther December 30, 2013, 12:22 pm

      I always love to hear your perspective Chris. Your post made me think about my own situation.

      I first learned the importance of critical mass when working with a large franchise organization. If you’re in the business of properly supporting other people’s businesses, you must grow your network fast! However, you must also be willing to accept compromise in the quality of end user experience.

      With respect to management of residential real estate portfolios, I believe owners should ensure, from day one, that there is adequate cash-flow to get and pay for all the help they’ll ever need. However, as in franchising, delegating tenant selection and service, without compromise, is extremely difficult.

      Unless rentals are treated as a commodity (which is a legitimate business model if average rents are only $800/door), profitability and value of the underlying asset are almost certain to slip if management is fully delegated. The good news is that it really isn’t that difficult to stay close to your customer with only a few hundred units.

      It seems reasonable to expect that a professional property manager’s capacity might be exhausted even sooner than an owner’s. Therefore, a decision to fully delegate also tends to dictate a significant shift in the business model. This is a decision that faces every entrepreneur seeking sustained growth – one with which I constantly struggle.

      Clearly Gladwell has got you thinking – and me too. I envy your growing family and perceived economies of scale. And, as always, your perspective on money, happiness, and deferred gratification is just one good reason why you are so good at helping real estate investors achieve their goals.

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