Pros and Cons of Starting a Property Management Company for Your Rental Properties
Almost 21 million mom-and-pop real estate investors self-manage their properties. Maybe you’re one of the 45% of rental property owners who manage their own units. Have you thought about setting up a property management company? If you’re looking for ways to earn active income, start an additional income stream, or protect your assets, forming a management company may be right for you. Before you jump in, consider these pros and cons of starting your own property management company.
What Is Property Management?
Property management is the daily operations of a rental unit that are carried out on behalf of the property’s owner. Real estate investors may outsource all or some of these tasks to property management companies:
• Maintenance and repairs
• Rent and fee collection
• Cleaning
• Leasing and advertising
• Property inspections
• Evictions
• Accounting
• Financial reporting
• Property sales
• Outdoor services
Management companies often specialize in certain portfolio sizes or specialties. As a real estate investor, you may be in a sound position to start your own management company.
Pros of Starting a Property Management Company
Property owners handle the daily operations of almost 80% of individually owned rental properties. That means you probably have a good skill set related to property management. There’s plenty of opportunity here. You could decide to use your management skills for your own properties or to market your services to other investors. This is a smart way to use your existing skills and knowledge in an adjacent field.
Low Cost Requirements
Property management is a relatively low-cost field to enter. This industry focuses on people and services. You don’t need expensive equipment, merchandise, or storefront space to get started. You may need a license or certification, depending on the state. Most entry-level managers usually have a high school diploma (or equivalent), but advanced degrees aren’t required.
Hands-on Experience
Are you looking for additional hands-on experience in the rental property field? According to one report, an estimated 76% of property owners spend less than 40 hours per month managing their properties. And 42% spend less than four hours per month on their units. Property management is a good option to gain more experience. Being active in the real estate market in another capacity will expose you to different situations.
Do you want to test the waters with a different type of rental property before you invest in it? Managing one or two properties from the new market will help you gain experience and learn from the investors you take on as clients.
Increased Earning Potential
Managing rental property isn’t for everyone. That’s why the property management industry produces $99.4 billion in annual revenue. Offering management services to other investors means you’ll have an additional revenue stream. You can then either reinvest that income in your management company or take it as salary and invest it in your rental properties.
More Active Income
Even if you decide to limit your management services to your own properties, there may be a tax advantage. According to the IRS, rental property income counts as passive income. But when you pay the management fees from your rental property accounts, those fees reduce the property’s profit. You’ve lowered your passive income.
The management fees come back to you through the management company. Since this isn’t rental income, the IRS considers this revenue as active income. If you need to earn W-2 wages or lower your passive income, starting a management company can help you.
Asset Protection
Rental properties come with legal and financial risks, like lawsuits from injured tenants or unpaid creditors. Your business and personal assets may be at risk if you haven’t put safeguards in place.
One common strategy to protect your assets is to run all your interactions with tenants and contractors through your property management company. This helps limit your liability and protect your assets if your rental properties are structured as LLCs or real estate trusts.
Cons of Running Your Own Property Management Company
Of course, setting up and running a new company has some downsides.
Additional Legal Requirements
Setting up a new company comes with the usual admin tasks, like applying for tax IDs and setting up accounts. But property management companies face additional requirements. For example, some states require you to have a licensed real estate broker as an officer of the business.
You’ll need to follow your state’s conditions specific to property management. This is when it’s handy to work with a real estate attorney. Find someone with expertise in each state you want to operate in. They’ll help you navigate the requirements set by the division of real estate.
Potential for Increased Taxes
Forming another company means the IRS has another entity to tax. Check with your tax adviser to make sure there’s a tax advantage for you. If you manage only your own properties and the management company is a pass-through entity, it would be the same as taking proceeds from the rental company.
The management company’s legal structure will affect your tax liability as well. You may be subject to self-employment taxes, state and federal income taxes, and payroll fees. The additional tax and administrative costs might not be worth the benefits for you.
Expertise Required
Many real estate investors hire property managers to help limit their liability. Investors rely on managers’ expertise to deal with finances, legal matters, maintenance, marketing, and more.
If you lack experience in real estate law, legal standards, and building codes, then property management may not be a good fit for you. Failure to enforce or follow through with legal and maintenance matters can open you up to lawsuits.
Demanding Work
Tenant requests, building repairs, and emergencies are the norm for property managers. Managers have a varied role, so every day is unique. Each property has challenges based on type, size, location, and owner. You must be flexible to handle a variety of people and tasks.
Balancing your management commitments with your other responsibilities can be stressful. Burnout is a common issue that can affect both your business and health. If being available 24/7 isn’t for you, you may need to hire a staff to assist you.
Takeaways
Property management is a good fit for many real estate investors, so setting up your own property management company may be tempting. You’d have a way to convert passive income into active. You could add another layer of protection to your real estate investments and use your experience to form an alternative source of income.
But forming a management company will add another layer of complexity to your life. It’s time consuming. If you’re already maxed out handling your properties, adding more administrative requirements or management clients won’t help. Talk to your tax adviser and real estate lawyer if you think setting up a management company could help your real estate investments or financial position.
And if you need help tracking your property management costs, try REI Hub’s accounting software specialized for real estate investors. We offer a free trial so you can see why our customers have given us a 5-star rating.
