Economies of scale is a phrase you may or may not have heard of. In the investing world it is very common, mainly because it allows us to get into larger projects and ultimately create higher returns. The Oxford definition is as follows: “A proportionate savings in costs gained by an increased level of production.” What this means is that we get to reap the benefits of reduced costs through investing in larger properties.
Here’s an example…. Let’s say I’m looking at 2 separate properties, a 4 unit and a 40 unit with identical rents, tenant base, occupancy and location. If I were to call a property management company and they quote me 10% as a management fee, how likely do you think I could negotiate that price down to 8%? I would say the chances on the 4 unit are slim and they are decent on the 40 unit. Obviously, this is a random hypothetical scenario, but let’s talk about why I have more confidence in negotiating the 40 unit. The answer is economies of scale. For a property management company, they are looking at 2 possible income streams with these 2 properties. One of them happens to offer 10 times the revenue as the other. Do you think they would have to hire 10 times the amount of staff to operate the 40 unit rather than the 4 unit? Absolutely not. It will definitely create more work for their company, but they very well may not have to hire a single additional team member to efficiently run that property. That is why they would be more willing to negotiate on their fee schedule, and that is why we love the economies of scale.
The same can be said with contract services. Bringing on a handyman sporadically to do a repair will most likely get you retail pricing. However, if you have a larger complex and can basically guarantee that you will keep a contractors’ crew busy continually, that will incentivize them to offer reduced pricing. Even better, if you own enough units in a market, you may even be able to bring a maintenance crew “in-house” and get the absolute best pricing. Another factor that comes into play here is the consistency of the work being done and time it takes to complete the job. If you are able to do 3 unit turns a month with the same crew, they should be able to get an efficient and effective system in place to do the turns faster than a crew that comes in once or twice a year to do the same turn. This reduces vacancy costs and improves quality of work.
This is how you can really scale your business. The larger you grow, the easier it is to reduce your costs and be more competitive on your offers. It can be very difficult to build up to that point, not to mention finding the right team members as you are on your way up, but the payoff is totally worth it!
Can you think of any other ways in which apartment buildings can benefit from economies of scale? What have you seen in your own investments?
As always I hope this was clarifying and until next week, invest wisely!