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Tom Sedlack on Understanding the Real Valuation of Your Company

Tom Sedlack on Understanding the Real Valuation of Your Company

Today I’m talking with Tom Sedlack, the general manager of 33rd Company, a leading property management company in the Minneapolis area.  

Tom’s an experienced real estate investor, and he’s been a featured speaker at numerous NARPM events.  You’ve probably seen him around and may have heard his talk on company valuation models at the most recent Broker/Owner Conference.

In this interview, Tom’s going to share where most property management entrepreneurs go wrong when it comes to acquisitions, on both sides of the deal.  

A lot of people are interested in this theme, this topic, the idea, but the execution has quite a few places you can go off the rails. Tom’s here to keep you on track.

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Topics covered:

  • (01:14) – Background Leading Up To Today
      • (01:20) – Tom shares how he got started in the property management industry.
      • (03:15) – Where his company is today.
        • (04:29) – Tom discusses how he built his portfolio.
          • (04:36) – The importance of organic growth.
  • (05:32) – Acquisitions
      • (06:22) – Tom shares his personal experience with acquisitions.
        • (06:30) – The inherent challenges involved.
  • (08:11) – Buying and Selling a PM Company
    • (08:34) – Tom discusses the pre-requisites for a business owner looking to sell.
    • (10:26) – Traditional valuation considerations for a property management company.
      • (12:10) – The differing perspectives between a buyer and a seller.
      • (13:33) – Understanding the intrinsic value of your company.
      • (14:46) – Unencumbered cash flows and owner perks.
    • (17:12) – Tom’s thoughts on growth versus profit as it relates to valuations
      • (18:19) – The dangers of playing a short term valuation strategy.
      • (21:09) – The valuation differences between small and large portfolio companies.
        • (22:06) – Understanding the motivations of a buyer.
        • (23:44) – Financial engineering efforts at the hand of Wall St.
    • (26:09) – The current state of the acquisition market.
      • (27:12) – Tom’s opinion of the maturity of the market.
      • (28:54) – Identifying red flags.
        • (29:09) – Buyer motivation.
    • (31:40) – Tom’s thoughts on the idea of being ‘staffed for growth’.
      • (33:34) – How growth affects underlying economic models.
    • (36:52) – Tom discusses price optimization and ancillary revenue.
      • (36:52) – The Quality Circle Model.
      • (39:28) – The relationship between quality and pricing.
      • (42:43) – Tom’s advice for owners who are unsure how to maximize their fee structures.

Rapid-fire Questions:

  • (45:17) – How did your military service influence how you run 33rd Company?
  • (45:58) – Who do you learn from?
  • (47:14) – What’s the maximum number of G’s you’ve pulled?
  • (47:44) – What books have impacted you the most?
  • (48:30) – If you could do it all over again, what one piece of advice would you have given yourself at the beginning of your career?
  • (49:52) – Are entrepreneurs born or bred?

Resources mentioned:

  • NARPM – The National Association of Residential Property Managers.
  • Broker Owner – NARPM’s conference & expo for designated brokers, company owners, and regional managers.
  • Peter Senge  (37:16) – Tom referenced in regards to quality circle models.
  • The E-Myth  (48:08) – Influential resource recommended by Tom.
  • The Profitable Property Management Facebook Group  (51:56) – Get connected with other property management owners.

Where to learn more:

To find out more about Tom and his company and to get in touch, head on over to his website 33rdCompany.com.  Or you can find him on the The Profitable Property Management Facebook Group.

Transcript:

Jordan: 0:00:00.0 Welcome closers. Today we have another episode of The Profitable Property Management Podcast coming at you. This is Season Three on Profit.

I’m your host Jordan Muela, and every week I interview world-class property management entrepreneurs and industry experts who share actionable insights to help you grow your property management empire.

0:00:18.0 Whether you manage 100 or 1000 units, this broadcast is designed to help you see the big picture and to give you the tools and tactics that you need to get to the next level.

0:00:27.7 Today I’m talking with Tom Sedlack, the general manager of 33rd Company, a leading property management company in the Minneapolis area.

Tom’s an experienced real estate investor, and he’s been a featured speaker at numerous NARPM events. 0:00:45.5 You’ve probably seen him around.

You may have heard his talk at the most recent Broker Owner on company valuation models, which was pretty well received.

0:00:51.9 And in this interview, Tom’s going to share where most property management entrepreneurs go wrong when it comes to acquiring a portfolio.

A lot of people are interested in this theme, this topic, the idea, but the execution has quite a few places you can go off the rails.

We’re going to dive into that a bit and Tom, I’m excited to have you on the show. Thanks for coming on.

Tom: 0:01:11.6 Yeah, thanks for the invite, this is exciting.

Jordan: 0:01:14.9 So let’s start here: Give me some background. How did you get into the property management industry?

Tom: 0:01:20.5 Well, like all good businesses, we started in our jammies in the basement. That’s where all the entrepreneurial spirit seems to generate. And we grew our business from nothing to about 50 properties in six months.

0:01:38.2 Both my wife and I quit our day jobs and focused on the business, and in the next six months we added another probably 50 properties. And in the year after that we added about another 150 properties.

0:01:51.5 So, we really got a good push off the pier in the right direction before we committed.

And then at that point, we recognized that the revenue was there, the potential for that business was there and it was an exciting leap that we took. 0:02:06.2 And we have never looked back.

Jordan: 0:02:08.3 So why property management? You mentioned that you started in your business, but what was interesting about this specific vertical for you?

Tom: 0:02:13.6 Well, we had already essentially cut our teeth in managing properties. We had owned – probably at that time we had about five or six rentals. Single-family homes that we had been managing and we went through, you know, all the iterations of good, bad and ugly.

0:02:31.5 And at that point we recognized that we could do it. 0:02:36.5 And we basically hit a crossroads. It’s either we continue to manage – self-manage our own properties and create our own management company out of it, or hire a management company.

0:02:49.7 And this is, of course, back in the late 90’s. And we realized that maybe starting our own management company would give us more opportunity and more control, and that’s what we did.

0:03:00.7 And then it was shortly after that that we had a lot of inquiries from friends and acquaintances that asked for help in managing their properties.

0:03:10.4 And by then, like I said, we had already cut our teeth and decided that we’d give it a try. So it’s been a good thing.

Jordan: 0:03:15.3 Alright. So we fast forward to today. Where’s the company at now in terms of head count, size, etc.

Tom: 0:03:20.7 So today we have about 20 employees. We’re located in four states. We’re in Wisconsin, Minnesota, Kansas and Missouri.

And we track and manage properties in two large metro area locations. The Twin Cities and the Kansas City market.

0:03:39.5 And it’s just funny how distinctly different they are, but it’s nice to be able to pick up on the different nuances of the different metro areas.

0:03:49.3 We manage about 2500 total properties. We do a mix of rental properties. We do Homeowners Association.

0:03:57.0 We also have brokerage services that we do, and maintenance. We have a separate maintenance company called, Handy Quick. 0:04:04.6 And so, we support all of the properties that we manage.

Jordan: 0:04:08.0 Alright. Good healthy mix of property types and you’ve got the maintenance thing going too. Imagine you’re busy.

0:04:14.8 What was the journey like getting there? Specifically, I want to understand why valuations and acquisitions are relevant to you. How much of that 2500 that you just mentioned came through organic versus purchasing portfolios?

Tom: 0:04:29.2 We picked up a few small portfolios along the way. The vast majority of what we’ve done is organic.

0:04:36.0 And I think that should always be the primary focus for property managers, is creating and embedding that talent, that skill of growing organically, your own base of properties.

0:04:52.1 Because at the end of the day when you’re acquiring and adding through acquisition, you’re really not adding an organic number to your portfolio. You’re not adding additional market share that is new market that you’re grooming and bringing into the market.

0:05:16.0 You’re just simply reallocating who is managing what between the existing management companies.

0:05:20.4 So I think having a good organic capability is fundamentally, first and foremost, the most important thing that managers can do and should do, in terms of their long-term profitability.

Jordan: 0:05:32.5 Yeah, that’s great. So let’s just talk really high level about the opportunity with acquisitions. The upside of acquisitions is obviously velocity. Right? You’re moving quick, you’re imbibing a lot of doors.

Some of the downsides. 0:05:44.9 The first thing that comes to me is, just riffing off of what you just mentioned, is the idea that it’s a catchall, or it’s a panacea. It’s going to fix underlying problems.

The business that you already have, if it’s struggling, is going to be the same business if you double in size.

0:06:02.4 And the doors that you’re buying, the state they’re in, you’re going to inherit, in large part, even if you’re plugging it into a healthier system.

0:06:10.6 So, it certainly isn’t a way – it certainly is not a shortcut that comes without quite a bit of growing pains in process.

0:06:22.3 When you went through the deals that you went through, what was the impetus there? Did folks come to you? Did you go to them? Like, how did that opportunity arise for you?

Tom: 0:06:30.9 Well, when we get individual doors, you just have to understand that it’s different. The leases are different, the management agreements are different.

0:06:42.0 The culture of what you’re bringing in is different. The expectations of the clients are different. 0:06:50.2 It’s all different across the board.

0:06:51.2 And simply adding doors or multiplying your door count through acquisition is a very tenuous strategy and it’s fraught with all sorts of risk.

0:07:05.3 Not to mention the lack of compatibility and culture of what you’re bringing in, but it also doesn’t fit your business model. You’re going to have to re-tool, you’re going to have to make onesey, twosey accommodations.

0:07:19.2 Even, you know, everything down to manually cashing rent cheques because you don’t have the requirement in the leases that you just inherited to 0:07:28.5 <Inaudible> automatic ACH direct debit, which are a part of your processes.

0:07:35.1 So, it’s all those little things that are going to detract from your day to day efficiency.

0:07:41.7 And simply adding doors is not necessarily going to add profitability. And, in fact, that door count could quickly evaporate as your standards of quality, service and delivery start to erode because of that.

0:07:56.3 And then the customers leave you. 0:07:58.0 And so, all of that money that you just spent acquiring doors will be frittered away in a year or two if you don’t quickly onboard them and get them integrated into your current processes and move forward. 0:08:10.3 So it can be risky.

Jordan: 0:08:11.7 So ignoring the due diligence on a specific deal. Let’s talk about basic qualifications of being ready to purchase a portfolio.

Somebody comes to you, they heard your talk at Broker Owner and they say, “Hey, Tom, somebody came to me, they’re interested in selling. Should I do it? Should I not?”

0:08:27.6 What are the pre-requisites for a business owner being ready to take that step in your mind?

Tom: 0:08:34.5 I think the biggest thing is making sure that the doors that are available are actually a fit. 0:08:40.3 They’re a good fit for your company, there’s some commonality in the leases and the business processes that you use.

0:08:48.6 And it’s not going to be such a difficult piece of the puzzle that you just can’t fit them together elegantly and make them work seamlessly and efficiently.

0:08:59.4 So, in some cases, you may not want to acquire for those reasons. 0:09:04.8 You may just say, “You know, this is actually going to ruin my current operations. It’s going to make me less efficient, it’s going to reduce my overall profitability.”

And ultimately, at the end of the day, it’s not a door count that you’re looking for, it’s a profitability metric that you’re trying to achieve. 0:09:23.1

0:09:22.8 And so, simply acquiring doors for the sake of acquiring doors is going to cause more problems then it’s going to solve, in most cases.

Jordan: 0:09:31.1 So this awareness of the whole acquisition conversation happens on both sides. It happens on the buyer side of scouting for portfolios, but it also happens on the sell side. Right?

What I find is that, oftentimes, we don’t spend a lot of time thinking about what the underlying business asset, the equity that we own, we don’t spend as much time thinking about the accretion of value of that asset as we do think about ongoing cash flows.

0:09:59.5 Which is just more kind of day to day, in your face.

But at some point, for most folks, somewhere in the lifecycle of the business, they’re going to want to sell and that’s obviously a pretty germane part of the conversation.

0:10:10.8 Part of the feedback that I experience and I hear others kind of communicate about your talk is that some of the ways that you were looking at valuing what the business is actually worth, was a little different. So let’s kind of go into talking about that valuation.

0:10:26.1 First off, can you give me some of the traditional ways to value a property management business. Which is really going to be the same as any business.

Tom: 0:10:35.1 Sure. There’s a lot of ways to slice and dice. When it comes to valuation methodologies, you’ve got income based, asset based, market and other techniques that you can use for valuation.

0:10:48.0 It’s interesting that an IBDA multiple based approach is actually a market based valuation methodology.

0:10:57.0 So, it strips out – it really essentially takes the discounted cash flow formula and it strips out a lot of those embedded variables like growth, and intrinsic value, and it simplifies and boils it down into a rudimentary multiple that can be used to compare between different sales or different comparables in the market.

0:11:22.2 That’s what a multiple-based strategy is.

0:11:25.3 And a lot of business brokers use that because they want a simple tool, they want something that is understandable, that is easy to repeat.

They want something that buyers are interested in as well as sellers – can at least be convinced to use a multiple.

0:11:42.3 But at the end of the day, it’s nothing more than a comp. 0:11:47.9 And it doesn’t really value the intrinsic value of the company. It’s more of a relative value or a comparative value.

0:11:56.3 Intrinsic value is when you actually take your cash flows and you actually project them out and you discount them to present value using a DCF model, or formula.

0:12:10.0 And that is really what – especially sellers need to understand. Is that their value is much different than what a buyer’s value is.

0:12:22.2 A buyer’s valuing current cash flow and they don’t want to put too much in the risk hat as far as growth or projections or anything like that.

They simply want a supportable IBDA that they can go forward with. 0:12:39.3 And then they can do their own improvements and integrations and all those sorts of things.

0:12:42.8 A seller, however – when a seller is selling, they’re looking at all of the unencumbered cash flow that goes to their bottom line.

0:12:51.8 In other words, any free cash flow that is not going into operations is a effectively unencumbered cash flow that goes into their pockets.

0:13:00.6 And when you take that cash flow and you add it all up and then you grow it, you know, using a DCF formula, and then you discount it to present using an appropriate discount rate, that’s when you find out that the company value is significantly higher for the seller, for the owner of the company, than it is ever going to be for the buyer.

0:13:24.0 And so, when I spoke at the Broker Owner, my goal was to tell people that there’s a bid and there’s an ask for every transaction.

0:13:33.3 And because a business broker comes to you and says, “We’re going to use a multiple valuation, a comp value, and your company could be anywhere between, you know, three and five multiples of IBDA.” That is purely a comp.

0:13:49.0 That has nothing to do with the intrinsic value of the net present value of future cash flows. It doesn’t include growth projections, it doesn’t include any of the specific cash benefits that you’re getting as a principle, as an owner of that company. 0:14:04.5 And that’s one of the biggest problems.

Jordan: 0:14:07.6 Right. So the conversation we’re having here is really about, “What is it worth to me as the owner?”

Which has very little to do with what is it worth to somebody else plugging into their model.

0:14:17.3 And without getting overly specific, I think we’ve all heard some of the larger players that are coming in and are doing portfolio acquisitions and some of the logic around – the logic that goes something like this: “Well when we buy your doors, we’re going to plug it into our model. And we don’t charge such and such a fee.”

Or, “Our contracts are structured in x, y, z way, so therefore, we’re not going to get the benefit of how your contract’s currently structured.”

0:14:41.3 Whatever it may be, as a seller, that ain’t my problem. Right?

Tom: 0:14:46.0 Exactly. That’s exactly right. Your problem is already been solved. You’ve got embedded marketing, you’ve got a BD person. You’ve got proven growth.

You’ve got unencumbered surplus cash flows that you’re using for soft compensation, for company cars, for all those perks and things that company owners receive.

0:15:10.1 And much of that is not going to be added into a valuation multiple from a buyer. 0:15:16.2 A buyer doesn’t care that you’ve got a cell phone, for example, that you use for business and personal.

0:15:23.8 When you sell your company, guess what the first thing you’re going to have to do? Is the cost of that cell phone is going to remain in the company, you’re going to have to go out and buy your own cell phone.

0:15:33.0 So now, you’re recognizing that you’re either going to be expending funds to preserve your lifestyle, basically, to preserve what you had in terms of unencumbered free cash flows.

0:15:51.3 And now you’re going to be in a worse position, because things that you were getting for free, like combined business and personal vacations, or cell phones, for example, now are going to be out of pocked expenses for you once you sell the company.

0:16:05.9 And you’re not going to get a valuation credit for those extra costs that you’re going to incur after you sell.

0:16:11.3 And similarly, you may not even get credits for other mixed use personal business – excess owner salaries, personal use of company assets if that’s what you’re doing.

0:16:25.2 As an owner of a company, you’ve got wide, broad discretion to maximize your life valuation. And those typically are not going to be boiled into a multiple formula.

0:16:36.7 That’s where the DCF unencumbered cash flow is really going to help a seller really get the true value of what that company is worth to the seller.

Jordan: 0:16:45.9 Sure. Now, obviously, what you’re communicating, it can be neutralized by certain life circumstances. You get sick. You just can’t handle it. You have a breakdown. You can’t run the business. In those kinds of circumstances, it is what it is.

But if you’re really focusing on building an asset that you can maximally leverage and you have growth, and the business is growing and the person you’re selling it to doesn’t give you credit for that growth, that’s a problem. There’s missed opportunity there.

0:17:12.7 But, that said, let’s have the conversation about growth versus profit. I’m sure that you have come across conversations that go something like this: “Well, we’re not particularly profitable right now, but we’re growing fast, we’re soon to be growing fast and we know that once we’re two or three times the size, we’re going to be a much more prime acquisition target for a potential buyer.”

0:17:38.4 How do you think, in your own business, about the trade off between profit versus growth. And when I say growth, let’s just define that as door growth.

Tom: 0:17:47.2 Yeah, well I think growth is a significant driver in any type of valuation analysis. And it should be.

0:17:56.4 Unfortunately, with a multiple strategy, growth is not even included in the 0:18:02.6 <Inaudible>.

0:18:03.0 So you’ve got IBDA, sometimes they even use backwards IBDA. They use an average of the last three years IBDA, because they want to equalize the risk.

0:18:11.1 All they’re doing is diluting out the growth that you had over the last there years and making your value even worse than it already is.

0:18:19.7 A lot of individual sellers look at this IBDA model and they say, “Oh, I’ve guess I’ve got to play the game.”

0:18:28.0 So if I’m going to position my company to sell, I’m going to have to strip out an employee or two. I’m going to have reduce costs. I’m going to have to refrain from personal expenditures.

I’m going to have to do all these short term strategies, not having excess capacity for growth. In fact, maybe not even investing in business development at all.”

0:18:49.0 Because growth is not even part of the equation for IBDA.

0:18:51.3 And so, if you do all these short term, nearsighted strategies, what you’re going to get is you’re going to get a huge boost in your current year’s IBDA and it’s going to be temporary.

0:19:02.2 And then, going forward from there, that earnings number is going to fall off precipitously, because now your growth hasn’t been invested into.

Now you’re behind the market and you haven’t been putting the money into the efficiency and the capacities and to making your company continually grow year after year.

0:19:20.7 And so, that’s a very short term focus and I see a lot of people trying to do that. They want to just goose it up for a year, cut their costs, even sacrifice their marketing to see if they can boost that IBDA and get a higher multiple when they sell.

0:19:33.0 Of course, the buyer’s going to come back and say, “Oh I see that your last year’s IBDA spiked up. That’s great, except now you’ve got a volatility situation between the last three years of income. So we’re going to average the three together.”

0:19:47.7 And you’ve just shot yourself in the foot multiple ways.

0:19:51.7 One is, you don’t have a consistent track record of IBDA, or earnings. You’ve got volatility now, which reduces value.

And then number two is that value that you thought you had because of that last year of playing games, now has been diluted because the buyer has said, “Let’s just average the last three years together.”

0:20:15.0 And now you’ve got 0:20:17.1 <Inaudible> looking numbers that are trying to give a present valuation when in fact your future isn’t even being considered at all.

0:20:24.5 And so, that’s a huge mistake that’s being made in terms of valuation and a sales strategy.

0:20:30.5 So my recommendation is don’t do it. My recommendation is don’t get caught in that trap. Don’t try to manipulate your numbers.

Focus on the long term. That’s what made you a successful entrepreneur in the first place. 0:20:42.6 You’re investing in the long term. You’re making these long term decisions like buy versus rent when it comes to office equipment.

0:20:50.5 Or investing in software or investing in good management software. 0:20:57.5 You’re making decisions based on the long term growth and profitability of your company, not on short term earnings numbers that you’re trying to jigger around so you can maximize your value. Does that make sense?

Jordan: 0:21:09.6 Yeah. Any competent seller is going to identify with what is going on there. Math is math.

But let’s talk about how the math can change based on size. 0:21:20.1 So this is part of the nuance of the conversation.

There’s a lot of detail to what you were describing. But the reality is, the level of scrutiny, due diligence and the complexity of the math is going to be different at the high end of the market. Buying a company of several thousand doors versus buying a 100 door portfolio.

0:21:39.2 At a certain size, when a company is small enough, it’s pretty clear that you’re just buying doors.

So the distinction between buying doors versus buying an actual company – walk me through what determines whether or not an acquisition errs on one side or the other. 0:21:55.8 Because it’s a pretty different experience.

With doors, you’re stripping out everything but the doors. With the company, you’re buying a functional organization, brand, etc.

Tom: 0:22:06.6 Sure. Well, it all boils back to what the seller’s looking for in terms of an acquisition. If you’re a – and if you’re a buyer, what are you looking for?

0:22:18.3 You have to understand what the reason is that there’s a buyer and that there’s a seller.

I consider it a red flag when the first question out of some buyer’s mouth is, “Do you have an assignment clause in your lease agreements.”

0:22:32.8 Because it’s a clear red flag that all they really want are the doors. They really don’t want my company. 0:22:38.5 And that’s a bad sign.

That means that you’re not going to get a good value for your company. They don’t care about your employees, they don’t care about your operations, they don’t care about your contracts, they don’t care about the attorneys, the vendor base that you’ve established.

0:22:51.6 They don’t care about your growth record that you have. They don’t care about trademarks, your market position, your SEO value. None of that is on the table. 0:22:59.2 They really don’t care about your company, all they want are the doors.

0:23:02.8 And that’s no different really then a local competitor trying to buy you, because that’s all they want. They already have operations in that city, they already have an office. They have employees.

Chances are good they don’t want anything but the doors and they’re not going to pay a premium for your company if all they’re acquiring are doors.

0:23:20.8 And wether you’re small or large, the goal is what are the valuation metrics for that company that you have.

0:23:28.7 I mean, where are you along that paradigm of SEO, of business development, of growth, of competitiveness.

Of where you are in the landscape in the property management business. 0:23:39.5 And those are all pieces of the puzzle in terms of adding a total value.

0:23:44.0 Similarly, with some of the larger companies that you mentioned, like the Wall St. companies that comes to buy you out, sometimes that strategy really doesn’t do anything except boil itself down into financial engineering.

0:23:59.1 One of the fun videos that I play from The Big Short, in my presentation was Anthony Bourdain showing what to do with three-day old fish. You re-package it and you put it into a stew and now you’ve got a whole new thing.

0:24:14.3 Well, that’s basically what Wall St. has done many times in the past.

In fact, the most recent large example is the HVAC consolidation that went on in the late 90’s, early 2000’s.

0:24:26.0 And basically, Wall St. said, “Let’s buy up all these mom and pop HVAC companies around the country. Consolidate them into one large ownership and then we can create value, we can create money for ourselves and fees and ultimately, have a very profitable experience.”

0:24:46.9 Well, the whole thing was a failure. In fact, if you Google, ‘HVAC consolidation failure’ you’ll be able to read all about it.

And essentially, what Wall St. – all they did was they went in there and they took individual mom and pop companies that individually were selling for multiples of maybe five to seven.

They bought them up, they packaged them together, they sold them off to private equity, and the multiples for private equity were in the nine to twelve range.

0:25:11.5 So they instantly made money for doing nothing other than simply putting all these little companies under one large national ownership.

0:25:20.8 And then, as they went to small cap and the valuation’s multiples went higher, the PE’s are what they’re called.

0:25:28.4 And so, ultimately, through simple financial engineering, that’s how Wall St. creates its – takes it three day old fish and creates something completely new and makes money on.

0:25:38.2 Did they bring efficiency? No. Did they bring innovation? No. Did they bring anything to that industry? No. 0:25:44.7 And that’s the reason that it failed.

Was because it was purely an effort in financial engineering and I think I see some of that going on now with the property management acquisitions, where they’re buying up these management companies solely so they can benefit from private equity multiples on a larger scale.

0:25:59.8 But they’re not adding efficiency. They’re not bringing innovation, they’re not bringing all these things to the marketplace that really would make such a consolidation successful.

Jordan: 0:26:09.6 So that’s a perfect segue. Let’s talk about the state of the acquisition marketplace right now.

Because I hear what you’re saying, but Tom, at the same time, the thing that occurs for me is just realizing that right now, the market is so soft, in terms of – like here’s just an obvious fact: Fact, there is no dedicated seller side representation specifically within the property management industry. Right?

0:26:31.3 There’s no vendor showing up to NARPM events, there to specifically represent property management companies. Well why does that matter? 0:26:39.1 What that would be indicative of, would be the maturity of the marketplace.

So, while there may be kind of the roll up play, financial engineering element happening, at the same time, the market is so soft in terms of the opportunity to take a shotgun approach.

To send out mailers and to actually get meaningful responses and pick up some of that low hanging fruit. 0:27:03.8 I think it’s still there.

What is your opinion about the maturity of the acquisition marketplace within our industry right now?

Tom: 0:27:12.5 Well, in terms of individual company ability to grow, I see it there. I see the individual mom and pop’s out there continuing to show top line growth.

And additionally, bottom line profitability, depending on where they are in their cost structure and their scaling as they grow.

0:27:33.1 From an acquisition point of view, again, acquisition growth is not organic growth, it’s simply acquisition growth.

0:27:41.1 And you’re bundling together disparate pieces and they don’t always fit well and so it can cause significant problems.

0:27:49.8 In terms of an opportunity to sell, you know, our new president, obviously, has created a new tax structure that took effect this year. 0:27:59.0 And the capital gains rate has plummeted substantially.

0:28:01.1 So, for those looking to sell, probably this is one of the best times to consider doing that because you’re going to see the least impact from capital gains taxes from selling.

0:28:13.4 But, the question though, is who are you selling it to? What are you selling it for? And what is the real value of the company to you? What are you selling and know what that value is.

0:28:23.6 And don’t just give it away as some – as many small property management companies have done.

And I’ve seen it happen where they’ve given themselves away for this multiple and they don’t’ recognize until too late all the value, all the benefit, all the perks, the soft compensation, all the business personal travel, all of that all of a sudden disappeared.

0:28:47.8 And in one fell swoop they realized that they took 20 years of blood, sweat and tears and they’ve given it away.

Jordan: 0:28:54.7 Yikes. I mean, what is an obvious red flag for you? For example, if the buyer is effectively paying you out of your own cash flows. What would just be an obvious red flag signal that somebody just got a raw deal?

Tom: 0:29:09.0 Well, a red flag would be – lots of red flags, actually. As a seller, you’ve got to know what that buyer is looking for. What do they want? What are they interested in?

0:29:19.7 Like I said, if the first question out of their mouth is, you know, “Do you have an assignment clause?”

Or maybe, if they don’t ever show up and all their due diligence is purely financial, trying to extrapolate what the current IBDA is.

And they don’t actually visit your operations, they don’t check out your SEO, they don’t look at your trademarks, they don’t look at your contracts, they don’t look at your employees, they don’t look at your legal history, good, bad or other.

0:29:46.4 You know, they’re not doing the broad due diligence that a buyer that wants your company for value, would do. They’re doing the fundamental, surface due diligence simply for a door acquisition. 0:30:06.0 And you’re not going to get money for a door acquisition.

You didn’t go into business to create all these doors just so you can sell all your doors off and still have your business now with no doors. 0:30:15.4 I mean, that’s basically what you’re doing.

“I’m going to sell my entire cash flow and having nothing except all this expense and office space and all of these other things.”

I mean, it’s just ridiculous that you would even think that you would do something like that. Yet, that’s basically what a lot of the buyers want. 0:30:32.8 They just want to strip your doors.

And that’s like taking the seed corn off the stalk and running with it and then leaving you to pick up the aftermath. 0:30:43.6 And now you don’t have that cash flow going forward. You don’t have all those benefits that you had as an owner.

Jordan: 0:30:51.0 Got it. So, in a nutshell, if the asset is being viewed as your doors and you can infer that by basically seeing if your brand is going to die.

If the organization and the brand is going to go away and get rolled into something else, you’re pretty much selling your doors and at that point in time you’ve got to really scrutinize whether or not you’re getting a sale valuation that actually recognizes the value of the whole company. Totally makes sense.

0:31:17.9 I do want to go back to that conversation about profit versus growth. This is related to the IBDA conversation.

0:31:27.5 For organizations that are staffed for growth, currently – this word comes up, I’ve actually gotten some feedback, some pushback for kind of stigmatizing this word.

0:31:40.3 My question for you is this: Tom, under what circumstances does it make sense to be staffed for growth? And under what circumstances does it not make sense to be staffed for growth?

Tom: 0:31:52.1 Well, I think any company that is a going concern, should always be looking at growth. If you’re not growing, you’re dying.

You’re going to have competitors that are going to nip at your heels. 0:32:07.7 You’re going to lose market share, you’re not going to remain competitive. You’re not going to implement new ideas or features or functions or service.

0:32:15.6 So, you should always be looking at growth. If you’re planning on staying in business for any length of time.

0:32:22.8 Anybody that sits on their hands and decides, “Ok we’re at 100 doors, I’m happy. We’re good. I don’t want to grow anymore.” They’re not going to go anywhere. They’re just going to sit there. 0:32:33.6 And all they have is a paycheck.

You want to grow yourself to the point where you can grow out of a paycheck and have something that is a long term life asset that you can do something with.

0:32:45.3 Whether it’s keep it and hire operations people that manage it day to day so you can not be in the office. Or maybe you hand it off to your kids, or whatever.

0:32:56.2 But, you know, that’s the point of growing a company. Is to give yourself that flexibility and ultimately, give you that profitability that’s going to make it really fun.

0:33:08.0 A lot of people have said that when you hit that 400 door count, you know, above that that’s when the cash really starts to pour in. That is a true statement.

0:33:16.4 And whether you blend different types of property management and brokerage and maintenance and all that together, doesn’t really matter.

0:33:23.8 Once you hit that revenue mark where the efficiencies and the scale starts to kick in, that’s when it really becomes exciting to own and operate a business.

Jordan: 0:33:34.7 So this is really interesting to me. My question is: How does door growth change the underlying economic model?

My going concern is that folks, somebody who’s managing, let’s say it’s 200 doors currently, and they’re really struggling to show any kind of a profit. 0:33:55.1 They basically have an income.

But the belief is, if I can get to 400, let’s just call it 400 doors – if I can get to 400 doors, somehow things are going to change.

0:34:02.6 Because, currently, the labor cost is out of whack. OpEx is too high. The revenue per door is low and they don’t have the gumption to go back to their existing owners to renegotiate contracts, to change the contract going forward, etc.

0:34:17.8 There’s some implicit tension there, and my concern is that scaling a weak economic model does not get easier over time. It gets harder.

The further you get down that road with a broken underlying economic model, it simply increases the gravity of how difficult it is to try to reposition and scale.

Tom: 0:34:37.5 Yeah, I agree with that. And that’s why door count should be secondary to profitability. 0:34:44.2 But I think people need to focus on profitability and efficiency.

They need to focus on their operations and make sure they’re putting things in place on a persistent, regular basis that gives them that efficiency and that ability to grow.

0:34:59.3 They should always have some capacity in their company for that surprise investor with 20 properties that comes and knocks on their door.

0:35:05.8 Or for, all of a sudden there’s a surge in the market, where they bring on 20 or 30 doors a month for three or four months.

0:35:15.1 You’ve got to have that capacity in place. Trained, ready to go and available. And you have to have systems that are efficient.

0:35:24.8 You’re absolutely right that if you don’t spend your time on that, your growth-profitability curve is going to flatten out.

0:35:33.0 So as you go from 200 to 300 doors, maybe your revenue is higher, but your net profitability is the same.

Might even be less, because now you’re hiring and you’ve got inefficiencies and then you’ve got some customer service problems and some legal issues.

0:35:48.1 So you’ve got to be careful how you grow, but I think if you focus on profitability, number one, and let the door count take care of itself, I think that might be the best perspective.

Jordan: 0:36:00.0 So let’s just talk about the levers that you can pull.

You have a limited finite number of choices in terms of meaningful lovers in your business that you can pull to impact, in this case, the valuation of the underlying asset.

0:36:13.7 Here are just a couple: We have the growth lever. Right? Simply adding more doors.

We have the monetization lever, which is basically ancillary revenue, changing your pricing, etc.

0:36:22.2 And then we have the retention lever, which is ultimately going to increase your customer lifetime value.

0:36:28.6 These levers are not created equally. It’s very clear to me that monetization, in terms of impacting bottom line results, is going to have a disproportionate impact, relative to the others.

Do you come from the same school of thought on that? What are your overall thoughts on pricing optimization, ancillary revenue, etc.?

Tom: 0:36:52.7 Well, you know, absolutely. The efficiencies on where you are and where you’re going are always going to be in the back of your mind when you’re trying to increase profitability and increase growth.

There’s a model called – it’s called The Quality Circle Model, I think the book was Peter Senge, back in the 90’s.

0:37:16.5 And basically, what it is, is as you grow, right? Your quality may well drop if you don’t invest back into your business. And if the quality drops, then your client satisfaction’s going to drop.

0:37:29.7 And if the client satisfaction drops, you’re going to lose contracts, you’re not going to be getting referrals and you’re not – and your business development is going to suffer as well.

0:37:38.1 And then you’re going to go right back down. 0:37:39.9 So you may have grown and pushed growth from 200 to 300 properties, but you didn’t have the operations and the fundamental underlying infrastructure to support it.

0:37:48.9 And so, that quality circle, now is going drag you down because of the clients that are disillusioned and the lack of referrals. 0:37:59.5 So now you go from 300 doors back down to 250 or 220.

0:38:02.9 And so, you recognize that you hit this glass ceiling. And I think that glass ceiling in property management is right around that 3 to 400 door level, where people get up to that point and they’ve never put in the infrastructure to make sure that that quality is consistent as they blow through that number on the upside.

0:38:19.8 And so, they get into this loop of degrading quality, loss of customers – and then once they’ve lost so many customers, now they have capacity again.

They’re able to provide good service and then they slowly grow back to that 300. Only to go through that same cycle again and again and again.

0:38:38.8 And so, I think that quality circle is probably one of the biggest challenges that individual proprietors face when managing their companies – is to recognize when that’s happening.

0:38:49.9 And the same thing can be true too when you have a spurt in growth and all of a sudden you pick up a contract, or you buy, or you acquire another company with doors. Right?

You’ve got to make sure that if there’s demand that’s ticking in, that you are able to accommodate it. 0:39:07.1 And maybe the way you accommodate it is you simply raise your prices to prevent all that growth from hitting you all at once so that you can implement improvements.

0:39:17.7 And then slowly you can bring your pricing back down to market parity without impacting or having the quality circle come and bite you.

So those are some things that I would be thinking about.

Jordan: 0:39:28.2 Certainly there’s a relationship between pricing and quality. Right?

The more margin that you have, the braver that you are in leaning into being able to command a higher price through a demonstration of higher value. The more margin you have to funnel into anything. 0:39:47.6 Quality, growth, etc.

0:39:49.4 That’s the opportunity that I see around and I hate using this term, some folks would call it ‘fee maxing’. You could call it additional lines of revenue. Value added services.

Whatever you want to call it, what we’re looking at is tuning the underlying unit economic financial model that your business lives or dies by.

And that, to me, is an incredible value added experiment and effort as opposed to focusing on absolute door unit growth.

0:40:21.0 And there’s leverage even if you do want to. Even if your goal is to get to 10,000 doors, profit is going to be the oxygen that gets you there.

Tom: 0:40:26.9 Right. I mean, there can only be – there can only be one Walmart, I guess is the best analogy.

Is that there’s only one lowest cost producer of services out there and everyone else is going to be in some other segment. Or they’re going to die trying to be that low cost producer.

0:40:44.2 So you have to be careful when it comes to pricing and service and the segment that you’re trying to fill.

0:40:51.5 Always, it’s better to be on the upper end of a service profile. Instead of Walmart, maybe be Nordstrom or something like that where you provide a higher level, a higher quality of service.

0:41:06.4 Ultimately, what do your clients want? They want peace of mind, they’ve got a multi-hundred thousand dollar asset.

They don’t need to be jerked around by a $59 dollar a month PM company that strips everything away and is providing a discount service because their sole focus is on doors. 0:41:21.7 You want to provide peace of mind and value.

And quite frankly, even at double that fee structure, you can provide more intrinsic value to a client, multiples of that, in fact, that will keep that client for life.

0:41:38.0 And that would be in the reduced tenant turnover, higher tenant satisfaction, meaning your tenants will stay longer, less turnover between tenants, less time to rent. Less delinquency, because you have better quality tenants.

0:41:52.9 I mean, you add up all of those little esoteric factors of providing that value and an owner will realize very quickly that it doesn’t matter what you pay for your monthly management fee, it’s the value that you get as a result of it that’s the important thing.

0:42:09.2 And when you have that multi-hundred thousand dollar asset, you know, there’s a lot of risk that you’re taking as an investor, and you need to find the best property management company out there that can do that for you.

0:42:19.2 So I really cringe every time I hear a management company saying that they want to be the lowest cost provider, or they’re focusing purely on growth or doors.

0:42:32.5 It just smacks of that Walmart strategy, and that’s not going to work except for maybe one entrant and then the rest of them are going to die trying.

Jordan: 0:42:43.2 So, what is your advice to that person that’s trying to – specifically I’m thinking about the person that takes great pride in saying that they always represent the owner and they hand every value added dollar from every fee, etc., back to the owner.

0:42:55.8 Or, the person that has thought – that heard the talk on fee maxing but they’re just afraid that if they try and implement it, all their owners are going to fire them.

If they try to collect any revenue off of maintenance, or to charge a larger leasing fee, etc. 0:43:12.7 What would be your encouragement to that person?

Tom: 0:43:15.2 Well, and obviously you do need to have fees that support the services that you’re providing and support the profitability. Absolutely.

The key though, is to make sure that those fees actually are providing value to that owner. They’re not just grabbing 0:43:31.5 <Inaudible>.

0:43:31.5 Because ultimately, at the end of the day, your owners are going to walk if they don’t see that value.

0:43:36.8 And so, that’s the key for the property management company. Is to say, “Are we providing a better service, a better value than competitor A, B, or C. Regardless of how the fee structure is set up.” And that’s the important thing.

0:43:53.7 Is, “Are we providing the best value.”

0:43:55.1 And ultimately, at the end of the day, those owner-investors are going to see that value and they’re going to flock to you. And that’s what you’re trying to do.

0:44:02.7 Property management is absolutely not a commodity. It is absolutely not a commodity. And I’ll say that a third time. It is absolutely not a commodity. 0:44:13.5 It is an experience based professional service that is few and far between.

And the reason that individual owners come to property managers is because of that unique experience and talent and knowledge that they have.

0:44:27.9 And it is something that you just don’t buy off the shelf for $39 dollars a month.

0:44:32.8 You need to have the best management company out there that you can possibly get and your fees can and should be set commensurate with that value. Not a problem. However you set your fees up.

0:44:47.4 But do not just give away a cheap service and expect that everyone is going to come to you. Because that’s not the case in this industry.

Jordan: 0:44:55.4 Couldn’t agree more. If you were worried about people treating you like a commodity, it very well may be because you act like a commodity.

0:45:01.6 People implicitly understand the difference between a McDonalds hamburger and filet mignon. 0:45:07.7 You don’t have to explain it, people just simply intuit it.

0:45:10.6 Tom, I want to transition to the rapid-fire section of the interview and get some quick guttural answers from you on a series of questions.

0:45:17.2 The first question is this: How did your military service influence how you run 33rd Company?

Tom: 0:45:22.5 Oh, I think processes and just the discipline of having a checklist. I used to be a Navy pilot, and of course we had checklists for everything.

0:45:33.9 And that’s the first thing we did when we started managing. Is creating an onboarding checklist. We created a lease up checklist. We had structured brochures. 0:45:44.6 We had a structured file saving system on our server.

So it was all very structured and we still, today, use many of those things. So they’ve just been improved and tweaked along the way.

Jordan: 0:45:58.3 Who do you learn from?

Tom: 0:46:00.5 NARPM. I’ll tell you, NARPM, one of the best organizations ever. We lucked out. I had no idea who or what NARPM was when we started our company.

But it was one of the first things we joined. I must have stumbled on it on the internet or something and decided, “Well, I’ve got to join something, I might as well join NARPM.”

0:46:17.9 And boy, was that a lucky decision. Some of the brightest people in property management, and let me tell you, multi-family management is one thing, but managing single-family homes that are shotgun blasted around a metro area – different paints, different exteriors, different carpets, nothing’s the same.

0:46:35.3 The appliances are all different. That is one of the most challenging aspects of property management in the industry and there are some people out there that do it extremely well and they’re very bright.

Jordan: 0:46:46.7 What would you say to the lone ranger that thinks, “Ah property management’s backwards, what could a group of property managers possibly know about business?”

Tom: 0:46:54.4 They couldn’t be more wrong. And they’re not going to be managing long if that’s their attitude. Because they’re not going to stay at the forefront of technology and innovation.

They’re not going to be providing value and staying current with the laws. 0:47:09.3 They’re not going to be staying current with customer needs and demands, so that’s the wrong approach.

Jordan: 0:47:14.4 Tom, what’s the maximum number of G’s that you’ve pulled?

Tom: 0:47:20.5 Oh, let’s see. Nine, a little bit over nine. 9.2 I think. I overstressed an airplane and I got in big trouble and they had to pull all the panels and do an over-stress inspection. And the plane was down, I think for five days. 0:47:34.3 I was trying to be an F-18, which I did. But unfortunately I kind of got in trouble doing it.

Jordan: 0:47:41.3 Sounds like it was a good story for another day. Alright. 0:47:44.1 Next question is: What books have impacted you the most?

Tom: 0:47:48.6 I think that Peter Senge book on quality circles is an excellent read. It’s a dated book now, but the information is as true today as it’s ever been. So I would recommend that Peter Senge book.

48:08 I think E-Myth is a good book. I think just working ‘on’ the business versus working ‘in’ it is always a good strategy. And quality.

And you don’t need a book to say, “Am I doing something that’s adding value to my client?” 0:48:19.5 If you just say that once a day, “Am I adding value for my client?” you’re going to be more successful than probably 90% of the business books that are out there.

Jordan: 0:48:30.0 Love it. If you could do it all over again and give yourself one piece of advice, at the very beginning of your career, what is the one piece of advice that you think would have made a difference for you?

Tom: 0:48:44.4 By career in property management? I think, boy I don’t know. We hit it just at the right time.

I think I would buy more properties. There’s – we own a lot. We also own the business, the building that are business is in. And there is no greater satisfaction than actually owning real estate versus managing it.

0:49:10.6 And I think everybody out there who is trying to be an investor, ultimately is going to need a property manager. But a property manager already has a property manager, and they should be buying real estate too.

0:49:23.3 And I think that’s where that value is. If an investor can buy a property and still be profitable paying a property manager, why can’t a property manager buy that property and be even more profitable and better off because his costs of doing business is lower.

0:49:39.1 And I think not enough people in NARPM are taking advantage of the fact that they should be buying real estate themselves.

Jordan: 0:49:47.4 Love it. Diversify. Immediately adjacent opportunity. Totally makes sense.

0:49:52.0 The final question of the interview is this: I ask every guest this question: Tom in your opinion, are entrepreneurs born or bred?

Tom: 0:50:01.2 I think they can be either. I was absolutely not an entrepreneur. In fact, our first rental, it was my wife Lynne that convinced me to buy the property.

And I was biting my nails the whole way. Kicking and screaming. “Why are we doing a rental property?”

It wasn’t until after we had it and I’d done my taxes for the first year and I realized, “Oh my god, what a hidden gem this is.”

Depreciating it as the asset appreciates. What a concept.

0:50:30.9 And so, we recognized then that that was the direction to take. 0:50:35.6 But, I didn’t go into it, and I wouldn’t have gone into it had I not been pulled into it by my wife.

0:50:41.6 I was an engineer, I was a Navy pilot, I was process oriented. I was not, per se, an out of the box thinker. I was more of the structured, “Let’s do it this way because this is the way it should be done.”

0:50:54.0 And having got into the business, I’ve become more entrepreneurial, only because you have to to be competitive.

Jordan: 0:51:02.2 Hmm, ok. So you see a little bit of both sides of the coin. You see folks being able to get there from either destination. Makes sense to me. Appreciate you coming on the show.

Tom, if folks want to learn a little more about 33rd Company, or specifically some of your work as it pertains to valuations, what’s the best place for them to go?

Tom: 0:51:19.6 Well, they can go to NARPM. That cash flow company valuation course for those that went to the Broker Owner is available. The slides are available to pull down.

0:51:29.4 I’d be happy to chat at any convention or broker owner workshop. You know, I’m a NARPM instructor as well, so I do hit the regionals and I also go out and teach on the road.

0:51:41.5 So I’m happy to talk on any topic with any of the NARPM members that are out there. I think real estate – I just start to shake when I talk about real estate. I love real estate and it’s shutting me up that’s the problem.

Jordan: 0:51:56.8 Alright. Sounds good. We’ll make sure we add Tom to The Profitable Property Management Facebook group. If you guys have questions, maybe you can ping him there.

Thanks again for coming on today and we’ll see you at NARPM National. That’s where we will see you next.

Tom: That sounds great. You’re so welcome. Thanks.

Jordan: Have a great day.

Tom: You too.