Why do some small-time real-estate owners struggle while others thrive?

Question

This is something about this field I'm trying to understand. Whenever I talk to a regular person who managed to save up and buy an apartment building or a duplex or something like that for rental income, they always say it's a lot of trouble and isn't a reliable profit and so on.

But then you have people who just keep going after they get started, to the point that years (or decades) down the line, they own thousands of units, entire city blocks, malls, and so on. (Those people are the 1%, sometimes even billionaires.)

What is the difference? Why can some spin it into a gigantic enterprise while others buy one 3-unit building and seem to get stuck?

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(I'm from the U.S. but I don't think it makes much difference, the same is true everywhere.)

Answer 1

First off, I'd question the premise a bit. There are plenty of investors that have large real estate holdings and correspondingly large loan amounts and expenses that are constantly verging on bankruptcy.

Large investors have the benefit of diversification and professionalization.

Diversification If you own a single rental unit, you have a great deal of idiosyncratic risk-- you might find that you've got a great tenant that pays on time every month for a decade and leaves the place spotless or you might find that your tenant lost his job and can't pay rent for several months while you try to evict him and then find that you're on the hook for several thousand dollars in repairs. If you're a small landlord, one bad tenant can wipe out years of income. If you own a hundred rental units, you can reasonably bank on some percentage being empty, some percentage being behind in rent, etc. and end up with a much more consistent return.

Professionalization If you own a single rental unit, the tenant probably calls you directly when the water heater dies. You then have to drive out, take a look, fix it or call a plumber, etc. That's a lot of hassle to deal with in the middle of the night. If you have an apartment complex with a hundred units, on the other hand, you'll have handymen on staff to take care of most maintenance problems, management to bring in plumbers when needed, and contracts with plumbing companies that give you a discount for sending them a consistent amount of business. If you have one rental unit, you have to learn how to advertise, how to screen tenants, how to deal with maintenance issues, how to evict someone, etc. yourself and you probably won't be great at any one of them. If you have a hundred rental units, you can hire people that specialize in each aspect.

Of course, there is also the simple issue of skill. People that are good at being a landlord tend to make more money than those that aren't great at it. People that make more money as a landlord tend to buy more units than those that don't make as much money. So, over time, people that are good at being a landlord end up with more units than those that aren't so great at it.

Answer 2

While I think Justin Cave raises some good points about economies of scale, this isn't quite what you asked. Economies of scale are beneficial after you have a lot of capital, but you asked why some people are able to grow their real estate enterprise from an initial small investment, not why the people that have already grown it seem to do better.

The answer is, to a large degree, luck. No one wants to hear this answer, because:

• if you're already successful, you might feel you didn't earn it, and
• if you're not successful, it means there's nothing you can do about it.

And yet, research shows luck is far more significant in all kinds of success than typically acknowledged. Of course competence and determination matter -- investing requires effort and skill. But if you could look at the 1% most skilled, most determined investors, you'd find most of these will not go on to be the 1% most successful: they will be overtaken by somewhat less skilled or less determined investors that got lucky. As you look at a smaller group of most successful individuals, luck explains an increasing share of the variance.

While in many fields the nature of this luck may be obscure or surprising (for example, being born in January significantly increases your chances of playing professional hockey in the NHL) in real estate investing it's pretty obvious: you're investing all your capital in 1 or a small number of properties in a stochastic, competitive, volatile market when you start.

Answer 3

You may simply be dealing with selection bias.

Suppose there are 10,000 investors renting out one unit each. Most of them are struggling, dealing with empty units, repairs, renters that won't pay... So if you talk to most of them, they will say exactly the kind of things you are hearing.

However, a small proportion, say 100 of them, or 1%, are really on top of things. Their tenants pay on time, they leave their units spotless and in good shape, the units don't stay empty for long. These landlords are happy and will tell you so when you ask them. But because they are a tiny minority, you will likely not talk to them! Note that it's not important whether this success is due to higher competence or to luck.

Now, which part of our population will go on to invest more in real estate? It's the successful 1%, because they have (a) the optimism that comes with a good track record, and (b) the money that comes with success. So these 100 landlords will go on to own 10 or 20 units. And one of them will be wildly successful, and will start (ghost)writing books on real estate management.

And the top 1% may not differ all that much from the other 99%. Maybe they were a little smarter or more perseverant, or maybe they had a little more luck. The end result you observe is a lot of unhappy small real estate investors, and a tiny number of large and apparently successful ones, who brim with confidence.

Answer 4

When people say that they’re not making a profit on rental properties, they generally mean that their short-term cash flow isn’t very strong. They ignore the capital appreciation which is the source of most rental profits, but can’t easily be realised while you still own the property. Bigger investors tend to be better capitalised and thus can more easily take the long-term view.

Answer 5

Besides many good answers which describe the Survivorship Bias of successful investors, I want to highlight the lack of skills of the ones that fail.

Most landlords don't do the Math

There are many landlords who do not understand the impact of financial factors. Instead they are acting emotional, for example keeping an inherited property although selling it and reinvesting the money would create better profits.

The biggest and most common mistake I noticed is that people don't differentiate or don't decide between cashflow and wealth accumulation. If you want to secure your retirement or quit your regular job, it might make sense to fully pay down the real estate to reduce the risk of overdue loan payments. If you want to grow your wealth faster, you should keep your job and leverage the profit with a loan as much as possible.

Also you have to understand the laws and taxes in your country. It's fine to let the tax consultant do the paperwork, but your strategy must take those details into account. For example in my country it's advantageous to sell real estate after ten years, because you don't have to pay taxes on the increase of value and you can get out of any loan without penalty payment - even selling it to your spouse is better than keeping it.

Most "regular persons" focus more on housekeeping the physical object instead of managing the finances and therefore don't understand what they are doing wrong.

Answer 6

I'm going to suggest your causality may be the wrong way around.

Rather than "Large operations thrive, and small operations struggle". Have you considered the following:

Operations that thrive become large, operations that struggle don't.

This intuitively makes sense. If you're thriving and making lots of profits then you probably invest that money in expanding so you can make even more money. Continuing in a virtuous cycle until either you stop thriving, or you decide you're big enough.

Whereas if you're struggling and your first property isn't even turning a profit, then adding an extra property will just compound the problem, so you probably avoid it (and likely don't have the money to buy a second one anyway).

The size isn't the cause of the success, but rather the outcome.

Answer 7

Sales and Operation

Most small time real estate investors have to be part of the operation of the real estate. If you own 1 apartment and rent it out, you have to be the estate agent. You have to be the insurance provider (for lost rent or belligerent tenants) etc. You have to get new tenants when the old ones move out. It is easy to overlook that there is actually an operation part of real estate, and there is a sales part - someone has to keep tenants coming in as others leave. This part can be tricky to cover professionally by smaller players.

Big real estate players hire estate agents, or buy it as a service. And if one tenant skips pay, that doesn't "flip the kiosk" as we say where I come from. And they are big enough to do proper marketing.