Law of Diminishing Returns

Most everyone has heard of the law of diminishing returns. First year economic students usually cover this in class. For the sake of those people who did not take economics 101 or those who may have forgotten, let’s define the definition for the sake of this blog. Britannica.com defines it as follows:

Diminishing Returns Defined

“Diminishing returns, also called law of diminishing returns or principle of diminishing marginal productivity, economic law stating that if one input in the production of a commodity is increased while all other inputs are held fixed, a point will eventually be reached at which additions of the input yield progressively smaller, or diminishing, increases in output.”

So what does this mean for property managers and real estate investors? There are plenty of applications of this principle in the realm of real estate properties and management.

The purpose of this BLOG is to shed some light on areas where this law can be applied to your business of managing properties. Hopefully, you can think of your own examples beyond this BLOG and ultimately improve and grow your business/portfolio. That is our goal anyways!

Diminishing Returns Example

When I owned a small painting contracting business in my younger years, I learned this law even though I didn’t know the proper terminology. Many of my contracts were apartment complexes that had standard apartment sizes. I learned that I could (by my self) paint the apartment in 8 hours when a tenant moved out. Then I hired another painter to work alongside me. Together, we were able to cut a single apartment down to about 4 hours. That’s 50% savings in time. However, when I brought on a 3rd painter, we didn’t see another 50% drop in time. We were lucky to see a 20% cut in time. So at some point, I realized that there was an optimal number of painters that would provide me the best rate of return. Now this is assuming my contracts remained the same, no new contracts and no loss of contracts.

Applying the Law of Diminishing Returns to Real Estate Property Management

So how does this apply to property managers. There are many areas where this law can be applied.

  • Vendors
  • Employees
  • Properties
  • Property Owners

Let’s look at a small property management company with a single manager. How many properties can you effectively manage by yourself? 20? 30? 50?

Now add another property manager employee. Now, how many can you manage? Of course, if you hire another employee you need to increase your property owner clients. Assuming you can manage 30 properties by yourself, can you manage 60 properties now? How would doubling your portfolio of properties to manage change your P&L?

Now let’s look at the flip side. Let’s say you manage 100 properties with a team of 6 employees. Have you past the point of diminishing returns already? This is the more critical analysis then not having enough employees. While the first example causes you to miss out on growth opportunities, having too many employees will reduce your ROI.

These are very basic examples and when I mention employees, I’m not referring to back office employees that are needed wether you manage 5 of 500 properties. I’m referring to employees that are directly handling property management tasks.

Do Diminishing Returns Apply to Contractors

Does this law apply to contractors (as opposed to employees), such as plumbers, electricians etc.? Initially you my be inclined to say no. You only pay them when you need them. And that may be correct. But consider this, if you have 5 electricians on contract to handle your 200 unit portfolio, are you getting the same level of dedication from those 5 electricians? Are “you” considered a smaller customer to a particular electrician and as a result, they put you below their larger customersas far as priorities are concerned? Could that hurt you in turn around time, increased vacancy times? Would it be better to have 3 electrical contractors that are more dedicated to you as a customer and will work harder for you and complete the needed work quicker?

Finding the Sweet Spot

I hope this BLOG will get you to start examining your property management business in regards to what was covered here. There are so many applications of this law that you can apply to your own business. I hope this helps to identify those areas and in return, help reduce your costs or increase your portfolio or property management business.

Find the ‘sweet spot’ for your employees, vendors, property owners etc. Once all these are attained, your business will be prime for maximum profits and who knows, an acquisition.

About PropertyZar

PropertyZar is a real estate technology company specifically in the web-based property management software for owners and professional property managers. Learn more www.PropertyZar.com