The TCO Method ™
Episode 04 
What Is The TCO Method ™? Total Cost of Ownership
Hosted by Andy McQuade

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[Music]

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Welcome to the TCO method, the only show focused on helping you massively increase your net operating income.

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I am Andy McQuade and as always thank you so much for listening to me ramble on for the next half hour.

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I will again apologize in advance for anything I may say which will offend people.

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I’m not really sorry though.

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All right let’s get started.

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So for this episode I’ve had a couple people reach out and ask me specifically what the heck is the TCO method?

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Like what do you do?

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I have no idea.

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No I’m kidding.

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So the TCO method is a trademark that I started using actually probably late in 2021 because I had a client that really kind of hooked on to the idea of total cost of ownership.

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And I had always, since I launched my company in 2019, I had always sort of pitched total cost of ownership as part of the reasons to bring me in to help them on a value add buy and hold project.

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And let’s qualify it.

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I work mostly with commercial multi-family operators, thousands of doors under management.

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Buy and hold is my sweet spot value add is the best place to get me involved at the very beginning because the ROI is way higher.

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Because you already know if you’re in a value add project your ROI numbers are going to be whatever they are you’re adding value to the property you’re going to be able to raise rent.

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You’re doing all of these things to improve the overall condition of the property so that your maintenance costs and whatnot will go down for a period of time right and eventually all the new stuff you’re putting in will start having issues in failing and you’ll have some tenants that are rough on it and blah blah blah.

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By bringing me in at the beginning of a value add project my customers were able to spend a little bit more.

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But they save over time so where a project that would you know I would recommend someone do.

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Like doing a green up project for LED lights if it hasn’t been done yet more efficient furnaces boilers hot water tanks to save on natural gas costs and water saving fixtures across the property might have an ROI.

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If they’re being done alone for say 30 months 36 months 48 months whatever it may be right.

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By doing it at the beginning of a value add you can flip that around and you can spend maybe five or 10% more.

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But your ROI increases drastically because now you’re cutting costs on all of the normal expenditures that chip away you’re not operating income over time.

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And it’s not just the utility use right usually we try to put products in the have less maintenance less operational expenses all of that goes back into the N.O.I. for the property.

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And after 20 months 24 months whatever it may be they start to see a net return on investment for what they spent to bring me in and what they spent on the product in total not even above and beyond like a lot of these things if you’re going to buy.

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I don’t know a toilet right.

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And it’s going to cost you 99 dollars is it’s a cheap home depot toilet and you have option B which is a toilet that costs you.

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150 dollars right.

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Your labor is fixed you already know that replacing toilet a is going to take the same amount of labor that replacing toilet be is so your neutral on labor cost.

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The trick is you’re going to spend the extra money to buy the better toilet however that toilet doesn’t have a flapper in it which is typically what we recommend.

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And it cuts your water use down below whatever the other one is right high efficiency flapper lists vacuum assisted toilet.

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And it has a better warranty so you’re going to put this unit in and typically just doing the toilet labor materials included would have an R.I. in most parts of the country between.

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24 and 36 months but when you’re only talking about spending an extra you know fifty bucks.

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And you’re already committed to spending the money your R.I. is like nine months a year for the extra that you spent.

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And then that thing eventually pays for itself and starts paying you back by impacting your not operating income right same thing with.

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If you’ve got old boilers and furnaces from the 60s and 70s that are you know they were rated at 80% efficiency you’d be lucky if they’re 60% efficient now despite maintenance and tune ups like they just you can’t maintain them that way.

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You know even your highest efficiency furnaces now 96 98% they lose a percentage of efficiency after like five years 10 years down the line it’s even more.

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So there’s there’s a lot of improvements that can be made.

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That reduce more than just one line item on your P.n.l. because ideally what you want to do is you want to go in and you want to chip away at every single line item and then start converting some stuff into additional income streams or to use.

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You know some of your overhead and operating expenses in a more intelligent way so you can make more money through capitalizing on what would be opportunity cost right so perfect example you use the 99 dollar toilet from home depot three years down the line the flappers leaking.

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Because that’s your average lifespan of a flapper and toilet.

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So now your water bills going up because that toilet’s running. It’s not your tenants bill so unless the toilet running and noise them they’re not going to call you and tell you that the toilet’s running until it stops working correctly right I go to flush toilet it doesn’t flush.

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There’s a lot of pieces and parts that go into what your maintenance operations are and so there’s a there’s a process costing.

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That almost no one does but really should be part of the operational package when you’re you know once the apartments are stabilized you really need to know.

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What is every single thing we do cost us because nothing is free right you’re paying you might pay once a year for software you might pay monthly for electric and gas to heat the office you might pay once every three years for a computer.

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Or you know a company vehicle or whatever it may be however you’re operating your business every one of those operational line items.

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Goes into what you’re paying.

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Your employees right like they need a place to work on the property most likely not always but most likely.

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Sometimes you’re paying for mileage sometimes you have a company vehicle on site that that is used to drive back and forth to home people and lows and go pick up landscaping supplies at the garden center down the street or whatever it may be.

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There’s a very finite set of inputs that go into operating a real estate business right there’s always risk and risk management compliance but that’s what we’re talking about.

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Part of what I do with the TCO method is I try to create.

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An understanding through data of exactly what everything costs over time so that you can turn around and.

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Take action to correct it so if you have an hourly associate sitting at your desk taking phone calls from eight answer whatever doing other jobs as well.

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What does that person cost you per hour once more than twenty dollars per hour because you’ve got unemployment insurance you’ve got workers comp you’ve got whatever benefits you give them right you’ve got the other seven percent of their social security Medicare Medicaid blah blah blah.

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Right so already your twenty dollar an hour associates like thirty five maybe maybe more but then you’ve got all the overhead and operating expenses for that office space right so you’ve got.

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All the office equipment that has a depreciation and a lifespan you’ve got the computers you’ve got the software you’ve got the lights you’ve got the heat you’ve got the coffee maker you’ve got all these things.

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That go into.

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The overhead right soft costs that you don’t see you don’t really quantify.

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But they’re part of what the packages for that person to do their job.

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So if your employee takes a phone call for maintenance call right as opposed to having it in an app which is what I recommend if you have a system that allows you to do.

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Tenant automated maintenance requests through an app that’ll feed it directly to your maintenance people.

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Do it automation is good right I’m not big on getting written like getting rid of labor and overhead but there is a cost to paying this person other than their hourly cost to sit behind the desk.

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To take that maintenance call because then they take the maintenance call.

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And then they punch it into the system so let’s say you’re your fifteen minutes in after you get the explanation.

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I’d say seventy five percent of the time they have to go to the unit check out the problem so that person calls the maintenance guys that’s a blah blah blah we need to get over there punches it into as a work order into whatever system you are either using if they have one.

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So you’re at about half hour worth of touch time and then your maintenance person stops doing whatever they’re doing.

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Or eventually goes over right checks it out.

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And then you get this part oh and while you’re here there’s two or three other things going on.

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Okay so then you know they run to the to the apartment they check it out they leave they either go to the shop or they go to the store to buy the stuff to fix the problem.

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Or they don’t have the ability to do that so they have to schedule it out.

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By the time everything is said and done you’ve got one or two employees spending between in a perfect world fifteen minutes realistically a half hour to an hour just to figure out what the problem is and what the parts are and you gotta pay for the parts.

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And if you don’t have an onsite shop where you’re buying the product at a good price in bulk and you’re storing it.

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You know and there’s a there’s a carrying cost for that to you have to weigh the carrying cost of what your inventory is costing you versus where that money could be put to work elsewhere.

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From a from an operations and budgeting standpoint but I think the pandemic taught everybody that you really need to have something in stock to replace what’s in those units because you may not be able to get it.

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But anyway.

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By the time they get up there replace what needs to be replaced.

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Test it all you’re at two hours two and a half hours not including parts.

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So what is what is that payroll impact right.

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And yes that’s a cost of doing business.

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It’s a quote unquote right off.

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But consider if that entire service call could have been avoided.

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What is that worth.

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Right.

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And assuming that you live somewhere like here locally one of the one of the municipalities includes a percentage of the water bill into the taxes through the sewer charges for the property.

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So not only is that leaky toilet flapper issue costing you the labor to fix it assuming you get the call.

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But every single flapper on your property starts failing after three years right.

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That’s not a ton of money necessarily but if you’ve got 400 doors on a property it adds up really fast.

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So you’re paying extra property taxes you’re paying the water bill.

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Because I know very few multifamily complexes that’s that you know break out the water in any reasonable fashion.

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And then you’ve always got the outlier where the tenant doesn’t care.

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And they let the toilet run 24/7 for six months and you get a $2,000 water bill out of nowhere.

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Oh and that’s going to go on your taxes also.

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For the sewer side so how are you winning in that kind of in that situation you bought the $100 toilet.

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And I’ve got all these other things that start at year three and continue until you replace the toilet again.

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All right even if you change the flapper you’ve still got all that labor to do the work and you put the stupid thing in.

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And then three years later you’re back at it again best case scenario.

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So the TCO method.

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When we go in we try to understand what every single process is costing the client.

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To build the case that your ROI isn’t just on what you’re going to save on the utilities.

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It’s what you’re going to cut down in your overhead use and then there’s also the opportunity for your people.

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To be focusing on other things they can help you make more money.

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Well what does that look like? Well a lot of people will you know have their maintenance crew.

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Especially after a complex wide value ad project where rehabs were done to a majority of the units.

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They’ll have them internally run some.

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Pression up projects let’s call it their make ready is there light rehabs you know a coat of paint and maybe some minor repairs here and there to a unit getting it ready for another tenant but.

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The intention of that is to help you make money so you can have them fixing a problem.

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That shouldn’t have existed to cost you money you can have them going to work.

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Making you more money right through a value add through the ability to lease a unit for more money to get somebody into the property period because vacancies are bad right empty units do nothing for you but cost you money.

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So in addition to process costing you have to understand the opportunity cost that goes into it as well because there’s multiple levels.

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And we try to correct when we’re first starting out looking at a property or a portfolio for helping generate more N.O.I.

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And as everybody knows in commercial real estate you know the more N.O.I. you get it’s not just about what you take home or what you potentially take home at the end of of every year.

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So what’s that property worth because the amount of money that you make in N.O.I. is directly tied to the value of that property should you choose to sell it.

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Now it’s going to be worth whatever it’s worth in cash flow based off of scaling and all the other stuff that’s going on.

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But from just an opportunity standpoint you want to make sure that you’re maximizing the value of your property.

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I’ve seen properties that guy just finished one where the prior owners deferred maintenance for two and a half years and just drove the thing into the ground lowered rents by two to three hundred dollars a month per tenant.

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And we’re trying to make up I think a section eight play I don’t really know.

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But they couldn’t cash flow enough at the property because they drove it into the ground and the quality of tenant was so bad that they ended up with like 50 or 60 vacancies they ended up with 50 something people not paying rent in addition to the vacancies you’ve got a property that was a third vacant basically or a third not not cash flowing.

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And then just the amount of damage that was caused because of of of challenging tenant issues and then you you turn around and my client picked it up on a mortgage pre foreclosure which was great for him.

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And then he came in and got to do a value add project where I was involved and more than double the value of the property versus what he paid for it in 14 months.

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And that was at 82% occupancy it’s not even done yet we still got it on their like 30 units we have to turn.

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But the reality of the situation is as an owner or operator you should be doing whatever you can in your power to drive and I and that’s not just I need my N.O.I. up today.

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Because there’s a lot of things on a rehab that you can do that’ll drive in a Y today and for a year or two until that stuff starts to fail right it’s that whole what we talked about in the last show about saying a quiet part out loud where there’s kind of an incentive to put the cheap stuff in just put a bandaid on it and if it dies into yours who cares well if you’re flipping it if you’re doing a value add for resale play.

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Then you don’t need to worry about the toilet that’s gonna last for 15 years and not leak because it’s not your problem because by the time flapper start failing it’s not going to be your your property right and while there are some again ethical things that come into that it’s not necessarily what you’re looking looking for.

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So the TCO method we look at all the costs across the property utilities labor overhead we assign process costing to everything what’s it cost you to do a B and C.

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And then if there’s a rehab plan already assuming there’s there’s a budget right people have been doing rehabs and value add place for the last like five years with no budgets because they could just get whatever they wanted for it afterwards because they were just gonna dump a bunch of money into it turn it around and sell it.

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And that’s how they get paid like the cash flow part wasn’t really high on their priority list of them to get 95% occupied level leave a little meat on the bone and sell it.

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But the reality is that you can’t always do that in a rising interest rate market right rising interest rates cap rate compression values go down just by accident.

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So NOI and cash flow become way more important which means hey guess what budgets matter you need to have a reserve now for capital expenditures.

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You need to actually be able to prove that the renovations you’re doing to your units for a rent increase play are going to pay for themselves before you need to do another capital improvement on a value add play to raise rents which means whatever you’re putting in.

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Did pay for itself in two to three years would be great five is acceptable in some cases depending on the property any amount of work that has to be done.

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But whatever you’re putting in there needs to last you from seven to 10 years.

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Which means you want to have at least two or three years at the tail end where you’re just cash flowing off of what you did and yes maintenance costs do go up but it’s nowhere near the amount of money you spend per door to bring a unit up to you know current market.

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Standards and market rent.

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For whatever it is a matter of its a b or c the amount of money you spend on a on a cat X rehab.

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Is always going to be more than your maintenance cost unless there’s something very wrong with the building or the operation.

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So anyway.

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We try to take everything into account.

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Because you can’t really like total cost of ownership is a is a thing that’s existed for.

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40 years basically it started popping up in in it and manufacturing.

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Decades ago 80s early 80s.

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And for real estate there’s so many inputs and so many things you can’t control it’s really hard to get a final number on what total cost of ownership is going to be over time because of insurance and taxes and inflation and you know accidents that happen lawsuit slip and falls all the stupid stuff that you have to deal with as an owner it makes it very hard to predict what that property is going to cost you.

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However, however the way you address that is when you’re making your decisions through the TCO method when you’re looking at maintenance operations when you’re looking at cat X when you’re looking at procurement specifically right because I left my old job to open a procurement outsourcing and management consultancy.

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Right arm procurement advisors.

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That’s where the TCO method came in because when you’re doing it at the base level of procurement you’re looking at it from what is my business impact tell me the business problems this solves tell me how this benefits the business as a whole.

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And then you have to look at how does this address risk management to the insurance companies like this is this going to help keep me out of harm’s way or is it going to give me more insurance claims.

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Compliance so not just you know is this required by code in my area but does this add to the health and well being of my tenants whoever they may be.

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And is it something again that increases my liability or moves liability and in cost avoidance well what’s my maintenance look like on this over this useful life well if we just said that a capital improvement project to bring something up to market rate is going to last you seven to 10 years is the stuff you’re putting in going to last you seven to 10 years.

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And what’s the savings going to be for you in that period of time where’s the ROI hit.

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So while you might not be able to take all of that and all the inputs that are hard to predict on utilities and insurance and all the other garbage that’s going through the roof right now for for owners.

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But you can make informed the decisions by doing the right amount of research so people’s eyes glaze over when you say procurement but there’s.

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Chief procurement officers now right so I tell people I I see PO for you when you bring me and I take over is chief procurement officer because I know.

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The sales side from the supplier standpoint.

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I worked for some of the biggest building material suppliers and MRO suppliers in the country I understand how they buy who they buy from what their margins are.

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How they operate their logistics.

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What they have to make to keep the doors open in a light son.

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How they pay their sales people. How they negotiate. And so I know what the market rate is for a lot of these things and if I don’t have current information on market rate it’s easy enough to shop it and extrapolate what they’re really paying for based on what I know.

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From 25 years on the supply side managing numbers.

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So when I go in to a project and I secure.

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A nationwide contract with say Sherman Williams for installed carpets installed hard surface flooring blinds and paint.

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I know what those numbers should look like for that apartment complex for that portfolio of properties for that.

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You know 10 or 15 states the customer is working and you know, surely is in everywhere they don’t have install services everywhere but they install more carpet than any other single supplier in the United States to multi family.

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It should be a no brainer.

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It isn’t always you have to know who to talk to you have to know how to set that kind of account up and it’s doable but who has the time to do it because the problem again is without somebody focused on knowing the products knowing the technical stuff knowing the risk management compliance impact knowing the long term operational costs knowing failure rates right there’s a ton of stuff that goes into that.

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And the problem is that most operators are spoon fed products and services by the people who sell them and they don’t care about anything but that you know 12 month 24 month warranty or manufacturer’s warranty whatever it may be.

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And most sales people don’t know the technical stuff they don’t know the failure rates they don’t know the long term impact of these products and it’s their job to sell whatever the company they work for sells whether it’s a piece of garbage or not.

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So a lot of buyers just get spoons fed bad information.

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And the products work right a toilet is a toilet you do things in it you flush it the waste goes down the drain.

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But we know that there’s some out there that are better than others it’s the same thing with smoke detectors the same thing with light fixtures right like I see it all the time new construction.

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These massive companies put together these huge huge apartment car complexes you know I mean even it doesn’t matter high rise.

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Multi family patio garden apartments light commercial three stories or less four stories or less in some states.

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And they put integrated LED light fixtures throughout the property which is cool.

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I don’t know a lot of apartment complex managers that want to provide light bulbs to their tenants right.

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I’d say in 90% of instances light bulbs are the tenants problem when they burn out.

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So what happens with a LED integrated fixture with a 10,000 to 50,000 hour lifespan that it that essentially turns into a one to five year useful life.

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You want from not buying light bulbs. At the cost of a buck or two a piece.

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Right by the time you get all the handling and ordering in the city on your shelf tying up capital to be used elsewhere blah blah blah.

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A buck or two a piece.

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Now you’ve got a twenty five to eighty dollar light fixture.

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That you’ve got to put a maintenance guy or an electrician into a unit to replace at your expense.

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So I’m going to provide or not provide a two dollar light bulb every couple of years.

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Or I’m going to replace an eighty dollar light fixture every five years not including labor.

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How is that helping.

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Operate a property efficiently and affordably and.

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I mean it doesn’t even it doesn’t even meet the the useful life target for your typical market rate apartment.

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Like you want to be.

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On the outside of seven years hopefully ten before you have to do a massive cat X Renault again.

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But you’re putting a fixture that you’re on the hook to replace.

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And it’s really hard to blame the tenant unless they smash it with the the broom handle or a hammer or something.

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It’s really hard to blame the tenant and stick the tenant with a three hundred dollar bill to replace a light fixture.

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That just failed because it wasn’t the right fit for your apartment.

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And yet when you go to home depot you go to low as you go to any of these mom of optical places.

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You get all these really nice looking high end fixtures and they’re all integrated LEDs.

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Outside of your typical flush mount boob light.

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Which is not the best looking fixture out there.

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Your choice of bulb taking fixtures is very low.

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And I wouldn’t have as much a problem with it as I do.

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If they made replacement parts or those integrated LED light fixtures and nine times out of ten it’s not the LED bulb actually more like ninety nine times out of a hundred.

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It’s not the actual LED itself that burns out. It’s the driver pack behind the LED that burns out.

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And while I’m getting stupidly technical.

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This is the stuff I do in the TCO method to help my clients avoid costs that they don’t need to have to pay down the road.

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Because if it’s if it’s a one to two year play conversation changes completely versus a five to ten to twenty year hold.

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Right in my recommendations on a lot of things change based on what the disposition plan for that property will be.

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But the entire point of this.

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Podcast is to help you.

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The real estate person whether you’re a new investor experience investor property manager whatever.

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Make better more informed decisions right and this isn’t a sales pitch for my services I couldn’t possibly handle like I’m a one man show I can’t handle.

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That kind of business I do advisory services I do like outsourced procurement officer CPO stuff I do you know project pre planning.

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And I’ll do an evaluation I’ll do an audit where I just come into the operation I look at what you’re doing and higher operating I put a bunch of numbers on paper and I make a list of recommendations that says.

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This is all the stuff I think you need to do.

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This is where I see the opportunity for you to save money and make more in that operating income.

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And my fees pay for themselves like a hundred times over by the time you know it five years down the road.

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It’s just money in the bank for the owner who do it but there’s a lot of change management there’s a lot of internal operational stuff that has to go through it to make it effective right so.

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It’s not like oh my god I’m going to get this list and everything’s going to be perfect now you’re going to there’s resistance to change there’s.

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You know stuff that people should have known if they had done five minutes of research their stuff that people would never have known if they don’t do what I do because I because of what I do I get to see the inside books and what they’re paying across.

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You know 100 something vendors and based on the volumes that they’re purchasing and how their their relationships are set up I get to see what they’re paying for everything.

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And I use that information to help my other customers leverage where they should be in the market so when I’m telling people they’re over paying for stuff.

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There’s a ton of margin baked in on this side of the equation whether it’s manufacturing supplier distributor whatever it may be there’s there’s ways to trade buying power volume right.

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For service and pricing concessions from vendors if you’re willing to commit and there are certain vendors where if they can’t come to the table with a minimum discount there’s such a pain in the butt to deal with it’s not worth doing business there like if you’re dealing with home deep or lows.

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It is not worth doing business with them unless you’re going to save 15 to 20% off their retail prices.

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And I’m not just talking on paint I’m talking on everything 15 to 20% will do they have that margin yes they do their stores operate it like a 35% gross margin.

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The company is itself runs a net profit of between 14 and 16% every year.

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Yes they can afford to take a 20% discount on most things.

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They won’t only for people who have the buying power to do it but the reality is if you’re not getting at least 10% off on everything it’s not even worth walking in the door.

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Like we’ve placed orders for projects I’ve placed orders for customers where you order $5,000 worth of product and nine different delivery vehicles show up with nine different people in one day.

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Nine for five grand worth of stuff it was like 30 skews.

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Just the labor cost of meeting nine deliveries and checking products in eats up a few hundred bucks.

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Opportunity costs and hard cost labor just deal with them.

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And you don’t want your people driving there and shopping for hours at a time windshield time and off site time is just as bad as having to meet nine delivery trucks there’s no good answer there.

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Sometimes it’s worth ordering things that from hd.com and paying a little bit of a prayer hd supply and paying a little bit of a premium to have it show up you.

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Sometimes it’s worth dealing with the mom and pop down the street and paying extra money to support your local community get everything in one in one delivery.

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So there’s there’s trade offs and it all depends on how and every business is different I’ve never walked in.

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To a property management operation and seen the same set of circumstances twice.

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Like there’s there’s a lot of similarities a lot of companies are challenged in the same ways with similar issues.

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But the class of apartment the number of properties in the portfolio how the employees work maintenance and warehouse operations like everything has to be taken into account so everything has to be kind of tweaked and tailored to give the best solution overall.

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And there’s certain things where I’ll say this isn’t really costing you enough for you to do the change management part because I think it’s going to cost you around 7% of your budget to make this shift.

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Right.

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So there’s a ton of stuff that can go into this.

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But the long and short of the TCO method is it’s built around total cost of ownership for however long you’re going to own that property and it is everything all inclusive.

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It is your maintenance your overhead labor operations insurance.

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There’s yeah you name it if it’s a cost on your P and L right anything on your P and L it’s part of TCO potentially like there’s certain things that are going to be fixed that we have nothing to do with.

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But up a defined procurement operation procurement should be weighing all those things we talked about risk management cost avoidance compliance budgets and a Y targets.

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Right and then they should be signing your contracts for your insurance they should be shopping your subcontractors they should be looking at the contracts they should be doing if money is changing hands right so the definition of procurement.

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Is any product or service that is an input to your business for you to operate.

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Should be going through procurement and there should be a process.

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But when you say procurement in construction and real estate it’s usually purchasing it’s usually not a mature defined process and it’s usually the race to the bottom that we talked about in the last show.

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People’s eyes glaze over when you say procurement in any type of blue collar industry quite quite frankly.

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But it can literally add six figures to a single properties and a Y for a year by making a few adjustments and changing how you’re doing things.

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I’ve never seen I can’t say I’ve never seen I’ve never worked on an improvement project an NY improvement project that didn’t deliver a minimum of $50,000 in a year from two or three separate things being executed.

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And if it’s a value ad rehab it’s typically six figures and it’s typically an ROI to the business that decides to use it in less than 36 months.

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It’s not a hard concept to grasp and yet people don’t really see value and procurement or purchasing because it’s spending money.

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I have to spend the money anyway I’m going to just spend as little as possible.

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Well that little as possible is going to cost you more over time.

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Highest and best use best value to the company.

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And we’re not talking about cheapest price.

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cheapest price will almost always bury you in real estate.

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Low bid low cost provider will always cost you more in the long run just like deferred maintenance.

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Thank you for listening.

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I hope I helped to explain what the TCO method is total cost of ownership.

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Why you should be looking for certain things and at certain things when you’re making your decisions.

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And if you disagree please email me podcast at tco method dot com I will respond to that I will also respond to any of the TCO method social media channels Instagram Twitter LinkedIn.

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And please go and find this podcast wherever podcasts are sold.

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Yeah anyway Apple podcast Google Spotify Stitcher I heart pod bean wherever subscribe comment review.

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I appreciate it get the word out share it with your friends.

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Have a great rest of your day.