Investors can take advantage of real estate economies of scale to lower their costs and increase the value of their investments. Economies of scale are cost advantages that businesses have when they become large enough to enjoy lower per-unit production costs. For example, a builder with more than one project going on at once might be able to buy materials in bulk at cheaper prices than someone who is building one home at a time. The same goes for real estate investors who have multiple properties under management. They can take advantage of economies of scale in areas like marketing, advertising, or even just having stable cash flow coming in so they can minimize the risk in their real estate portfolio.
Real Estate Economies of Scale Matter to Investors
Real estate economies of scale are cost savings that can be attained by increasing the size of a business. They allow businesses to reduce costs and increase profits, which in turn allows them to grow even larger.
You can break economies of scale into two broad categories: internal and external. Internal economies of scale refer to the cost savings that firms gain from being larger and better able to take advantage of their size. External economies of scale occur when a business takes advantage of an industry-wide process or service that reduces costs for everyone within it, but not necessarily just because they’re large.
When investors choose to own larger properties, each property helps improve the economic outlook of the company by adding economies of scale that cut costs, minimize risk, and improve profits. It is the reason many real estate investors would rather invest in multifamily over residential units. One of the many benefits of real estate investing includes direct control through your activity. Because of this, real estate economies of scale far outweigh any scale benefits you may see with other asset types.
While extremely beneficial to an investor, attaining economies of scale can be incredibly difficult when building a portfolio on your own, which is one of the main reasons many investors choose to partake in group real estate investing, such as with a real estate syndication or an investment fund. This way, an investor can capitalize on their general partner’s economies of scale and receive a higher return on their investment, while putting in less effort to do so.
Types of Scale Benefits in Real Estate
Technical Economies of Scale
In real estate, technical economies of scale occur through improvements and process optimizations in production. As the output increases, a real estate firm can invest in more efficient equipment and software to improve operations. While these investments may have a high fixed cost, larger firms can spread this cost out over the many units they produce. Technical real estate economies of scale could be as simple as improving the software that manages their investments or it could go as far as improving the process of development of warehouses.
Managerial Economies of Scale
The term managerial economies of scale refer to the ability of real estate managers to realize efficiency gains through specialization. As a company grows, it can hire more people who specialize in different areas of a business. Instead of having a team of generalists, a larger firm can afford to hire employees who handle asset management, who handle IT, and who handle finance. As the company gets larger, you can break this down even further. Asset management generalists will then break down into leasing experts, property management experts, and maintenance.
A specialized workforce can be more efficient, knowledgeable, productive and motivated than an unskilled laborer or a generalist manager. Specialized employees also tend to be more innovative and creative because they have been trained in a specific area that they know well. When you hire a plumber who is skilled at his trade, he will likely perform better than someone who has little experience with plumbing but can do many other things well (such as working in sales). The same is true for real estate professionals: those with experience handling similar transactions may provide better results than novice agents who have never sold before.
Finally, managerial economies are achieved through flexibility: having multiple professionals on your team allows different people to take care of different tasks when needed so that others can focus on what they do best without having to worry about other responsibilities like marketing or accounting.
Marketing Economies of Scale
Marketing economies of scale are the cost savings that come from being able to reach a larger number of customers. When you buy one ad, it’s less costly than buying multiple ads because you only must pay marketing costs once. Marketing is more effective when you can reach many people—it’s important to consider the respective benefits and drawbacks of both large and small scales when thinking about your business strategy.
In a multifamily property that has 3 vacancies, your advertising cost per unit to fill that unit will be far lower than if you need to run 3 advertisements for 3 vacant properties in a single-family portfolio. On top of that, if the single-family investor owns 24 units, and the multifamily investor owns 48 units, the multifamily investor can spread that marketing cost over the 48 units and achieve a lower cost per unit. Additionally, when you invest in larger properties, a property’s brand will be far stronger, and you may even need less advertising to fill vacancies.
Financial Economies of Scale
Financial economies of scale are achieved through cheap access to capital and financial markets. As organizations grow, their credibility also does, including the credit of the firm. Financial real estate economies of scale include:
- The ability to borrow money with different types of loans at lower interest rates
- The ability to use financial instruments such as bonds and mortgages
- The ability to invest in capital projects. This can include new buildings, renovations or even improving internal processes (which may result in more efficient operations).
When investors join a real estate group, they benefit from the financial standing of the real estate syndication or investment fund. For instance, when an investor joins a real estate syndication, the investor can use leverage on their investment by partnering with the deal sponsor, without putting their own credit score at risk.
Commercial Economies of Scale
The second type of commercial economies of scale, which is often referred to as “bulk discounts” or “bulk purchasing,” occurs when a company purchases large quantities of goods or services at reduced prices.
In the context of real estate investment, this can be achieved through discounting and bargaining power. For example, if you owned 10 units in the same region, you would likely get a better price with contractors since you can negotiate for all of them—creating more buying power for you. This is similar to how big box retailers get discounts for buying in bulk from manufacturers: they pay less per unit but have enough volume that their overall costs go down compared to buying from the manufacturer individually (and therefore make more money).
Networking Economies of Scale
Network economies of scale are achieved when the marginal costs of adding additional customers are extremely low or decreasing. These real estate economies of scale exist when a company expands its network of users by making it easier to use, more valuable, or more efficient for each user.
Investors often overlook network economies because companies can’t see them or measure the impact that they have on sales and profits. However, these hidden assets are often the most powerful kind of economies of scale—and a key driver behind business growth and profitability. At Eikon Investment Group, we use an innovative modern investor portal to help our investors better manage their investments. By making the investment process easier to use and more efficient for each of our clients, we have built out a network economy of scale.
Risk Bearing Economies of Scale
As companies grow, they increase their real estate economies of scale, which helps them grow even further. As a result, firms generally hold more diversified portfolios than individuals, because they have access to a broader range of funding options and can thus take on more risk in order to achieve a higher return on investment. With more diversified investments, larger firms can protect their capital through the down real estate markets and unstable economic cycles.
The larger firms can afford to take more risks with other successful revenue streams, such as real estate rentals or commercial development. This gives them an edge over smaller companies that are less likely to be able to diversify their economies of scale across different property sectors and investment strategies.
Get Started Scaling
We hope that this article has provided you with a better understanding of the concept of economies of scale and how it applies to real estate investing. Real estate is one business where economies of scale can have a huge impact on your bottom line boosting profits and improving your brand. If you’re looking to grow your portfolio in an efficient way, then you need to invest with economies of scale in mind! By choosing a competent syndication sponsor who understands how to implement real estate economies of scale, you’ll soon be on your way to generating wealth through this powerful investment vehicle!
If you are eager to experience the perks of investing in real estate, you can always reach out to us at invest@eikoninvestments.com or register as an investor to start being notified of our investment opportunities.
Happy Growth.
