Handling Tenant and Owner Funds
The most important indicator of a property management company and a reflection of the systems they have in place are its accounting and handling of tenant and owner funds. It is an area of management with the most enforcement actions and loss of licenses. It also one of the areas of property management that present the most liability to the owner.
Here are a few questions that you should ask the property manager.
Payment to Owner
- What day of the month should owners expect their funds?
- Do they provide direct deposit or ACH?
- Will the check be for that month, or will the management company hold an extra month of rent?
- Have the property manager explain to you the accounting process and how rents are collected. They should have knowledge of how funds get from the tenant to you with a specific timeframe.
As mentioned earlier in the article one of the most frequent reasons real estate licenses are lost in almost any state is the handling or misuse of security deposits.
As a company we occasionally see scenarios when picking up new clients where a previous property manager hired by an owner has spent, or disappeared with the security deposit. Unfortunately for the owner the security deposit still remains the responsibility of the owner and the owner ends up spending their own funds to replenish the security deposit account.
Remember laws on handling security deposits vary from state to state so check with your legal counsel or State Real Estate Authority. Here are just a few questions you should ask.
- How do you handle the security deposits or trust accounts?
- What is the typical security deposit amount?
- Remember State laws vary on this as well and the property manager should have a firm grasp on the laws that govern them. For example below are the laws from the Department of Consumer Affairs Website in California as of the writing of this blog.
Unfurnished rental unit: The total amount that the landlord requires as security cannot be more than the amount of two months' rent. If you have a waterbed, the total amount allowed as security can be up to two and-a-half times the monthly rent.
Furnished rental unit: The total amount that the landlord requires as security cannot be more than the amount of three months' rent. If you have a waterbed, the total amount allowed as security can be up to three-and-a-half times the monthly rent.
Plus first month's rent: The landlord can require you to pay the first month's rent in addition to the security deposit.
- What is the Management Company policy on what type of funds can be used for security deposit?
- Move in funds should always be certified funds. Such as a cashier’s check or money order. A traditional check could bounce and the tenant would already have possession of the property.
How quickly can complete the security deposit distribution?
- Each state has varying laws, in the state of California as of the writing of this blog the maximum amount of time that the property owner, property manager or other representative has to return the security deposit funds is 21 days. If it does go over the 21 day mark the court will decide to award the full security deposit back to the tenant regardless of damages caused.
- Does the Management Company provide you with an IRS-1099 and a Profit and Loss Statement at the end of the year?
- When should the owner expect the year end documents?
- Do they keep detailed documents such as receipts, invoices and other bills?
The goal is to provide a clear audit trail for all funds for each property. Look for a company that keeps and is happy to provide you with copies of all invoices. This will also help with tax and liability issues.
- Do they have full time accounting staff or outside contractors?
This will give you an indication of how informed staff will be on the financial condition of the property.
- How often do they send out reports? When are they sent out?
Monthly is the standard and in some states the legally required minimum.
- Do you have online Report access?
All owners deserve transparency and it reduces the possibility of fraud.
- What accounting system the company uses?
Property Management is almost no different than a professional bookkeeping service in this regard and the property manager should be using software that reflects that commitment and investment into the business. Excel will definitely NOT be suitable software for property management.
- What kind of Reports do you offer?
- Reports are often one of the few times you will see the financial health of your investment. Make sure you understand the statement but also have the property manager go over a sample statement with you. This is to confirm that not only you understand the statement but your property manager does too.
Reports should be easy to read and show collected rent, deducted property management fees, maintenance, net dollar amount, etc.
- Do they make payments for owners (mortgage, insurance, property taxes, hoa dues, etc.)?
- What are their policies in regards to paying vendors?
Do they have vendors perform work and then not pay them until rent is collected or the unit is rented? Keeping vendors waiting for long periods of time strains the relationship and forces the vendor to raise their prices to compensate for the delay’s negative impact on their cash flow. A properly funded reserve should prevent this from being a problem.
- Do they have an Accounts Payable Process?
- All property management companies should have a payables process to reduce the possibility of mistakes such as double payments and the possibility of fraud.
Given the potential liability and responsibility to maintain accurate records, it is always a good idea to raise these questions during the interview process and to make sure you understand the company’s approach to accounting. Next, we'll look at the management company's policies and practices regarding rental market analysis, setting and collecting rent.