By Carla Toebe, New Century Realty, Kennewick, WA

If you have decided to delve into the world of property management then the banking procedures will be a bit more involved than simply having a bank account, making your deposits and payments, and balancing the register at the end of the month. I want to stress that every state’s laws are different. Much of what I talk about in this article relates to the best practices specific to the state of Washington.

The first rule of business is to establish a trust account with your commercial bank. Oddly enough, once you have sat through the session to get this going, do some telephone banking and ask the representative what kind of account you have set up to make sure it was actually set up as a trust account. Just because they tell you that it is a trust account doesn’t mean it is. You have to follow up to make sure that the personal banker did their job correctly. You could find out the hard way that this account was never in fact a trust even if you were told it was. If it isn’t a trust then it will not be protected from potential seizure in the event of bankruptcy or other issues with separate personal or business accounts. Do your due diligence and don’t rely on the initial set up.

Additionally, you should not have any business operating funds coming into or out of this trust account. The account should only have tenant money or client money. All this money should be attached to a property. You must pay out a monthly commission as stipulated by all management agreements at least once monthly. The checks should also state that it is a property management trust account and the leases should state where and what bank the security deposits are held. If the owner of the property is holding the security deposit then you should hold back rental income in order to keep the security deposit in your trust because you are responsible for that deposit while you are managing the property.

The security deposits may be kept in the same account as the rental income but if you have many units with the same owner then it is advisable to get a separate interest bearing trust account and another trust account for the rental income. If you are dealing with multiple owners that do not have a large number of properties then it is better to get a combined account for both rental income and security deposits. If you have an interest bearing account you should be transferring the interest each month into the regular trust account as interest income to the owner. You will need to transfer the security deposit into the regular trust account before you can pay the owner any money from the refund due to charges as well.

If you keep a combined account, all the security deposits held on account as stated on the balance sheet and the rent roll must match the security deposit liability and the cash in the register must match the accumulation of all the owner balances plus the security deposits. You must balance the rent roll with the balance sheet and the register with the bank statement each month. Failure to do so could put you out of compliance with the state and if you are not in balance each month it could be a serious problem.

There should be two places for receipts, the computerized accounting system and the handwritten deposit ticket for all the payments. Copies of all checks should be kept, whether carbon or photocopied. Copies of duplicate deposit receipts should also be kept once the funds are deposited.

It is always a good idea to write a detailed process and policy for your property management banking to show that you are practicing due diligence with other people’s money held in trust. This way anyone who handles the trust account is fully knowledgeable and accountable about the importance of practicing all the state law requirements.

The rules, regulations, and customary practices vary wildly across the country. As I mentioned above, these are some of the best practices for Washington. For example, in Washington it is O.K. to comingle rent and security deposits in the same bank account, however it’s a big no-no in Massachusetts, and in California it’s customary for rental owners to hang onto the security deposit. Also remember that rules about reporting vary from state to state, i.e. if it’s not customary to get a full month’s rent as security, then your rent roll won’t tie to security deposit liability.

Clients put their trust in property managers and believe that they are doing the right thing. The way you handle your banking will solidify this trust with both clients and tenants, thus keeping you out of trouble!

Editor Note: If you’d like to contribute an article about your state’s best banking practices, please send an email to Justin@buildium.com

By Salvatore Friscia, San Diego Premier Property Management, San Diego, CA

For property management companies, the month of January signals a time to prepare and issue year end statements to their clients for tax preparation purposes. Consequently, each January the IRS requires that any taxpayers who have made payments in excess of $600 to workers that are not considered employees must prepare Form 1099 – Miscellaneous Income. Property management companies are also federally required to file Form 1099 for their clients regarding rental income received throughout the year. In addition, copies of this completed form must be provided to the IRS. The IRS compares the payments shown on the information returns with each recipient’s income tax return to determine whether the payments were reported as income and done so properly.

-The filing deadline for Form 1099 is January 31, 2012.

-The IRS also requires that you file a Form 1096 to identify all of the Form 1099s.

-The filing deadline for Form 1096 is February 28, 2012.

Failure to issue a Form 1099 and file Form 1096 results in penalties and potential disallowances of deductions for those amounts paid. Thus it is imperative to comply with these filing requirements. In years past, SDP Management would spend a lot of time and resources preparing large bulky paper laden year end packages to meet these requirements. The packages, which contained printed year end statements and other tax required documents, would detail the properties prior year performance and provide necessary documentation for the client’s CPA or tax preparer. All packages would be carefully prepared prior to the end of January and mailed via snail mail (USPS) at a considerable cost. Well, the industry has advanced and those days are long gone. The advent of cloud computing and advanced property management software, such as Buildium, have allowed property managers to formulate numerous detailed reports and provide them via email in PDF format to clientele at a fraction of the cost and time.

These reports also meet state and federal requirements. It has also allowed the tedious and many times misunderstood Form 1099 to be computer generated and scheduled for automated mailing. Not only is this convenient for property management companies, but it also allows clientele to continue forwarding the year end PDF report to their CPA or tax preparer regardless of where they are in the world.

Don’t let 1099s and year end reports get you down, use January to focus on the upcoming year and not the past.

By Geoff Roberts, Buildium, Boston, MA

As many of you know, Buildium has been publishing a property management industry blog since 2008. That said, it wasn’t until earlier this year that we gave the blog a face lift, a new name and domain, and hired a staff of contributing writers from across the US and beyond (Hi Jo-Anne!). In doing so we’ve seen a significant increase in our readership, and we hope that you’ve found our All Things Property Management blog to be a valuable resource for your property management business.

I’m very excited to announce that All Things Property Management is now also a contributor to Zillow Blog. Zillow, which publishes hundreds of thousands of rental listings across the country, will be publishing selected articles from the All Things Property Management blog. Some articles will then be syndicated to other sites, including Fox News, Yahoo, US News and World Report, The Street, and a variety of other sites. While All Things Property Management speaks directly to an audience of professional property managers and others interested in learning more about managing real estate, Zillow Blog is focused more on an audience of renters. With this in mind you’ll see that our articles have been rewritten to address renters – by educating property managers and residents alike, we’re moving the industry towards manager-resident bliss – one blog post at a time.

I’d like to take this opportunity to thank Salvatore Friscia, Ben Holubecki, Peter Lamandre, Colin McCarthy, and Jo-Anne Oliveri for all of their hard work and contributions to the All Things Property Management community. Salvatore Friscia recently had his article Renters: How to Get Your Security Deposit Back published on Zillow Blog and Ben Holubecki’s article 10 Tips in Communicating With Your Landlord was published on Zillow Blog and US News and World Report.

We’re excited to keep growing All Things Property Management and are striving to become the best property management industry blog on the web. Keep on tuning in!

By Salvatore J. Friscia, San Diego Premier Property Management, San Diego, CA

Every property owner should require tenants to issue a refundable security deposit which is held on file to insure against non-performance of the lease agreement. Non-performance may be, but is not limited to, anything from damages occurring during occupancy to expenses accrued due to the tenants conduct or failure to pay rent.

The confusion begins with the property owner not knowing how much to require the tenant to issue for the security deposit. It is important to understand that security deposits for residential properties are controlled by statute and call for nondiscriminatory  and equal treatment. It is a prohibited discriminatory practice to charge a family a different amount then an applicant without children. It is also prohibited by law to require an excessive amount for the security deposit. In addition to collection of one month’s advanced rent, the maximum security deposit allowed (at least in the state of California) for an unfurnished unit is two months rent and three months rent for furnished properties. [California Civil Code 1950.5(c)] Check your local area laws for similar guidelines in your area.

Many owners will ask for the first and last months rent along with the security deposit. This is allowed; unfortunately most renters are unable to afford twice the rent plus the security deposit upfront. Some owners will offer their property with a reduced security deposit. The owner will advertise the rental property at $1,000 monthly requiring a security deposit of $500, half the monthly rent.
Now, initially this looks like a good idea, an incentive for the prospective tenant to take occupancy without having to pay a large amount upfront. This security deposit structure is common with larger apartment complexes. Most individual property owners don’t realize that large apartment complexes typically have a higher rent roll and more funds on reserve to draw from in the event of unexpected non-performance that exceeds the security deposit funds on file.

Now let’s look at why most professional residential property management companies would advise property owners to require the tenant’s security deposit to be at least equal to the initial rental rate. First, it weeds out the financially challenged tenants or prospective tenants that may be stretching their finances to reside in your property. If a prospective tenant is unable to pay the full security deposit upfront, this could be a sign of financial instability. Second, it provides an emergency buffer that can be used if the tenant defaults on their rent. Third, some tenants will vacate the property unannounced (without giving notice) thinking the security deposit can be used as the last months rent regardless of what the rental lease agreement states. When this occurs the property is usually in need of repairs and you are left without the last months rent and an insufficient security deposit to cover the cost associated with preparing the property for another tenant.

If this occurs you can serve a 3-day notice to pay rent or vacate — upon expiration  you can file an unlawful detainer action against the tenant. This will allow you to use the security deposit to make the necessary repairs and apply the remainder, if any, towards unpaid rent. If there is a remaining amount due, the owner could place a demand on the tenant for that amount and if unpaid pursue them in small claims court.

Depending on your property location and the local market conditions, when given the choice of having more or less security deposit funds on file, having more only makes sense. Stay consistent and within the law when requesting a security deposit and require your tenants to issue a deposit at least equal to the monthly rental rate.

Keeping records on hand is important for a number of financial and legal reasons. Just because you’ve paid off an account or a tenant has vacated a unit, it doesn’t mean that you’ll never have cause to deal with these vendors or individuals again. Whether it’s for taxes, future loan applications, or legal issues down the line, you always want to be sure you have access to the information you need at any future point. Following are a few things to keep in mind about keeping records.

What kind of records do I need to hang on to?
As a business owner you will want to hang on to records that pertain to:

• Personnel
• Tenants
• Financial transactions (both payments received and payments made)
• Property-related information (both your properties and your clients)
• Insurance
• Legal documentation
• Audit documentation

How long should I keep records for?
The answer is: It depends. While the default answer for this question tends to be “seven years,” that is only the case in certain instances. Different types of records should be kept for different periods of time. Standard time periods include one year, three years, seven years, and, in some cases, permanently. As it relates specifically to property management, you will want to keep the following information for these specific periods of time:

One Year

• Employee applications
• Purchase orders
• Meeting minutes

Three Years

• Banking records
• Expired insurance policies
• Correspondence (with clients, tenants, real estate agencies, vendors, etc.)
• Internal audits

Seven Years

• Accident reports/claims
• Accounts payable ledgers
• Accounts receivable ledgers
• Bank statements
• Expired contracts and leases
• Employee records (seven years post-termination, not beginning of employment)
• Expense reports
• General journals
• Invoices (both incoming and outgoing)
• Payroll records
• Purchase orders

Permanently

• Articles of incorporation
• External audits
• Canceled checks for property purchases and taxes
• Deeds and mortgages
• Year-end financial statements
• General ledger balances
• Licenses and permits
• Property appraisals
• Property records (costs, blueprints, etc.)
• Tax returns

Happily, thanks to digitization, keeping all these records doesn’t mean that you need to have stacks of boxes clogging up office space. Many of the items included in this list can also be kept electronically. Remember, though, computers crash and are replaced over time and records can go along with them. Particularly when it comes to records that should be kept for longer periods or permanently, make sure that they are electronically preserved either on an external drive or on a secure server. If your records are overwhelming (or if you want to digitally archive all old records in one fell swoop) outside contractors that specialize in this function can be hired. Hard copies of vital records (such as deeds, mortgages, and property records) should be protected in disaster-proof climates, such as a safe or vault.

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To generate more rental income, it’s sometimes necessary to put a little work into your property. If a potential renter is comparing your property to a similar, less expensive property, the renter will need to be able to easily identify those aspects (whether it’s aesthetics or features) that make your unit worth more than the competition’s. Depending on where you’re starting from and where you want to go, upgrades may consist of as little as some simple “rejuvenation” projects or, alternatively, some larger-scale renovations.

Generally speaking, your bathroom and kitchen are two key areas that play a large role in making or breaking the value of your rental unit as compared to competitors’. All other factors being equal (such as size and location), chances are most renters will select the unit with a nicer looking or more upgraded bathroom or kitchen. Many renters will even be willing to pay a bit more if there is a noticeable difference or greater utility in one or both of these two rooms. In other words, these are the first places you should make improvements if you want to command additional rental income for your property. What does this mean exactly? Let’s take a look.

Renovation
There’s not really any way around it—complete renovation of a bathroom or kitchen (appliances, lighting, tiling, fixtures, etc.) will cost you a few thousand dollars. However, it will also likely pay off in the form of a higher rent rate.

Consider a renter who is looking at your apartment and another similar one in your neighborhood. The apartments are the same size and age. However, your apartment has a new, updated kitchen complete with a dishwasher, updated appliances, new tiling, flooring, and lighting. Similarly, your bathroom has recently been redone—new tile, new tub, new sink, the whole nine yards. With all of these new upgrades, it’s likely that you can now command up to an extra $200 per month, depending on the rental market in your area. With that in mind, even if you spend a few thousand on each room, you will earn your investment back quickly because of your new-found ability to command a higher rent rate.

Rejuvenation
Let’s say that you simply don’t have the desire (or the financial resources) to make these overhauls. You can still drastically improve the aesthetic appeal of your units by making smaller changes that have a big impact. For the kitchen, put in new countertops, flooring, or up-to-date hardware on cupboards and drawers—this is a great way to modernize a dated kitchen, and can be done fairly inexpensively. Similarly, you can put new faucets and lighting fixtures in the bathroom or perhaps update the mirror for a more modern look. You can also consider re-doing bathtub porcelain with Miracle Method, which will cost far less than replacing the tub altogether.

Changes like these are far cheaper than a complete overhaul (a few hundred dollars as opposed to a few thousand dollars) and will still allow you to raise rent prices, though perhaps less significantly.

In addition to renovating or updating bathrooms and kitchens, remember that flooring or carpet should be thoroughly cleaned, waxed, or polished (or replaced if necessary). Particularly when showing vacant apartments to potential tenants, flooring provides a clear indication of how well-kept your unit is and adds to aesthetic appeal. The better impression you make, the easier it will be to command the rental rate you desire.

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If you’re overwhelmed with the amount of work to be done at your property management company, hiring additional staff is a logical place to start. Before you rush out and post a Craigslist ad, consider the type of work that’s really drowning you — is it maintenance work and showing units to potential tenants, or more administrative type work? The links below will help deal with the extra workload, whether that includes finding the right employee or the right software application for the jobs at hand.

• Entrepreneur.com weighs in on How to Decide When to Hire an Employee.
• If you are a small property management shop or an individual looking to grow your business by adding your first employees, this article from the Wall Street Journal is a great place to start.
• You’ve already decided that software can help save you the time you need by streamlining your more administrative type tasks. But should you be looking for web-based or installed software? 37Signals makes a case for web-based software.
• If you think that software is your company’s best bet, we’re a bit biased towards Buildium. You can hear more about our property management software in this video. You might also want to check out the Buyer’s Guide provided by Software Advice.

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There’s no doubt about it—of all the business problems you could potentially have, being too busy is certainly not a bad option. However, being too busy can become a problem if you lack the bandwidth to stay on top of things. If you consistently find yourself putting off certain tasks or letting them fall through the cracks altogether, it’s time to make some changes. Being overloaded can result in a slip in the quality of the service you provide or oversights, both of which may guarantee you’re not so busy for long.

The obvious answer to too much work is bringing more hands on deck. But, of course, just because you’re busy doesn’t necessarily mean you have the budget to hire additional employees. Property management software may give you the extra help you need at a lower cost than an additional salary.

Multi-tasking Functionality
One of the great benefits of property management software is that it essentially acts as an office generalist. For example, hiring extra staff to take care of accounting work may alleviate that workload, but that same person can’t necessarily take on other tasks such as advertising. Modern property management software, on the other hand, handles a diverse variety of functions. It does accounting, allows tenants to make rent payments online, provides an advertising platform, runs credit and criminal checks, creates reports, and keeps records.

Cost-effective Investment
Property management software requires only a nominal investment when compared to hiring new staff and adding an additional salary to your payroll. Depending on what type of software and package you choose, you may pay an upfront fee, an annual fee, or a monthly fee.

Streamline Systems
A good property management software system will do away with redundancies. Rather than entering information multiple times for multiple purposes, you only have to do it once, saving time and effort. For example, when you pay bills through a software program, it simultaneously records the transaction for you.

Buy Time
At the end of the day, property management software essentially buys you the oh-so-precious commodity of time. Not only does it take care of calculations, notifications, and receivables for you, but it can also decrease the time required on your part to provide great customer service. By providing relevant parties with usernames and passwords they can both look up records and enter things like payments and maintenance requests by logging on to the software program (assuming you select a web-based program).

There are certain situations when taking on a new employee is required. If, for example, you need help performing property maintenance or showing units to potential tenants, no software program in the world will do the trick. However, if you simply have more administrative, accounting, or customer service work than you can handle, software may well be just the cost-effective, low-maintenance solution you’re looking for—no salary or extensive training required.

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The business entity you choose for your property management company will affect you in very real ways—especially when it comes to taxation and financial and legal liability. This is a big decision and one that you may want to make with the assistance of your accountant or attorney. Following are the four business entities most commonly used by property management companies and some basic information about each.

Sole Proprietor
The title of this business designation pretty much says it all—a sole proprietorship is a business owned by one individual. Unlike more complex options, sole proprietorships do not have to be legally registered with the state you do business in. Rather, a sole proprietorship’s existence is solely based on the fact that you’ve gone into business. In other words, it’s simple and free to set up.

Sounds too easy, right? Well, there is a drawback. Because you are one and the same with your business, business gains and losses are filed on your personal tax forms and, most notably, you are liable for the business, both financially and legally.

Partnership
A partnership is much like a sole proprietorship, but it involves two or more owners. As with a sole proprietorship, no paperwork or registration is required—you are simply in business. Again, partners claim their share of business income on personal tax forms and are held liable for the business’ financial and legal claims.

Limited Liability Company (LLC)
LLCs are a bit more complex to set up than sole proprietorships or partnerships, with paperwork and costs due upon establishment. One of the great benefits of a LLC is that (as the name indicates) owners’ legal and financial liability is limited. Note, however, that in terms of taxes, LLCs function more like sole proprietorships and partnerships—each owner pays taxes for his share of the business on personal tax forms.

Corporation
Corporations are completely separate from individual owners for taxation purposes—in other words, personal and business taxes are filed separately. Personal income gleaned from the business (salary, bonuses, etc.) are filed on personal taxes, but corporate income remains solely on the business’ tax forms. Likewise, owners are not liable for business finance and legal issues.

When setting up your business, think carefully about how various business designations will affect both your taxes and liability. Protecting both should be your primary consideration.

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Whether numbers are your forte or not, there are certain ratios and calculations every property manager should understand. Following is a look at five key ratios that apply to your property management business, how to obtain them, and what they tell you.

1) Vacancy Rate
Your vacancy rate demonstrates the number of units available or unoccupied versus the total number of units available for rent on a property. The lower your vacancy rates, the better. The formula for this is simple:

Vacancy rate = Total number of unoccupied units in a property ÷ Total number of units in a property

This total can then be converted into a percentage.

While average vacancy rates vary from region to region, according to a January 2011 article on MHN Online, “[President of Axiometrics, Inc. Ron] Johnsey’s forecasts call for the average vacancy rate to drop in 2011 to 5.8 percent—a solid statistic considering apartment properties aim for vacancy rates of 5 percent for optimal rent increases.”

Note that your occupancy rate can be easily determined by subtracting your vacancy rate from 100 percent. For example, with a vacancy rate of 7 percent:

100% – 7% (vacancy rate) = 93% (occupancy rate)

2) Depreciation
Depreciation helps you determine how much value your property has lost over time due to age and wear and tear. Depreciation is considered an expense and will come into play as a write-off when completing taxes. Note that depreciation is completed over a 27.5 year period and applies only to the actual building on the property, not the land. To calculate depreciation:

Purchase price – Land value = Building value

—then—

Annual depreciation = Building value ÷ 27.5

3) Operating Expense Ratio
The operating expense ratio is simply the ratio between total operating expenses and the gross income of your property. This total amount shows how much of your property’s income is being used to actually support and run the property. Operating expenses include those expenditures that support the operation and maintenance of a property. Gross income is the actual yearly income—this may include not only rent, but also income from things like laundry machines and parking fees.

Operating expense ratio = Operating expenses ÷ Gross income

This total can then be converted into a percentage.

4) Capitalization Rate
The capitalization rate (or cap rate) will help you determine the actual value of a potential investment property, beyond the actual property’s more straightforward appraisal value. In other words, how much can you really expect to make off of this property, once expenses and operating costs are accounted for? To obtain this figure, you’ll need both the operating income and recent sales prices for comparable properties. Once you have both of these amounts, you can figure the cap rate, which will help you determine exactly how valuable a potential investment property will be for you or the potential property owner.

Cap rate = Sales price of a comparable income property ÷  Net operating income of comparable income property

This total can then be converted into a percentage.

5) Net Operating Income
Like cap rates, calculating the net operating income (NOI) of a property will help you determine how valuable it will actually be. In order to determine this figure, you will need to calculate both your gross potential income and vacancy and credit loss (in other words, the realistic loss of rental revenue due to vacancies, etc. based on previous years’ statistics). You can then complete the following calculations.

Gross operating income = Gross potential income – Vacancy and credit loss

—then—

Net operating income = Gross operating income – Operating expenses

Whether you’re attempting to gain a better understanding of where an existing property currently stands or how much a potential property investment will ultimately pay off, the black and white numbers provided by the formulas above will help provide a clear picture of how your current (or future) properties are actually performing.

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