How to Monitor Your Management Company

1. Introduction

Professional property management firms can help relieve the day-to-day aggravation of management. In many instances management firms can even improve property cash flows to more than compensate for their fees.

Unfortunately, many owners have had bad experiences with management firms. The main reason for the bad experiences is that owners often neglect to do a good job in selecting management firms. Worse than that, owners forget the fact that just hiring a management firm is not the answer.

Owners have to work with their property managers. Owners have to set goals and objectives for their properties and review results from operations on a regular basis. With the right type and amount of interaction by the owner, property managers can become a valuable asset to the owner.

As an employer, or for that matter as an employee, we are quite aware that a performance evaluation is a very crucial step in the development of a mutually successful working relationship. Most employers schedule a performance evaluation or reviews on an annual basis. The review is used to provide detailed feedback and an opportunity to set meaningful goals for the coming year.

Similarly, every property owner should periodically perform a formal review of the performance of their property management company. This review should be performed to ensure that the owner's objectives are being met.

What follows in this article is an outline of what our firm, RealTax, does for our clients when they employ us to review their property management company/agent. The stated objectives of our reviews are to determine whether:

The property management agent complies with its property management agreement.
The operation of the property is accurately accounted for and reported to the owner.
Income from the property is accurately accounted for and passed through to the owner in a timely manner.
Disbursements are proper, authorized, and paid in a timely manner.
The property is adequately safeguarded and properly managed.

2. Prework

Approximately one month in advance of our review, the owner will notify the agent of the review. We will then obtain and review a copy of the signed management agreement for the property(s) being reviewed, including any amendments and extensions. We will also document concerns about the agent's performance that were discussed with the owner and their impact on the scope of the review.

3. Preliminary Review

Prior to visiting both the management company and the property, we will request and obtain a number of documents from the owner (ex: Agent’s internal procedures; management and marketing plans; walk-through reports; shopping reports; annual budgets; income and expense statements; rent rolls; sampling of rental agreements/leases; bank statements; etc.). If the owner cannot provide us with all the requested documentation, we will follow up with the agent to obtain this documentation

4. Work Program

a. Property Management

It has been our experience in better managed properties (small and large properties) that professional management companies have certain procedures that they follow to assure themselves and their owners that the properties are well and profitably managed. Our first step in reviewing the management company is to determine that the management company implements such procedures. To do so we:

Determine if the agent, upon taking over the property, conducted a walk-through and issued a report to the owner.
Determine if the agent prepared and sent a management and marketing plan to the owner.
Determine if the agent prepared and sent an annual cash budget, including recommended capital expenditures, to the owner.
Determine if the agent prepared a checklist of the condition of each unit at the time of move-out and that it has been signed by the agent and tenant prior to releasing any security deposit funds.
Determine if the agent prepared a checklist of the condition of each unit soon after each new tenant's move-in date and that it has been signed by the agent and the tenant.

b. Financial Statements

Financial reports are what owners and management companies require to assess the value and operating efficiencies of the property. As such, it is our practice to:

Determine if a balance sheet, general ledger, and income and expense statement are prepared and submitted to the owner timely.
Verify that the agent reviewed and approved the transmittal of the monthly report to the owner.
Verify the mathematical accuracy of the balance sheet. Trace all asset and liability amounts to supporting documentation such as bank account reconciliations, ledgers, and trial balances.
Verify the accounts receivable from the balance sheet and/or the delinquent rent report. Determine what collection efforts have been made for past due receivable amounts.
Verify that statements of accounts payable and accounts receivable are included in the monthly reporting package.
Verify the accounts payable from the balance sheet to the accounts payable ledger.
Verify the security deposits from the asset and liability on the balance sheet to the rent roll, the security deposit register or the detailed rent roll, and the bank account reconciliation.
Determine the amount spent for capital expenditures and identify individual capital expenditures over the agreed threshold limit to determine that they were authorized by the owner.
Verify the mathematical accuracy of the income and expense statement.
Compare actual income and expenses from the income and expense statements to budgeted income and expenses on the annual cash budget. Obtain explanations for significant variances from budget (ex: 10% or $1,000).
Verify the mathematical accuracy of the cash receipts and disbursements records and the schedules of accounts payable and accounts receivable.

c. Receipts

Income from operations is what is used to pay for bills and thus generate cash-flow. As such, we:

Determine if the number of units on the rent roll and the detailed rent roll agrees with the number of units in the building.
Verify that the number of vacant and occupied units on the detailed rent roll provided by the agent agrees with the latest rent roll sent to the owner.
For a sample of at least 25% of the units, verify that the unit number, tenant, rent amount, lease term, and security deposit amount as reported on the rent roll agrees with the leases.
Determine if the leases are properly signed and executed and conform with the owner's requirements.
Determine if new tenants have signed leases at rental rates approved by the owner.
Trace receipts from the rent roll and detailed rent roll to the income and expense statement and to the deposit register and the bank statement to ensure that all funds are accounted for and that funds are properly classified.
For security deposits not returned to the former tenant, we determine the justification for keeping the deposit or that the former tenant waived the return of the security deposit.
Using the detailed rent roll and the delinquent rent report, we verify that the agent is collecting full months' rent, recording uncollected rent as a receivable, properly accounting for prepaid rents, and making efforts to collect delinquent rents.
Determine whether there are any rental concessions and whether they conform to the management and marketing plan.

d. Disbursements

Controlling expenses is as important as maximizing the income. As such we:

Determine that the agent's management fees comply with the Agreement.
From a review of the manager's resume and discussion with the owner's personnel, identify the agent's employees and affiliates. Review any payments to the agent, its affiliates, or its employees for propriety.
Review the check register for large or unusual disbursements. Determine if any repairs, alterations, improvements, or contracts were for greater than 12 months or more than the allowed threshold and thus were pre-approved by the owner. Obtain explanations for any unusual disbursements.
Determine if the agent has contracted for utilities and other services as necessary for the operation of the property. Determine that the agent only paid for utilities authorized by the owner and provided for in the leases.
Verify competitive bidding.
Review canceled checks for all major disbursements to determine that they were properly endorsed by the payee. Review for unusual or second endorsements.
Determine that amounts which are due the owner have been remitted to the owner according to the Agreement. Trace remittances to posting to the owner's records.
Determine if there are indications that the agent has marked up the cost of in-house or outside goods and services by reviewing invoices, comparing actual amounts to budgeted amounts and reviewing for approval of variances, reviewing for competitive bids, noting if the agent uses several vendors rather than a few vendors, and discussion with agent personnel.

e. Custodial Accounts

Property management is a trust relationship. As such there is a fiduciary responsibility by the management to the owner. Therefore we:

Determine if the agent has established custodial bank accounts in compliance with the Agreement and that the accounts meet the requirements of the Agreement.
Trace the bank balance on the bank account reconciliations to the bank statement and the cashbook balance to the agent's cashbook and the balance sheet.
Examine the bank statement for alterations.
Verify the mathematical accuracy of the reconciliations. Verify that outstanding deposit and credit items were credited to the bank account balance promptly and obtain an explanation for any exceptions. Also, review old outstanding checks for essential items to ensure that payment has been made.
Determine that interest on custodial funds, if required by the Agreement, is credited to the owner.
Determine that voided checks have been properly voided.

f. Administration

Certain aspects of how the management company runs their own company is an important factor in determining how effectively they will manage your property(s). As such we:

Verify that fidelity bond coverage is in force and is adequate to protect the owner’s interests. If the bond is not adequate in relation to the volume of cash handled, advise the owner.
Determine if the owner approved the duties and compensation of employees hired to directly manage or maintain the property. Determine if the owner requested the agent to discharge any of its employees or contractors and whether the agent complied.
Determine if the agent has worker's compensation insurance for its employees. Verify that owner has been named as an additional insured on the policy.
Verify that the manager has complied with any agreed on changes to its internal procedures or financial statement reporting format.
Determine if the manager periodically evaluated the marketing skills of their on-site or off-site staff. Review shopping reports. Verify that the manager took appropriate action when quantitative and qualitative results indicated poor performance on the part of their staff.Determine if the agent has adequate procedures to respond to suspected drug and criminal activity and reporting property losses or other insurable incidents.
Determine if the agent adequately safeguards records related to the property, including leases. Determine that the agent has adequate control over its computer data files. Determine if the agent has adequate records to recreate data files, if needed.

g. Site Visit

No management review can be complete nor totally accurate without performing a site visit. As such we:

Perform an inspection of the property to verify that the property is adequately maintained and secured.
Determine if the agent maintains and repairs the property as needed by comparing records of maintenance and repairs performed by the agent to information noted in inspection reports and shopping reports and responses to tenant repair requests.
Verify that repairs, alterations, and improvements were properly performed for the larger items identified in this work program.
Obtain a list of vacant units from the most current rent roll. Inspect a sample of the units to determine that they are not occupied. If any of the units are occupied, review the lease for the unit noting whether the lease date is subsequent to the date of the rent roll and prior to the date of our inspection.
Using the rent roll and the detailed rent roll, select a sample of tenants and confirm directly with the tenant the amount of rent being paid and the status of the rent paid on the rent roll (prepaid, current, or delinquent).
Perform a petty cash count.

h. Follow-Up

As in the example of an employer-employee relationship, feedback and follow-up are essential to the relationship. As such we:

Summarize the findings noted during the review and provide backup documentation to support these findings in the work papers.
At an exit conference, we discuss the findings noted with the agent's management. Obtain responses of intended corrective action and the date of expected completion from the agent's management for inclusion in the report.
Prepare a final report on the results of the review. Advise the owner for follow-up on correction of the findings noted.

In closing it is important to note that successful management requires the owner’s attention and scrutiny. This can be accomplished best by the owner’s direct involvement and review. Alternatively, the owner can hire a real estate accounting firm to do the bulk of the review work. In either case, the management agreement is the key tool that should be used to set expectations.

RealTax professionals have the knowledge and experience to help you monitor your management company. We specialize in real estate oriented accounting, tax planning, tax preparation and related services. We invite you to contact us with regard to your specific needs.