The typical residential real property invester seeks property that provides a decent rate of return. Frequently, however, there is a limited inventory of suitable property in the investor’s locality. And, importantly, underpriced real property that will almost certainly be a good investment is often located in remote areas that will make it difficult to personally manage.
One of the primary deterrents for the novice real property investor is the knowledge that he or she will have to deal with tenants—who may or may not pay their rent. It is one thing for a real estate salesperson or broker to compute the investor’s potential rate of return in the abstract but quite another to face the reality that the “perfect” tenant you are inheriting has chosen to not pay rent, or has trashed the property or has caused anyone of a thousand different problems. You are then faced with the prospect of removal (eviction) of the tenant by filing a lawsuit (in California, this is known as an unlawful detainer action). Further, you might have to repair the unit in order to make it suitable to rent, and, importantly, locate a suitable new tenant.
Almost always, the solution to this problem is to engage a property management company. In most areas, there are numerous property management companies advertising for business. Each one claims to be the best—but how do you know? What criteria should you use? How do you know if they are doing a good job or properly accounting for the rent they collect?
The answer is, there are certain hallmarks you can and should look for in a professional real property management company. If the company cannot demonstrate that they satisfy the criteria, look elsewhere.
What specifically should you look for? Here are my top 13 tips:
Make sure the property management company is licensed. While it varies from state to state, usually a property management company (“PMC”) must be owned by or have as a responsible employee, a licensed real estate broker.
Other states, such as Nevada, require the real estate broker to have a special endorsement to their license authorizing them to conduct business as a property management company. You should always check on the license status of the broker to make sure they are authorized to provide property management services.
Ask for references and check the background of the company. As a starting point, it is always a good idea to ask to speak with two or three of the PMC’s existing landlords. While they may not tell you everything about the company, you may be able to glean how effective the company is in meeting the needs of property owners. Another source of information is the civil register of your local superior court. Usually, you can conduct a name search to determine how many times the company has been sued by either landlords or tenants or third party service providers. Also, do not forget to check the Better Business Bureau and online services such as Yelp to find out what others are saying about the company. Find out what the occupancy rate is on the units it manages. Ideally, the occupancy rate will be 95% or higher. You should also make sure that the company has a local business license and that it is properly insured.
What are the terms the PMC is offering for management of your property? Carefully review the contract. A typical term might be a one-year agreement with a management fee of 8-10% per month of rent collected. The contract will also likely include other fees such as set-up fees and a leasing fee (usually 50% of the first month’s rent or 25% of one month’s rent for lease renewals). It is also important that the contract provide for the establishment of a separate trust account in which all income derived from the property is deposited. The PMC should only be authorized to disburse money from this account for operating expenses and, in certain circumstances, debt service, with the balance of the funds to be disbursed to the owner. Additionally, detailed monthly accountings must be provided to the owner. Finally, make sure that the contract also (1) authorizes the broker to lease and enforce the leases he/she enters into on your behalf; (2) provides that the PMC may make ordinary and emergency repairs to the property through contracted services, employees or otherwise; and (3) has an early termination provision.
Management. It is important to know how the PMC actually operates. Ideally, the company will have an operations manual specifying each process or procedure that it uses for the common issues. (Ask to see the manual and be willing to sign a non-disclosure agreement should the PMC believe that its procedures are a trade secret.) These procedures would likely include (a) the intake of property owners; (b) set-up of accounts; (c) providing the owner with online access to specific information concerning his/her property; and (d) various disclosures to the owner with respect to the rights and duties during a foreclosure of the property, its home inspection policies, late fee policies and property condition requirements. Similarly, the Company should have a detailed procedure for the intake of new tenants; procedures for handling any default; and procedures for handling tenant complaints and/or repairs.
You should inquire about the staffing at the PMC. Staffing requirements vary from one property management company to another. Factors such as the age of the building and normal wear and tear come into play as well as the PMC's overall efficiency and automation of procedures. The more automated the organization the fewer property managers will be needed, particularly if the PMC has contracted with appropriate repair personnel to service the needs of the tenants. In addition to a property manager, a medium sized property management company it would likely have a bookkeeper to keep track of the monthly income and expenses and a designated intake person for both owners and tenants.
How does it handle complaints/concerns from tenants? It is critical that the PMC have a fixed procedure for handling complaints from its tenants. Except in cases of extreme emergency (e.g., fire), all complaints must be in writing and mailed, emailed, faxed or posted on the management company’s web site. Even in cases of extreme emergency, a follow-up written report must be made. The PMC must either have on staff or available through a contract, individuals or companies that can reliably make necessary repairs to the property. It is important that repairs be made promptly so as to avoid tenants claiming that the property was uninhabitable or that the rent is subject to a setoff.
How does the PMC locate new prospective tenants?The PMC should have an established marketing program to locate prospective tenants. Typically, this would include running newspaper advertisements and listing the property in the Multiple Listing Service.
What is the PMC's process for selecting tenants? The PMC should carefully evaluate each prospective tenant to make sure they have sufficient income/assets to make the monthly payment. The proposed tenants will need to authorize the pulling of their credit report and obtaining a background history. Any tenant with a FICO score of less than 650 should be rejected except in unusual circumstances.
How does the PMC establish the rental value of the unit? Prior to listing the property, the PMC should perform an analysis to establish the likely market rate for the property. This will include pulling comps from the local MLS.
Does the Company have a standardized lease form that all tenants must sign? You should carefully review the standard lease form to make sure that it is consistent with the law of your jurisdiction. It does little good to have a Landlord oriented lease agreement only to find later on that some of its provisions are unenforceable under state or local law.
Make sure tenant obtains rental insurance. It is a good business practice to make sure that tenants have renter’s insurance. Such insurance policies typically have two components: (a) insurance for the value of the tenant’s personal property; and (b) liability insurance. Your concern should be with respect to the latter issue. While you will carry a dwelling policy on the property, your tenant’s liability policy may also come into play should he or she negligently start a fire or injure someone on the premises.
What if the tenant defaults? It is important to have procedures set up for handling tenant defaults. Late fees should be imposed in the event the tenant pays the rent after the grace period. Further, if the tenant has not paid the rent by the end of the grace period, a Notice to Pay Rent or Quit should be immediately sent to the Tenant in the manner required by state law. If the tenant does not pay within the period specified in the Notice, the PMC should have its attorney commence an action to evict the tenant.
Accounting for the money.The collection of money and payment of bills by the PMC should be completely transparent to the property owner. Monthly reports should be assiduously prepared and transmitted to the owner. Additionally, the PMC should provide the owner with online 24-7 access to the financial information relating to the property.
The foregoing check-list is not intended to be all-inclusive of the issues you should be aware of in engaging a property management company but it should provide some peace of mind to prospective residential real property investors. Be prepared, however, to reevaluate your decision at any time during the term of the management agreement. If at any time you are dissatisfied with the PMC’s performance, speak up and address the issues. If the response is unsatisfactory and if you believe the PMC has materially breached its agreement, do not hesitate to terminate the agreement at the earliest opportunity or (if the contract so provides) engage in any dispute resolution procedure specified in the management agreement.
The author extends his gratitude to Mark Hall and Cindi Hall, the owners of Las Vegas’ premier property management company, Southwestern Management and Real Estate Team (“SMART”) (www.managevegas.com) and Realtor Bob F. Vavla (www.propzilla.com) for the comments and invaluable insights they generously provided with respect to this article.