Washington Real Estate Fundamentals Lesson 16: Property Management © 2011 Rockwell Publishing.

Washington Real Estate Fundamentals

Lesson 16:

Property Management

© 2011 Rockwell Publishing

Introduction

Property manager: Someone other than property owner who supervises operation of income-producing property.

Real estate firms often engage in property management as well as brokerage.


Investing in Real Estate

Income-producing property typically owned as an investment.

Property manager hired to help owner achieve investment goals.

Manager needs to understand basic investment principles.But real estate agent should not give

investment advice.Refer clients to experts instead.


Investment BasicsInvestments and returns

Investment: Asset expected to generate a return (or profit) for investor.

Depending on type of investment, return on investment may take various forms, including:

interestdividendsappreciationrents


Investment BasicsTypes of investments

Ownership investments: Investor takes ownership interest in asset.

Examples: real estate, stocksReturns: rents, appreciation, dividends

Debt investments: Investor loans money.Examples: mortgage loans, bondsReturns: interest on principal


Investment BasicsDiversification

Diversification: Investing in different types of investments instead of only one.

Mix of investments held is called investor’s portfolio.

Mix chosen in hope that loss on one investment will be offset by profit on others.


Investment BasicsInvestment income vs. earned income

For income tax purposes, distinction between:

investment income (such as interest, dividends, or rental income)

earned income (such as salaries, wages, or self-employment income)

Different rules may apply to the two categories.


Investment BasicsCharacteristics of investments

Three fundamental characteristics used to evaluate and compare investments:

Safety: Risk of losing money originally invested.

Liquidity: How quickly asset can be converted to cash.

Yield: Total return on investment (ROI).


Investment BasicsCharacteristics of investments

Liquid assets are generally safest, but do not offer high yields.

Savings accounts and certificate of deposits: liquid and safe, but with low yields.

Real estate: can generate higher yields, but at somewhat greater risk and without much liquidity.


Investing in Real EstateAdvantages

Advantages of investing in real estate include:

appreciationleveragecash flow


Advantages of Real EstateAppreciation

Appreciation: Increase in value of property due to outside factors.

May be due to inflation, other general economic forces.

May be due to increased demand for type of property.Example: when buildable property in

good location becomes scarce, value increases.


AppreciationHedge against inflation

Real estate values fluctuate, but tend to increase at a rate equal to or greater than inflation rate.

So real estate considered effective “hedge” against inflation.


AppreciationOwner’s equity

Appreciation increases owner’s equity.Equity: Difference between value of

property and liens against it.Equity adds to owner’s net worth.Equity can be used as collateral for

loan.


Advantages of Real EstateLeverage

Leverage: Using borrowed money to invest in an asset.

If asset appreciates, investor earns return on borrowed money as well as own invested funds.


Advantages of Real EstateCash flow

In addition to appreciating, real estate investment may generate positive cash flow.

Cash flow: Spendable income remaining after all property’s expenses paid. Including operating expenses,

mortgage payments, and taxes.

Cash on cash: First year’s cash flow divided by amount of initial investment.


Cash FlowSale-leaseback

Rental income is one way real estate can generate cash flow; sale-leaseback is another.

Sale-leaseback: Owner of commercial building sells it to investor for cash, then leases it back from investor.Frees up capital.Rental payments tax-deductible.Parties often also enter into buyback

agreement.


Types of Managed Properties

Four main types of income-producing properties:

residential rental propertiesoffice buildingsretail propertiesindustrial properties


Types of Managed PropertiesResidential rental properties

Residential rental properties include:single-family rental homesapartment buildings

Key aspects of residential management:compliance with landlord-tenant lawsmarketing and leasing

Short-term leases (month-to-month, one-year) mean high turnover.


Types of Managed PropertiesOffice buildings

Office buildings frequently:get constant traffic and userequire constant maintenance

Office space is leased:by square footon longer-term basis

often with escalation clause


Types of Managed PropertiesRetail properties

In managing retail space, tenant selection important.

In mall or shopping center, right mix of stores necessary to draw shoppers.

Tenant’s rent often tied to income from retail business.


Types of Managed PropertiesIndustrial properties

Industrial properties are very specialized.Expensive to build-out and operate.Leases usually long-term (for example,

ten years).


SummaryInvesting in Real Estate

• Property management• Investment• Return on investment• Diversification• Portfolio• Investment income• Earned income

• Safety• Liquidity• Yield• Appreciation• Equity• Leverage• Cash flow• Sale-leaseback


Management Agreement

Property management agreement: Contract between property owner and property manager.

Creates agency relationship.Parties: owner and real estate firm.

Firm appoints affiliated licensee to act as manager and execute contract.

Agreement must be in writing and signed by both parties.


Management AgreementScope of authority

Agreement should define scope of manager’s authority.

May or may not include authority to:collect and disburse fundshold and disburse security depositsset rental ratesexecute leasesundertake major repairshire and fire employees


Management AgreementOther basic provisions

Term of agreementType of property and legal descriptionNumber of units or square footageManager’s compensation

percentage of property’s gross incomecommission on new rentals fixed feecombination of methods

(continued)


Management AgreementOther basic provisions

Manager’s reports to owner on property’s operations (frequency and level of detail)

Statement of owner’s goalsDescription of manager’s dutiesAllocation of costs (for expenses such as

office help and advertising)


Management Plan

Management plan: Property manager’s plan for property’s operations.

Sets out manager’s strategies for achieving owner’s goals.

Addresses financial management and physical maintenance issues.


Management PlanOwner’s goals

Different owners have different goals.For example:

maximizing monthly income, vs.increasing property’s value for resale

Different goals dictate different management strategies.

Owner’s goals may change over time, requiring updated management plan.


Management PlanPreliminary study

To create management plan, manager studies the property and its context.

Four levels of analysis:regional analysisneighborhood analysisproperty analysismarket analysis


Preliminary StudyRegional analysis

Regional analysis: Concerns characteristics of metropolitan area where property located:

occupancy ratesmarket rental ratesemployment levelsfamily size and lifestyles


Regional AnalysisOccupancy rates and rental rates

Law of supply and demand governs relationship between occupancy rates and rental rates.

Demand for rental units exceeds supply: rental rates go up.

Supply of rental units exceeds demand:rental rates go down.


Regional AnalysisOccupancy rates and rental rates

Technical oversupply: More units than potential tenants.

Economic oversupply: More units than tenants who can afford current rents.

When there are more tenants than units, it’s either a technical shortage or an economic shortage.


Regional AnalysisEmployment levels

Employment rate in area affects ability of potential tenants to afford rents.

Manager should keep track of events affecting employment levels.For example, arrival or departure of

large company.


Regional AnalysisFamily size and lifestyle

Residential rentals strongly affected by average family size.

Demand for units with certain number of bedrooms changes over time.

Manager should pay attention to national and local trends.


Preliminary StudyNeighborhood analysis

Neighborhood analysis takes property’s location into account in management plan.

Neighborhood may be several square miles or only a few blocks.

Factors considered include:how well properties are maintainedwhether population increasing or

decreasingeconomic status of residents


Preliminary StudyProperty analysis

When manager evaluates property itself, factors considered include:

number and size of rental units or spacesappearance of property and rental spacesphysical condition of buildingphysical condition of rental spaces

(continued)


Preliminary StudyProperty analysis

amenities provided (laundry room; recreational facilities)

services provided (janitorial; security)relationship between site and buildingcurrent occupancy rate and tenant

compositionsize and efficiency of current staff


Preliminary StudyMarket analysis

Market analysis: Analyzing properties that the client’s property competes with.

First step is identifying pertinent market.For example, small multistory

apartment buildings.


Preliminary StudyMarket analysis

Factors considered:number of competing units or rental

spaces available in the areaaverage age and character of buildingsquality of average unit or space in marketnumber of potential tenants in the areacurrent price for average unit or spaceaverage occupancy rate


Management PlanManagement proposal

After completing preliminary analysis, manager prepares proposal for client.

Proposal includes:rental scheduleincome and expense projectionsschedule of day-to-day operationssuggested physical changes to building


Management ProposalRental schedule

Rental schedule: Lists rental rate assigned to each type of unit or space in building.

Manager sets optimum rent that can be charged while maintaining optimum occupancy.

Rental schedule should be reevaluated periodically, to make sure it’s in line with current market rates.


Management ProposalBudget

Budget in management proposal includes:total rental value of all rentable spacebad debt and vacancy factorincome from miscellaneous other sourcesestimated operating expenses

fixed: property taxes, insurance, salariesvariable: utilities, maintenance, repairs

cash flow (projected revenues minus projected expenses)


Management ProposalDay-to-day operations

Proposal also includes plans for property’s day-to-day operations.

Manager suggests:staffing needsemployment policies


Management ProposalPhysical alterations

Proposal may also present manager’s recommendations for remodeling, rehab, or other physical alterations.

Changes that will increase property’s value by responding to demand in current market.


Management PlanApproved by client

Manager submits proposal to property owner.When approved by client, proposal

becomes management plan.


SummaryManagement Agreement and Plan

• Management agreement• Management plan• Regional, neighborhood, property,

and market analysis• Technical oversupply or shortage• Economic oversupply or shortage• Management proposal• Rental schedule• Budget


Management Functions

Functions of a property manager can be divided into three main categories:

leasing and tenant relationsrecordkeeping and manager/owner

relationsproperty maintenance


Management FunctionsLeasing and tenant relations

Leasing and tenant relations includes:marketing the rental units or spacesnegotiating leasesaddressing tenant complaintscollecting rents


Leasing and Tenant RelationsMarketing rental space

Manager’s strategy: advertising to greatest number of potential tenants at lowest possible cost.

Amount of advertising needed depends on property type, location, etc.

Effectiveness of advertising evaluated based on cost per prospect.


Leasing and Tenant RelationsMarketing rental space

Marketing methods that might be used:signsnewspapers

classified adsdisplay ads

Internetradio and TV direct mail


Leasing and Tenant RelationsNegotiating leases

Manager shows property to prospective tenants who respond to advertising.

Points out features and advantages.With commercial tenant, discusses

alteration of space to suit tenant’s needs.


Negotiating LeasesScreening applicants

Manager screens applicants based on:financial qualificationswhether likely to be responsible,

cooperative tenantsChecks credit report and references,

contacts previous landlord.Must not violate antidiscrimination laws.

Once suitable tenant found, lease executed.


Negotiating LeasesRenewals

Managers generally prefer to renew leases rather than find new tenants.

Avoids vacancies between tenancies.Greater stability for property as a whole.Existing tenant easier and less expensive

to satisfy than new tenant.

Automatic renewal clause: Lease renewed on same terms unless one party gives notice of termination.


Leasing and Tenant RelationsTenant complaints

Key factors in retaining tenants:keeping property clean and in repairresponding to tenant complaints promptly

and professionally


Leasing and Tenant RelationsRent collection

Careful selection of tenants best way to avoid delinquent rents.

Lease should clearly state:how, when, and where rent is to be paidpenalties for late payment


Leasing and Tenant RelationsRent collection

Rent collection procedures should:be consistentinclude adequate recordkeepingprovide for immediate notification of late

payment

If rent collection efforts fail, manager should be prepared to take legal action to evict tenant, following client’s policies.


Management FunctionsManager/owner relations

Property manager required by law to account for all money received and disbursed in connection with client’s property.

Beyond that, how often and in what detail manager reports to owner is matter of owner’s preference.


Manager/Owner RelationsStatement of operations

Manager’s report to owner often made in a monthly statement of operations.

Statement typically includes these sections:summary of operationsrent rollstatement of disbursementsnarrative report of operations



Summary of operations: Brief description of property’s income and expenses, included at beginning of statement of operations.



Rent roll: Report on collections included in statement of operations.

Lists all occupied and vacant units.For each unit, shows previous balance,

current rent, total received, and balance due.

Info in rent roll obtained from separate ledger sheet kept for each tenant and rental space.



Statement of disbursements: List of all expenses paid during period covered by statement of operations.

Disbursements grouped by type (maintenance expenses, administrative expenses, etc.).



Narrative report of operations: Letter explaining information presented in other sections of statement of operations.

Particularly useful in months involving poor cash flow or unanticipated expenses.


Management FunctionsProperty maintenance

Manager supervises maintenance, including:Preventive maintenance: Preserving

physical condition of improvements.Corrective maintenance: Repairs to keep

property in working order.Housekeeping: Routine cleaning.New construction: Remodeling and

redecoration for new or renewing tenants, or to improve property.


Management FunctionsProperty maintenance

Manager should:inventory building’s physical elements

and equipmentcreate schedule for inspections and

repairskeep records on when elements of

property were inspected, repaired, or replaced


SummaryManagement Functions

• Marketing and leasing • Automatic renewal clause• Tenant complaints• Rent collection• Statement of operations• Preventive maintenance• Corrective maintenance• Housekeeping• New construction


Landlord-Tenant Law

Landlord-tenant relationship governed by:terms of contract forming the relationship

(lease)rules set by state landlord-tenant law


Landlord-Tenant LawRequirements for a valid lease

Lease: Contract that allows tenant to have possession of landlord’s property for period of time, in exchange for rent.

Also called rental agreement.Must have all essential elements

required for valid contract.Also must have property description.


Lease RequirementsWritten lease

In Washington, lease for a fixed term must be in writing and signed by landlord.

If term over one year: must be notarized.

Periodic tenancy doesn’t require written lease, unless rental period over one year.

However, any lease for property managed by a real estate firm must be in writing.


Lease RequirementsWritten lease

Written lease does not have to be signed by tenant (although it almost always is).

Management agreement commonly authorizes manager to sign lease as landlord’s agent.Without this authorization, written lease

signed by manager not valid.


Landlord-Tenant LawLease provisions

Best to use standardized lease form with specific rules that will govern tenancy.

However, landlord-tenant law may trump lease terms.


Landlord-Tenant LawLease provisions

Issues often addressed in lease:payment of rentuse of premisessecurity depositsentry and inspectionrenewalmaintenanceassignment and subleasing


Lease ProvisionsPayment of rent

Rent is the consideration that makes lease a valid contract.

Most leases require rent to be paid at beginning of rental period.

If not specified, rent due at end of rental period.


Lease ProvisionsUse of leased premises

Use of rented property must be legal.Use may also be limited by lease terms.

For example, lease of retail space might limit tenant to operating certain kind of store.

Without clear restrictive language, tenant can use property for any legal purpose.


Lease ProvisionsSecurity deposits

Security deposit: Money tenant provides in trust at start of lease in case of default.

Most leases require a security deposit, as protection against tenant:moving out without paying rent owedleaving property in poor condition

In Washington, deposit can be required from residential tenant only if lease in writing.


Security DepositsWritten checklist

In Washington, at start of residential tenancy, tenant must be given written checklist regarding unit’s condition.

Landlord and tenant both sign checklist.Tenant entitled to:

copy of signed checklistreceipt for security deposit

During tenancy, deposit must be held in trust account.


Security DepositsRefund or retention

Within 14 days after end of tenancy, landlord must:

return entire deposit to tenant, orsend tenant written explanation as to why

all or part of deposit was retained.

Security deposit may be used for unpaid rent, cleaning, or repairing damage.

Not for ordinary wear and tear.


Security DepositsNonrefundable fees

Landlord may charge a nonrefundable cleaning fee at beginning of tenancy, but this:

must be designated “nonrefundable”cannot be called a “deposit”


Lease ProvisionsEntry and inspection

Lease typically provides for inspection of premises by landlord during term.

In Washington, residential landlord may enter leased unit to:

inspect unitperform repairsprovide other agreed-upon servicesshow unit to prospective buyers or tenants


Lease ProvisionsEntry and inspection

Unless emergency, landlord must provide advance notice before entering.

Repairs or services: two days’ notice.

Showing unit: one day’s notice.


Lease ProvisionsOption to renew

Lease may give tenant option to renew.Typically requires tenant to notify

landlord of intention to renew by specified date.


Lease ProvisionsMaintenance

At end of lease, tenant must return leased premises to landlord in original condition, with allowances for normal wear and tear.

Landlord generally responsible for maintaining common areas, such as hallways and elevators.


SummaryLeases

• Written lease requirements• Written checklist• Payment of rent• Use of leased premises• Security deposit• Normal wear and tear• Nonrefundable cleaning fee• Entry and inspection• Option to renew


Landlord-Tenant LawTransferring leasehold estates

Landlord may sell leased property in middle of lease.

Buyer takes title subject to lease.


Landlord-Tenant LawTransferring leasehold estates

Tenant may transfer leasehold interest by:assignment,sublease, ornovation.

Tenant has right to assign or sublease property without landlord’s consent, unless lease specifically requires consent.

But consent always required for novation.


Transferring Leasehold EstatesAssignment

Assignment: Tenant transfers possession to someone else for entire remainder of lease term.

Assignee (new tenant) takes on primary responsibility for rent.

Assignor (original tenant) secondarily liable.


Transferring Leasehold EstatesSubleasing

Sublease: Tenant transfers possession to someone else for only part of remaining lease term. Also called sandwich lease.

Sublessor (original tenant) remains liable to landlord for rent.

Sublessee (new tenant) liable to original tenant for rent.


Transferring Leasehold EstatesNovation

Novation: When new contract created and old contract terminated.

Landlord may accept new tenant in place of old tenant, creating new lease.Original tenant released from liability.


Landlord-Tenant LawTermination of a leasehold

How lease ordinarily terminates depends on type of tenancy:

Periodic tenancy terminates at end of period if one party gives the other proper notice.

Tenancy for fixed term terminates automatically at end of term.


Landlord-Tenant LawTermination of a leasehold

Tenancy can also terminate through:surrenderbreach of covenant of quiet enjoymentbreach of implied warranty of habitabilityfailure to pay rentillegal or unauthorized usedestruction of premises condemnation


Termination of a LeaseholdSurrender

Surrender: Landlord and tenant mutually agree to terminate lease before term ends.


Termination of a LeaseholdCovenant of quiet enjoyment

Implied covenant of quiet enjoyment: Landlord’s promise that tenant’s exclusive possession will not be disturbed:

by landlordby third party with lawful claim

Covenant part of every lease as a matter of law, even if not explicitly stated in lease.


Termination of a LeaseholdCovenant of quiet enjoyment

Covenant breached if tenant wrongfully evicted.

Breach can take the form of:Actual eviction: Landlord actually expels

tenant from property.Constructive eviction: Landlord causes or

permits substantial interference with tenant’s possession.


Termination of a LeaseholdWarranty of habitability

Implied warranty of habitability: Landlord’s promise that premises comply with building and housing codes related to health and safety.

Warranty part of every residential lease, even if not explicitly stated in lease.


Termination of a LeaseholdWarranty of habitability

Warranty breached if leased premises become unsafe or unsanitary.

Tenant must notify landlord of problem.Landlord must correct problem within a

certain time after receiving notice.If landlord fails to respond, tenant has

several options, including terminating lease.


Termination of a LeaseholdFailure to pay rent

Failure to pay rent doesn’t automatically terminate lease.

Landlord must:give notice of nonpaymentfile unlawful detainer action against tenantobtain writ of restitution from the court

(also called writ of possession)

“Self-help” eviction illegal.


Termination of a LeaseholdIllegal or unauthorized use

Other grounds for termination by landlord, even if tenant pays rent as agreed:

illegal use of leased premisesuse in a way not authorized by lease

If tenant continues use after being told to stop, landlord can terminate tenancy.


Termination of a LeaseholdDestruction of premises

If tenant leases space in a building that is destroyed by fire or other disaster, lease is terminated.

If land as well as improvements were leased, destruction of building does not terminate lease.


Termination of a LeaseholdCondemnation

Lease may terminate if leased property condemned by government entity.


SummaryLandlord-Tenant Law

• Assignment, sublease, and novation• Surrender• Implied covenant of quiet enjoyment• Actual eviction• Constructive eviction• Implied warranty of habitability• Unlawful detainer• Writ of restitution or possession


Types of Leases

Five major types of leases:fixed leasesgraduated leasesnet leasespercentage leasesground leases


Types of LeasesFixed lease

Fixed lease: Tenant pays same amount of money each month. Also called flat lease or gross lease.

Landlord pays for operating expenses (maintenance, taxes, and insurance).

Type of lease used for most apartment rentals.


Types of LeasesGraduated lease

Graduated lease: Contains escalation clause, so rent may increase during lease term. Also called step-up lease or index lease.

Escalation clause: Provides for periodic rent increases, usually tied to Consumer Price Index or other measure of inflation.


Types of LeasesNet lease

Net lease: Tenant pays a fixed rent, plus some or all of property’s operating expenses.

Includes property taxes, insurance, maintenance costs.

Commercial leases are often net leases.


Types of LeasesPercentage lease

Percentage lease: Retail tenant pays:minimum rent, pluspercentage of gross or net income

generated by tenant’s business.

Most common in shopping centers.


Types of LeasesGround lease

Ground lease: Commercial tenant leases vacant land and constructs building on the land.

Typically long-term lease.


SummaryTypes of Leases

• Fixed lease• Graduated lease• Escalation clause• Net lease• Percentage lease• Ground lease


Washington Real Estate Fundamentals Lesson 16: Property Management © 2011 Rockwell Publishing.

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Transcript of Washington Real Estate Fundamentals Lesson 16: Property Management © 2011 Rockwell Publishing.