Level 24: Property Management - Chapter 2: Management Agreement

Sharing

In many instances (especially with large complexes, as opposed to duplexes or single-family rentals), the manager is not the sole party responsible for leasing the property. A manager may be working with a leasing broker, in which case the leasing fee will be split between the manager and the broker. If there are several brokers who cannot agree on who finalized a sale, only one broker (the broker with the most convincing claim) will be given the commission. Though sharing is caring, brokers are prohibited from sharing a commission with any non-licensed people. Whether the broker's fee will be derived from the property manager's fee or be an additional amount paid by the owner on top of the manager's fee is something that must be negotiated and — you guessed it — written in the contract.

Put It in Writing

In the last chapter you learned all about what property managers do, but when it comes to the nitty-gritty details of managing a specific property with a specific owner, those types of rights and responsibilities should be expressed in detail in writing in something called the management agreement, or property management employee contract. The management agreement is a written contract between a property owner and a property manager to establish all duties of the property manager, including operation and leasing activities. The management agreement should always be signed (or autographed, if you're feeling like Beyonce 💅).

Back in the Dating Game: Fiduciary Relationships

It is important to understand fiduciary duties because the property management agreement establishes that the property manager is in a fiduciary relationship with the property owner. This means that the property owner and property manager put a high level of trust in one another. Let's review the fiduciary duties you will owe to your clients and, most importantly, your property owner. (These are the same fiduciary duties you grew to love in Level 6, which covered Law of Agency. Now they're just being used in a different context.)

A Note on Disbursements

It's also important to include a provision in the management agreement to address what will happen in the event there is a month in which the property's account does not have enough money to cover the necessary disbursements. For example, under some agreements, the owner provides a sum of money in reserve to meet expenses that may exceed the amount in the disbursement account — like a "rainy day fund" of sorts. ☔️ Note: Disbursements are out-of-pocket expenses for managing the property, such as courier, postage, copies, etc.

Property Description

It's common practice to use a standard street address here, but it's not a bad idea to include the full legal description of the property. This is because the property should be described in such a way that leaves no doubt regarding its location, its identity, or the extent of the property to be managed. For example, if the address of an apartment building is the property listed on an agreement, but there is a convenience store occupying the ground floor of the building that is not part of the agreement, then this needs to be clearly reflected in the contract.

Owner's Responsibilities

Management agreements don't just outline the manager's responsibilities, but the owners' as well! For example, who is supposed to maintain property insurance for the property — the manager or the owner? What about the mortgage payments? Property taxes? Any items owners wish to maintain responsibility over should be outlined in the contract. In addition, the contract should also address the owner's responsibility for miscellaneous management expenses.

Why Management Agreements Are Important

Management agreements establish agency, meaning that they give the property manager the legal ability to act on behalf of the property owner. Property managers and property owners are in a principal-agent relationship, the principal being the owner and the agent being the property manager. Agents can further be broken down into general agents and special agents.

Be Anti-Trust!

No matter which fee structure the manager and owner agree upon, one thing remains certain: the terms should be kept confidential between the two parties negotiating the contract. Fees should not be discussed between competing property managers or management companies. Why? Because there is no such thing as a uniform rate for property management fees. So if competitors within the property management profession were to agree to impose the same fixed rate for their services, they would be guilty of price fixing, a violation of state and federal antitrust laws. Property managers must always be able to say their fee structures have been established independently from their competitors. Take proud ownership over your fee structures, managers. By doing so, you can put the trust back in antitrust. 👍 If that doesn't inspire you to avoid antitrust issues, maybe this will: the penalties for antitrust violations can include fines or imprisonment. Sometimes both! Yikes!

Allocation of Costs

Property managers are responsible for overseeing a variety of expenditures including maintenance, personnel, services, advertising*, and so on. The written contract should provide for the allocation of costs and expressly indicate the amount the property manager may incur without consulting the owner. *Note: Yup, advertising falls under the umbrella of normal operating expenses for properties and the allocation of costs for marketing/advertising efforts should be included in the contract. The agreement should also call for the owner to provide the manager with a schedule of payments for things like insurance premiums, taxes, special assessments, or other services that require periodic payment. The manager will need this schedule of payments in order to allocate the appropriate costs in the budget at the appropriate times.

Getting Risky with Risk Management

Risk management is the act of identifying and minimizing potential risks that could affect a property. Property managers will often need to assess risks so they can purchase the best insurance plan for their company at the best rate. A few risky factors to consider are damages from fire, floods, Worker's Compensation claims and liability, loss of income and occupancy, equipment and machinery hazards, and any cars owned and used by the property.

Personnel

Speaking of the manager's employees, the agreement should also grant the manager power to make hiring and firing decisions for maintenance and office personnel for the property. The specifics of the manager's control over personnel will vary from property to property, based on the owner's wishes. For example, a particularly involved owner might want to personally approve the hiring and firing of employees, but will grant the manager the right to supervise them. Other owners will find such involvement on their part unnecessary. The manager will want to include such a clause in the agreement for their own protection. This provision should clearly outline the owner's obligation to pay any fees, damages, settlements, judgments, or any other costs arising from claims that may arise from legal disputes with employees or violations of labor laws. As you might imagine, the property manager wouldn't be too thrilled to be held liable for claims that arise from incidents or situations that predate their management of the property. Including this protective language in the contract is important to prevent such conflict from arising. It's not uncommon for larger property management companies to hire a third party to handle all human resource needs for the property. This can include processing payroll, ensuring compliance with state and federal labor laws, and advising on employer-employee relations.

Scope of Authority

The agreement should clearly list the manager's authority with regard to things like leasing the property, collecting rent, setting rental rates, authorizing repairs and maintenance, hiring and firing employees, evicting tenants, and the ability to pursue legal action for the recovery of unpaid rent. The ability of a manager to sign leases on behalf of the owner is perhaps the most important aspect of a property manager's authority. It is imperative there be language in the management agreement that clearly grants this authority to the manager.

Fiduciary Duty: Accounting

The duty of accounting means that the owner should be able to rely on a property manager to accurately report on the financial status of the property via periodic (usually monthly) reports that itemize cash flow, revenue, operating costs, and all matters related to money in a detailed manner. This also requires that the property manager is prohibited from commingling funds — mixing a client's funds with the management company's funds. Have separate accounts for each.

Fiduciary Duty: Confidentiality

The duty of confidentiality requires that any confidential information gained by the property manager must remain confidential forever. Forever's a long time. Let's say that property manager has represented Owner A in the past, but is no longer representing them. Now that manager is in a fiduciary relationship with Owner B. If Owner B asks for confidential information about Owner A, the manager is still bound by the duty of confidentiality to Owner A and is therefore prohibited from giving Owner B information they would not have been privy to otherwise.

Fiduciary Duty: Disclosure

The duty of disclosure requires that the property manager disclose all information that relates to the property — the good, the bad, and the ugly — to the owner. When in doubt, disclose. Keep the owner in the loop!

Fiduciary Duty: Loyalty

The duty of loyalty means that the property manager must always put the interests of the owner first — yes, this means even above their own interests. Owners place a tremendous amount of trust in managers, and a big part of that inolves the manager acting without self-interest. For example, property managers must take time to select tenants carefully to ensure that leasing to them would be in the best interests of the property owner. The manager cannot simply lease to any ol' tenant as quickly as possible just to collect a commission for leasing a property.

Fiduciary Duty: Obedience

The duty of obedience means that the property manager must follow the property owner's instructions — provided they are lawful, of course. For example, if the owner instructs the property manager to lease only to tenants of a specific race or religion, then the property manager is legally obligated to refuse to comply with this request as it violates state and federal fair housing laws. The manager should terminate the relationship with this owner immediately. No one's business is so important that it should compel a license holder to violate the law.

Fiduciary Duty: Reasonable Care

The duty of reasonable care requires that property managers exhibit a reasonable degree of competence and expertise while managing the property. A property manager must not be negligent. They must remain well-informed on the operations of the property, as well as market conditions related to the property, at all times in order to properly protect the owner's investment.

Insurance

The management agreement should specify the insurance the owner will carry for liability and workers' compensation. Having sufficient liability insurance is not only for the protection of the property manager, but is also in the best interest of the owner. It's just part of good risk management! Insurance is typically purchased at the owner's expense. The contract may also include a stipulation that the manager can purchase insurance on behalf of the owner with the owner's funds. Additionally, owners typically depend on their property managers to work with insurance agencies to handle any claims related to the property that may arise.

Handling Funds

The property management agreement will likely stipulate that the manager is required to maintain a separate bank account for the owner's funds. A manager should NOT commingle the owner's money with their own, even temporarily. Keep those accounts separate! There should also be a provision in the contract requiring that any employees of the property manager who handle funds must be covered by a fidelity bond. A fidelity bond is a form of insurance that protects the policyholder by covering any losses they might incur as a result of theft or fraud by specified individuals (in this case, the manager's employees).

Property Managers: A Tale of Two Relationships

The relationship between a property manager and a property owner closely resembles that of a salesperson with their broker because the property manager is an agent of the owner (hence all of those fiduciary duties we just covered). However, the property manager's relationship with tenants is very similar to that of a landlord (in fact, in many cases, the property manager acts on behalf of a landlord). As you can see, the property manager's dual responsibility to both the owner and the tenants means that they have a very different relationship with each of them. On the following screens, I'll tell you what you need to include in your management agreement. Including all of these items will make sure you can do your job and honor the duties owed to both your tenants and your property owner.

Termination

There should be language within the agreement outlining under what circumstances the agreement may be terminated. It should identify how much notice is required — 30 days, 60 days, 90 days, etc. The agreement should also describe the penalties (fees) to be incurred if the owner wishes to terminate the agreement early and, if applicable, what circumstances are acceptable for early termination of the agreement by either party.

A Definition of Management's Responsibilities

What does the owner expect the manager to do? The manager's duties should be detailed in the written agreement. Typically, the manager will be expected to create periodic reports (usually monthly) informing the owner of all pertinent information regarding the property. The manager will also be responsible for disbursing money to various parties (trash services, cleaning services, etc.) on behalf of the owner for the ongoing monthly operations of the property. The names of these recipients and the amounts they receive should be listed in the contract as well.

Contract Period

What is the beginning date of the contract? What is the duration of the agreement? Are there any provisions for early termination of the contract? All of these things need to be addressed in the agreement!

Identification of the Parties

You know what they say: It only takes two to party! (People say that, right?) The property agreement contract will include these two parties: The name of the owner, exactly as it appears on the title or deed to the property (if it is owned by a partnership, each partner's name should be represented in the contract; if owned by a corporation, the corporate name should appear) The name of the property manager or management company

Management Fees

You probably want to get paid for all of this stellar managing you're doing, right? Luckily, you will get paid in the form of management fees. Yay! The management fee is the price an owner pays the manager (or management company) for their services. Simple enough, right? It should go without saying, then, that the management fees must be clearly expressed in the management agreement. But I'm gonna say it anyway! The management fees must be clearly expressed in the management agreement.

Fiduciaries

A fiduciary is an individual upon whom is placed the highest levels of trust and confidence when acting on behalf of another. Specific fiduciary duties include obedience, loyalty, disclosure, confidentiality, accountability, and reasonable care. As a property manager, you will owe the owner of the building(s) all of the fiduciary duties you owe your clients and more because a property manager's first duty is to the owner.

(Secret) Agents

A general agent is an agent who is authorized to manage all of a principal's affairs within certain specified areas; they enjoy broader authority than that of a special agent but less than that of a universal agent. General agents have a wide array of duties they perform for the owner; they do everything from signing leases and answering tenant questions to putting out fresh milk for the apartment's resident stray cat. Special agents are more limited, and only have duties in one specific area. A real estate salesperson is an example of a special agent, as they can only do some things on behalf of the property owner. As a property manager, you will probably act as a general agent. Universal agents are all-powerful. They can do everything their principal can do. Universal agents are usually appointed by a power of attorney.

Looking Ahead

After you know your responsibilities as per the management agreement, it's time for you to take the stage. Look at the property as is, but also look into the property's future. Keep an eye on real estate cycles and markets and be sure to plan ahead. This will help you generate profit for the owner, add to the property's value, and help the owner reach their investment goals.

Comply, Don't Lie

As a property manager, you will need to make sure you are complying with all regulations and policies, whether those regulations and policies be statutory or internal. It is a good idea to make sure all the terms of the management agreement are compliant with federal and state laws. This way, you will know the responsibilities you are carrying out on behalf of the owner are legal. Once the management agreement is signed you will be required to comply with its lawful terms, so make sure you know what you're in for!

Fiduciary Duties: OLD CAR

Fiduciary duties include: Obedience Loyalty Disclosure Confidentiality Accounting Reasonable care If you'll notice, the first letters of those fiduciary duties combine to spell out the words OLD CAR. What a handy way to remember! Whenever you need to recall the fiduciary duties, just imagine a 1965 Ford Mustang. (I recommend choosing sky blue as the color option in your imagination. It's a very pretty color.) 🚙

Percentage Fee vs. Flat Fee

Generally speaking, the management fee can come in two forms: Percentage Fee: A fee paid to the manager based on the effective gross income (EGI) of the building. This includes income from rent plus additional revenue streams. Flat Fee: Also known as a base fee, this is a fixed fee paid per unit, not based on a percentage of the income. Sometimes, the management fees can be made up of both a flat fee and a percentage fee. Recap: A percentage fee is based on a property's income and a flat fee does not vary. Fee structures are determined by the owner and their goals for the property. A percentage fee (typically 4-10% for smaller properties and 3-5% for larger properties) provides incentive for the manager to increase the income of a building. A manager being compensated by a percentage fee will work hard to maximize the revenue coming in. Flat fees are pretty rare, but may be more desirable when managing buildings where the owners are more interested in controlling expenses rather than increasing them.

Bonuses and Commissions

In addition to the management fees, the contract should also specify which bonuses or commissions the owner will pay the manager, if any. For example, an owner might offer the manager a commission for every new lease he executes. In another example, the owner might offer a lump-sum bonus if the manager is able to lease the building to capacity (meaning there are no vacancies). Any of these fees are negotiable and should, as always, be indicated in writing in the contract.

Statement of Owner's Purpose

In addition to the owner's responsibilities, there should be language in the management agreement that clearly defines the owner's purpose. Some owners may want to maximize profits, while others may simply want to maximize the tax benefits they receive from owning that property. In any case, the property manager should always seek to carry out the lawful objectives of the owner.

Chapter 2 Key Terms

✏️ management agreement: a written contract between a property owner and a property manager to establish all duties of the property manager, including operation and leasing activities ✏️ general agent: an agent who is authorized to manage all of a principal's affairs within certain specified areas; enjoys broader authority than that of a special agent but less than that of a universal agent ✏️ fiduciary: an individual upon whom is placed the highest levels of trust and confidence when acting on behalf of another; specific fiduciary duties include obedience, loyalty, disclosure, confidentiality, accountability, and reasonable care ✏️ risk management: the act of identifying and minimizing potential risks that could affect a property