This blog post is part one of a series with guest contributor Brandon Hall, The Real Estate CPA, and aims to educate property managers on accounting best practices.
Property management companies handle large amounts of money on a regular basis and, as a result, need a rock-solid financial system. One of the basics of that system is a means to collect money—and how you set up your bank account structure can make all the difference in staying organized.
A proper bank account structure will allow property management companies to operate efficiently and follow federal, state, and local laws related to cash management. And when I say “operate efficiently”, I really mean that it will enable your property management company to integrate with software necessary to manage the finances of the business.
Our CPA firm works with property managers and their clients: real estate investors. We have seen property management companies who have an optimized financial system in place and also those who, unfortunately, do not.
When we dive deeper into the property management companies of the latter, we generally witness large-scale disorganization that often stems from a misuse (or abuse) of banking and credit card accounts. The first step to avoiding an accounting debacle is understanding how to properly use trust accounts.
All property management companies should maintain a trust account to ensure resident security deposits. Funds in trust accounts are generally protected from seizure in the event of a lawsuit or bankruptcy.
Most property managers know that they should maintain security deposits in trust accounts as many states require this by law. However, we rarely see property management companies reconcile their trust account holding security deposits to resident leases each month. This is a tremendous oversight.
Without a monthly reconciliation, how can you know if the funds in the trust account will cover upcoming deposit reimbursement? What if an employee accidentally deposited a resident’s security deposit in your operating account a year ago? Monthly reconciliations will catch these issues.
And in most states, you as the property manager are responsible for the proper handling of the security deposit. If your client decides to hold the resident’s security deposit (for whatever reason), you may need to withhold rent to cover the security deposit and will eventually have to return it to the resident. Reconciling your trust account holding security deposits will enable you to keep tabs on these unexpected issues.
Aside from the trust account to hold security deposits, what else should a property manager consider?
First, don’t open a bank account for each client or property. We generally recommend that you have, at a maximum, three bank accounts total: (1) the trust account for your security deposits; (2) an account that collects rents and pays expenses related to the properties; (3) an operations account.
We see plenty of confusion around number 2 and 3 above. Oftentimes, property management companies will maintain two bank accounts total: the trust account and the account for everything else. The problem with this structure is you are co-mingling your business operations with your client’s property operations.
Is this an issue that has legal and tax implications? No, not normally. But separating your company’s operating account from the account that collects rents and issues disbursements for repairs or to owners is always a smart move.
You will discover creative ways to identify and eliminate routines that are no longer benefiting your business.
When you maintain three accounts, the accounting becomes much simpler to maintain. Even if you use the accounting features in Buildium to track and reconcile everything, separate accounts are still recommended.
For example, let’s assume you have three bank accounts: A, B, and C. Let’s also say you collect 10% on gross rents of $1,000 per month.
Bank account A is our property operation account and so the $1,000 of rental income will post there. Any expenses related to the property will be disbursed from bank account A and, if the client wants a disbursement, it’s also coming out of bank account A.
To “collect” your management fee, you would simply transfer funds from bank account A to bank account B (your company’s operating account). From bank account B, you will pay for general overhead expenses such as advertising, office costs, payroll, etc. All of these costs are associated with running your business, not necessarily the operation of a single rental property.
Bank account C would remain untouched each month as it’s simply there to collect and hold security deposits. But remember, we still want to reconcile bank account C each month!
Maintaining bank accounts in this manner makes everything easier. We have essentially segregated the costs that clients are incurring for the operation of their property versus the costs that we are incurring for the operation of our business. This allows you to flexibly manage your business by using Buildium for bank account A and QuickBooks Online, for bank account B.
Such segregation of expenses empowers you to monitor the performance of your business more accurately. You will have an easier time managing and projecting cash flow as well as developing tax strategies with your accountants if you segregate your operational expenses.
Though not necessarily related to banking, I wanted to share some other useful tips that we have developed after working with numerous property management firms.
Property management companies are susceptible to fraud, especially if they deal in or collect cash. Using a bill pay feature will put financial controls in place, which will reduce the likelihood of your employees committing fraud.
If something breaks at a property, it’s your job to ensure that it gets repaired quickly. If you don’t require reserves from your clients, that means you could be faced with floating an expense for your client until the next time rents are collected. Don’t set yourself up to be put in this type of bind. Require your client to maintain a certain amount of money with you as a reserve for future repairs.
Believe it or not, some property management companies do not have a way to automate fee collection each month from their clients’ accounts. If you segregate your bank accounts in the manner I described earlier, this becomes much cleaner cut. There are solutions that allow you to quickly collect your revenue each month, automatically. Don’t be the company creating massive spreadsheets and manually bill-paying yourself each month—Automate as much as you can!
As property managers, you have real responsibilities related to financial management. Make it easier on yourself by segregating your company’s operating account from your client’s rental operating account. Create a separate account to hold security deposits to stay in compliance with state and local laws. And lastly, automate everything you possibly can!