Ep. 60 | Making Sure Your Property Management Agreement Is Buttoned Up

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On this episode of The Mobile Home Park Lawyer, Ferd discusses property managers and property management agreements. Ferd goes through the most important provisions to include in your agreements, outlining the key duties of a property manager and what you need to look out for before you sign.

 

HIGHLIGHTS:

0:00 – Intro
1:28 – The property manager is typically the person who can do most the prep for the CPA to file tax returns
1:59 – Ferd recommends having a property management agreement
2:47 – Ferd prefers partnership taxation
3:53 – Commencement and termination dates, and authorities of the subsidiaries should be included
5:49 – The property manager will be the one responsible for retaining employees or independent contractors
7:20 – Make sure it’s written that the property has to comply with all laws and mortgages etc.
7:28 – Some key duties of the property manager is a budget and a marketing plan
7:47 – You need to include things about leasing
8:33 – The property manager will enter into service contracts
8:53 – The property manager will have the authorization to handle all tenant relations
9:03 – The property management will make sure the property insurance is covered
10:22 – The property manager needs to get waivers from vendors or makes sure the vendors have their own workers comp or general liability
10:43 – Financial reporting and record-keeping is a key duty of the property manager
11:42 – The property manager should keep the bank accounts
13:23 – Ferd discusses the different types of property management fees
14:20 – Another important provision is termination/cancellation rights
15:03 – You should identify conflicts of interest
16:01 – Ferd goes through some other typical provisions and boilerplate stuff and recaps the major points

 

FULL TRANSCRIPTION:

Welcome back mobile home park nation. I’m here today working on some 2020-year end bookkeeping close-up stuff, final accounting, things like that. Basically preparing the 2020 books for distribution to investors and owners, and then also getting everything prepped so that my CPA can finalize the 2020 tax returns and get those finalized here this month. As you know, when you have investors in a deal or members of an LLC, for example, you have to issue K1 tax statements. You have to file partnership returns at the state and federal level. And ultimately that falls on, a lot of that falls onto the onus of the property manager. So I’ve done a number of document reviews here, closing documents, bank documents, contracts, leases, things of that sort. So today’s agreement that I want to cover is the property management agreement.

And then typically the property manager is going to be the person who’s best able to do the initial prep or maybe all the prep for the CPA to file tax returns. So this kind of work is typically done end of the year in December, beginning of the year in January, assuming you’ve got a fiscal year ends calendar year-end. Which is what I have always done. I know a lot of companies do differently, but that’s just kind of how I’ve always done it. So my January is typically pretty busy, but that’s okay.

So I recommend having a property management agreement, even if it’s, you know, quasi related entity just to make it more professional set up the duties, the rights responsibilities, separation of risk and liability. So I do a little bit of property management, third party really, it’s only for mobile home parks that I’ve sold as, you know, either a courtesy to the people that I’ve sold to for a transition or perhaps as an inducement to the sale, depending on the case-by-case basis.

But typically my property management is for entities that I also control where I’m the promoter or syndicator, but then I have a related entity and I’m not going to get into tax status. But that entity for, in my case, is, is an LLC, but as taxed as an S-corp. I get asked quite often, should our LLCs be taxed as a partnership or an S-corp. In general I prefer partnership taxation for the flow-through benefits. There are some benefits of an S-corp if you have certain amounts of W2 employees and wages. So all of my property-owning LLC’s, they don’t have any employees. The only true W2 employees come from my management company. So it’s taxed as an S-corp. There are, depending on your personal situation, there are some potential tax carve-outs, some of which were in the 2017 Trump tax cuts.

So anyway, that’s a question for another day, but today I just want to hit high-level. What are the terms and provisions that you should have within your property management agreement? So, first off, I think pretty obvious, you know, the effective date, the names of the parties, the name of the name, legal description of the property that this is going to pertain to. You’ve got a bunch of recitals and I’m not going to go through a boilerplate and I’m not going to go through at the end, all the boilerplate terms like severability, complete agreement, you know, definitely gender-neutral, all that kind of stuff. I’ve covered that kind of stuff in other podcasts.

So the key terms here, you know, commencement and termination dates, the authority of the subsidiaries. Typically if it’s a syndication structure, you’ll have investors LLC and land LLC and homes LLC. So the property management agreement is basically signed by the land LLC and the homes LLC. And not the investors LLC, it is just going to, as a matter of course, that’s a little subjective. But that’s how I do it. So you need to make sure subsidiaries have the approval of investors. And then you want to just define that the status of the property manager. So it’s the subsidiaries and the property manager do not intend to form a joint venture partnership or similar relationship. Even though in this case, this document I’m looking at an entity controlled by me is the manager of the investors’ group, which owns is a sole member of Landon homes. And then an entity controlled and owned a hundred percent by me is the property manager, but they are different entities. So I’m signing on both sides of the document. But on one side, I’m the unilateral member. On the other side, I’ve been authorized in my private place memorandum in my operating agreement, by my investors of which I am the primary investor. But for legal liability purposes in the event that the property manager steps on a landmine, I don’t want the land LLC or the homes LLC, or the investors LLC, to have the same level of exposure. So I still do this, like it’s a third-party transaction.

So generally, what do you want in your management agreement? You need to set forth, what are the property manager’s duties, rights, responsibilities, limitations, I mean, limitations, like maybe they can deliver leases, signed leases. Maybe they can’t approve the tenants. But most likely they probably have the right to approve the tenants with the supervision and guidance of the ownership, or perhaps just the reporting to the ownership. You want to set forth in general, the status of the property manager as an independent contractor of the ownership group. But then also the property manager will be the one responsible for retaining either employees or independent contractors.

So my property management company, it’s called Guston property management. I have several W2 employees that are employed by that entity. But I also have a number of 1099 employees. I don’t know actually, probably have 1099 is going out the door today. And those 1099 are, some of those are too, you know, quasi related contractors that we have a regular working relationship with. And I’ll go over what makes them a W2 employee versus a 1099 contractor in another podcast. But then there are some 1090 nines that are just obvious. And there are guys like my concrete guy, he’s a professional company, he’s got his own website, got his name on his truck. He has his own worker’s comp insurance, his on general liability insurance. He works for me, but he works for a hundred people. That guy is definitely an independent contractor. He gets a 1099. You’re supposed to give 1099. I believe the limit is $600. If you pay more than $600 in a calendar year to one vendor, you have to give it a 1099, which basically means you have to get a W9 from them. You have to get, you have to pay, you have to not take tax to their paycheck, but you need to send them a 1099 in the year. If you don’t have their information, you need to withhold I think it’s 20% of their compensation in order to provide to the IRS for taxes.

Anyway, it’s important to make sure that the property manager is the one that’s responsible for hiring those people. And you want to make sure that it’s written that the property manager has to comply with all the laws, comply with mortgages, with FHA, other matters, things like that. A key duty of the property manager that will also be involved, have involvement in the ownership group is a budget and a marketing plan. And you can have something in there like the property manager shall submit by December 15th of the year to the subsidiaries for an approval of an operating plan, for the general operation of the property. You want to have things in here about leasing. Like this is common sense, right? The property managers shall use commercially reasonable efforts to obtain tenants. Commercially reasonable efforts to collect rent, other income, shall be responsible for repairs and maintenance. And then, you know, you may have a limit on repairs and maintenance or capital expenditures, such for example, anything less than $2,000 the property managers does, but property managers don’t have the authority to go, you know, repave the streets for $200,000, but maybe has authority to get bids and repay the streets, if it’s in the operating budget from the previous you know, previously submitted and approved. So if the plan is to redo the streets this year, and we’ve got a budget of $50,000, if $50,000 is what it’s going to cost, and then the managers does it, but if it’s a $60,000, maybe he or she needs to come back and get more authority. Typically the property manager will enter into service contracts, purchase supplies, purchase equipment. Might be the person that pays the property taxes and the mortgage. Sometimes the ownership group handles some of that stuff, depending on who wants to be in responsible for property tax appeals, for example and just other compliance-related issues.

Typically the property manager will have the authorization to handle all tenant relations. Other miscellaneous duties, miscellaneous rights, and this can be case by case. Typically the property manager will hold, make sure that the property insurance is covered, but also the property management entity should hold workers’ comp insurance and general liability insurance. That’s one of the benefits of having a property manager is that the ownership group doesn’t have to own and hold its own workers’ comp if all payments to vendors are paid out of the management entity. And worker’s comp, you know, it’s basically that the premium is based on one base charge and then $2 of wage paid. And then three job classifications of said, hourly wage. So if I’ve got a maintenance man making $30,000 a year, and I’ve got a secretary making $30,000 a year, the maintenance man is going to have much higher workers’ comp allocation because his job is more risky than more likely to end up in a claim then the secretaries job, but you still pay a premium for your secretary. It’s pretty small. There are certain areas like roofing, chainsaw work, driving heavy equipment, general contractor work that gets more and more expensive. And you need to check with your insurance carrier on that before you have those sort of duties being performed. You’ll also want to make sure that the property manager is either A, getting waivers from vendors or B, making sure that the vendors have their own workers’ comp general liability. Practically a lot of vendors don’t. So that’s where you want to make sure that they’re covered under your own workers’ comp deal and need to pay them and monitor them accordingly.

Another key duty of the property manager is basically your financial reporting and your record-keeping and keeping a book of accounts. You know, financial reports, I would say no less than quarterly, and then maintaining all supporting documentation, receipts, you know, payroll, you know, strips, everything like that. And just really being, having the investors and the owner having a right to audit the books. So there should be documents. Like I always have my private placement memorandum and my operating agreement, and all my reports kept in hard copy at headquarters. So in theory, when investors would show up and say, Hey, I want to audit the books. I want to look at the books and that’s there. Frankly, no one’s ever asked to jump at headquarters to see the hard copy, but they could. And typically there’s some sort of right to audit. And if it’s, if the audit, typically the audit would be at the owner’s expense, unless there’s a certain threshold, say 2% or 5% of error that is found, and then it would become the property manager’s expense.

The next thing is the property managers should keep bank accounts, right. I mean, an operating account, for sure. Sometimes you’ll have different investors accounts. Sometimes you’ll have a security deposit account, depending on your state law, if security deposit funds can or cannot be commingled. And you should say, who has access to the account. And typically my management company has access, even my third-party management, we set up online banking that the client and I, then my financial team, my accountant, my secretary, my dad can all have access online, dad, and I can sign checks. We can make deposits and we’re doing it straight out of the owner’s account. And obviously, we have a fiduciary rule. There’s no, we can’t just steal the money. But we don’t have to instead just spend everything out of our own money and then get reimbursed. And we do that a lot for the, for the workers that do not have workers’ comp or general liability. We pay it out of my management company because it’s protected. And then I seek reimbursement from them. Then frankly, have rights to reimburse it, just do it. My secretary will, pay a hundred dollars for John Smith out of property management and then be reimbursed by the owner’s account, a hundred dollars.

And that’s written in here somewhere authorization to reimbursement. And, you know, the manager has right to payment of expenses. You know, there’s generally a provision here about not commingling accounts or, and, or accounts that the property manager’s not reimbursed before. You know, certain things like fraud, gross negligence, perhaps any other insurance purchase by the property manager for the benefit of itself. And then, you know, litigation against the property manager may or may not be covered by the owner. So that’s important to have in here. What fees can, what expenses is the property manager entitled to reimbursement for.

And then you’ve got the regular fees, right? That are, you know, the management fee. Is it, you know, 5%? Is it you know, a salary fee? Is it, you know, an asset management fee? That’s probably not typically a property management fee. Are there bonuses? I think it’s often helpful to have the bonuses be attributable to success of the park. So for example, collections or NOI or new infill, new infill project, every home you bring in as all you know, has a lot of value to the asset, which has a lot of value for the ownership. So it’s often advantageous to tie up and link the managers compensation with the manager’s performance of helping with those things. Other important provisions, termination, or cancellation rights, a lot of lenders like your Fanny Mae or Freddie Mac lenders, they’re going to require that the owner can terminate upon 30 days written notice with or without cause because the lender may have to, if the loan goes bad, the lender is going to jump in and they’re going to want the right to terminate the property manager.

So typically the owner has stronger rights to terminate. The property manager, sometimes they can terminate for 30 days, but a lot of times it’s longer. Look, you can’t terminate for at least a first year. Otherwise, it could leave the owner in alert. But that should be spelled out here, it’s negotiable. And then sometimes there’ll be provisions on it. If there is a termination that the property manager has some additional duties for like a final accounting and a transition. And typically the project manager would get additional compensation for that. Cause that’s pretty onerous. That needs to be spelled out in here. You should identify things like conflicts of interest and the property manager should not be, you know, like if my brother’s a plumber, I shouldn’t be able to hire my brother as the plumber in our parks. Well, unless let’s disclosed or unless it’s a competitive bid, this is designed to not have, you know, insider dealing. But typically there is an allowable conflict, you know, whereby I could be the property manager for 10 projects in the same city. And that’s pretty much the norm. Now in mobile home park world, it’s not really that norm that much because frankly, I don’t know many people that own 10 mobile home parks in the same city, but in general, like if I’m managing an office building the fact that I manage 50 office buildings is probably actually good for each client because I have more access to information. I have more scale, you know, from even things like getting cost segregation studies from plumbers, from vendors, from HVAC guys. I have lots of personnel that I can rotate as needed for triage. But that kind of should be in here. You’ve got your typical stuff. Like where do you send notices? There’s arbitration, assignment, I mean, it’s pretty rare for the property manager to be able to assign the contract to just anybody without permission of the owner. But the owner may sell the property and possibly assign the rights subject to termination.

You’ve got your other boilerplate stuff, right? Governing law venue, heading representations, typically there’s a mutual indemnification by both parties. Those are important. You got to make sure you get your signature blocks right. Your authorizations right. But ultimately, you know, the big ones again are, what are the fees? What are the rights? What are the duties? What are the limitations? Who’s paying for what insurance or employees, things of that sort. Very important to have a good property management agreement. Typically if you’re doing a deal for a bigger investment or for a syndication, this at least in this in a form version would be attached as an exhibit to the private placement memorandum. In particular, if the property management company is related to the promoter, which frankly in the mobile home park space probably is on most cases because there are not very many property management companies that are MHP focused.

I mean, I can think of a couple, maybe a handful in the industry, but most people tend to have a self-management structure as opposed to, you know, office and retail. You know, there are entire large companies that are , Cushman Wakefield. Some of those companies, they’ll have entire divisions, all they do is property management, but in the MHP space, I’ve never hired a third-party property manager. I’d be, frankly, kind of afraid to do so. Unless they were more local than me, but still I’d want a property manager agreement with them or with my own entity and for the benefit of the investment group as well. So anyway, lots of minutia as it pertains to property management agreements, but certainly an important document. Till next time, have fun, God bless.

 

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