PART 1

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By Nate Bernstein, Managing Attorney of LA Real Estate Law Group.

Hiring a property management company can relieve an owner of many of the day-to-day responsibilities involved in operating and maintaining an investment property.  At the same time, delegating those responsibilities to a management company does not mean giving up oversight of your asset.  A well-drafted property management agreement should establish what the management company is responsible for, what authority it has, what it can charge, what information it must provide, the company’s duties and liabilities, and what protections remain available to the owner.

Property management agreements are often written in broad terms, which can create problems when the owner and manager later have different understandings about what services are included, what decisions the manager can make, or what expenses the owner is expected to pay.  Before signing a management agreement, the owner should identify these issues and address them clearly in writing.  A well-drafted agreement should not only delegate day-to-day responsibilities, but also establish clear limits on the manager’s authority while preserving the owner’s ability to monitor and protect the investment.

The following are practical considerations for an owner to address when negotiating a property management agreement.

#1. Clearly Define the Property Manager’s Duties and Scope of Services

Property management agreements tend to be very general.  If you want the property manager to perform specific tasks on a weekly, monthly, or annual basis, those duties should be set out in an addendum that is incorporated into the contract.  The addendum should identify the task, the applicable timeframe, and the due date for completing it.

This is important because the owner and property manager should have a clear understanding of what the management company has agreed to do.  The agreement should distinguish between ordinary management duties included in the management fee and additional services that require the owner’s prior approval and, where applicable, an additional fee.  If the owner expects the manager to perform specific tasks on a weekly, monthly, or annual basis, those responsibilities should be identified in an addendum incorporated into the agreement, together with any applicable deadlines.  Any additional task that is outside the agreed scope of services should require the owner’s approval in advance, particularly when performing that task will result in an additional fee or expense.  The more specific the parties define the manager’s responsibilities and the scope of services, the less room there is for disagreement later about what the property manager was hired to do or whether an additional charge was authorized.

#2. Establish Specific and Measurable Performance Standards to Achieve Financial Goals

The management agreement should also address goals for the performance of the property, such as vacancy factor, expense ratios, parking revenue, and liability controls.

An owner should try to turn broad promises about “good management” into specific and measurable expectations.  For example, rather than simply stating that the property manager will monitor vacancies, the agreement could establish what the manager is expected to do when a unit becomes vacant and how quickly those actions must occur.

The same principle can apply to other areas of management.  If the owner has particular expectations concerning expenses, vacancies, reporting, parking fees, or liability controls, those expectations should be sufficiently clear that the owner and manager can determine whether they have been met.

The agreement should also address what happens if the management company consistently fails to meet the agreed performance standards.  The parties should determine whether the standards are intended to be goals or contractual obligations and whether repeated failure to meet them can constitute grounds for penalties, fee reductions, and termination of the management agreement.

The goal is not to make every aspect of property management rigid.  Rather, it is to ensure that important expectations are specific enough to be measured and enforced, instead of being left as vague promises that may be difficult to evaluate later.

#3. Review Financial Reporting and Require Timely Documentation

Financial reporting is one of the most important ways an owner can monitor what is happening with the property.  The owner should review and audit the monthly, quarterly, and annual financial reports provided by the management company and look for charges that appear vague, unnecessary, padded, or otherwise unsupported, as well as income that appears to be missing.  If a charge is unclear or appears unjustified, the owner should be able to request receipts, documentation, bank and financial records, payroll records supporting the charge, and identification of the staff member who performed the work.  The agreement should also permit the owner to review payroll information when appropriate.

The timing and content of financial reporting should be addressed in the management agreement.  The agreement should establish how often reports are provided, exactly what they must contain, and the date by which each report must be delivered.  Depending on the arrangement, the parties may establish weekly, biweekly, monthly, quarterly, or annual reporting requirements.  Include a provision in the agreement requiring the management company to provide a line-item written accounting, a specific explanation, and supporting documentation within 7 calendar days upon demand.

An owner should not have to wait indefinitely for an explanation of a charge or for documentation supporting the financial activity of the property.  Establishing the rules and deadlines for reporting requirements in advance gives both sides a clear understanding of what information must be provided and when.

#4. Identify All Compensation and Fees

To protect the income generated by the property, specifically delineate the total compensation paid to the property management company and its managers.  This includes monthly compensation, annual compensation, bonuses for leasing, and any other compensation connected with management of the property.  Scrutinize, object to, and challenge compensation components that are not approved in the original agreement.

The contract should identify every fee the owner may be charged, not just the property management company’s basic compensation.  An owner should not sign a contract where the management company’s compensation is clear, but the additional ways in which the management company can make money from the property are not transparent.

For example, the agreement should make clear whether there are separate charges for leasing, property management services, administrative work, or other services beyond the basic management fee.  The owner should understand what each fee is for and under what circumstances it can be imposed.

A clear and specific line-item compensation provision protects the owner from unexpected charges and makes it easier to determine the actual cost of having the property managed.

#5. Confirm Insurance Coverage

Confirm that the property management company is adding the owners and main investors as insureds on all the applicable insurance policies, and that renter’s insurance is being purchased by tenants.

The owner should confirm what insurance coverage is required, who is covered, and whether the required coverage is actually in place.  Multiple insurance quotes should be obtained to help secure the best available coverage in the current insurance market.  The management agreement and the applicable insurance documentation, such as declarations pages, should be reviewed together.

It is important to know what protections are actually in place rather than relying solely on a general statement in the management agreement that insurance will be maintained.  You should determine whether you want to purchase excess insurance, such as an umbrella policy, to protect your financial interests.   

#6. Maintain Emergency, Crisis, and Tenant Problem Reporting Procedures

Emergency and crisis reporting at the premises should be addressed expressly in the management agreement.  Have a provision requiring that any emergency or crisis be reported to the principals immediately.  There needs to be a property manager that can receive emergency calls 24 hours per day, 7 days per week.  The property management company needs a written emergency and crisis plan in place.

The agreement should specify what constitutes an “emergency or crisis” requiring immediate notification.  It should also distinguish between ordinary tenant issues that the manager handles independently, significant tenant problems that require notification, emergencies that require immediate notification, and situations in which the manager is authorized to take immediate action without waiting for owner approval.

This distinction is important because a property manager will ordinarily be expected to handle many routine tenant matters without involving the owner in every decision.  At the same time, the owner should know when a tenant problem has escalated and become significant enough to require the owner’s attention.

Nuisance tenants and their units should be reported to the principal, together with a plan of action.  Depending on the circumstances, that plan will involve taking notes in the form of a timeline, a letter, a notice, or the start of an eviction proceeding.

The parties should establish these reporting procedures before a serious problem occurs so there is no uncertainty about when the owner must be notified and what action the manager is authorized to take.

#7. Require an Express Indemnity Provision that Protects the Owners and Investors

The concept of indemnity is an important legal consideration and protection for an owner.

Indemnity is by definition a legal obligation where one party agrees to provide financial protection to another party against specified potential losses, typically involving a payment of compensation.  Indemnity clauses are common in various agreements, ensuring specific terms are met and risks are covered, akin to a safety net in business and insurance contracts.  Indemnity can be expressed by contract or implied under the law. 

You should always have language requiring the property management company to indemnify the owners and principals for claims related to management of the property.

Because an indemnity provision can vary substantially in its scope, the owner should examine what the provision actually covers.  Consider what types of claims the management company is agreeing to indemnify, whether the provision covers the manager’s negligence or misconduct, whether there are exclusions, and whether the management company’s indemnity obligations are limited by another provision of the contract.  Strive for broad indemnity provisions to be placed in the management contract to hold the property management company accountable.    

The owner should not assume that every indemnity provision provides the same protection.  The actual language matters.  The owner should understand the circumstances in which the management company will be responsible for a claim and any limitations placed on that responsibility.

Some of these risks can be addressed with insurance. Other risks cannot, so make sure you have a broad express indemnity provision.

Stay Tuned for Part 2!

Author Bio

Nate Bernstein, Esq., is the Managing Counsel of LA Real Estate Law Group and a member of the State Bar of California.  His practice concentrates in the areas of complex real estate title litigation, commercial litigation, landlord-tenant law, employment law, and bankruptcy matters.  Attorney Bernstein served as in-house corporate litigation counsel at Fidelity National Title Insurance Company and represented the company’s subsidiaries and insured institutional lenders.  He is a 32-year veteran Los Angeles real estate and business attorney and trial lawyer.  Mr. Bernstein also has expertise in bankruptcy law, the federal bankruptcy court system, creditor’s rights and out-of-court workout solutions.  He serves as an expert witness on complex real estate, title, joint venture, and other business issues.

Mr. Bernstein is a frequent speaker at apartment owners’ association seminars and has been a featured speaker with the California Associations of Realtors, Apartment Owners Association, AAGLA, AAOA, the Collateral Lenders Association, and the Beverly Hills Bar Association.  He created www.laquiettitleattorney.com, a leading educational resource on quiet title real estate litigation. LA Real Estate Law Group handles litigation in Los Angeles, Ventura County, Orange County, Inland Empire, and San Diego.  For more information or to schedule a professional consultation, please contact the office at (818) 383-5759, or email [email protected].