Understanding Property Management Contracts

Property management contracts are needed because disputes between property managers and their clients sometimes arise, even between reasonable and rational people under the best of circumstances. It's important to have a contract in place that covers important issue areas, so if a problem comes up, all parties know how to proceed.

Key Areas Property Management Contracts Should Address

A good property management contract lists services and fees and also anticipates the things that can go wrong, as well as and spells out what happens in these situations.

#1: An Outline of the Scope of Work

Any property management contract needs to carefully define the scope of work. What, precisely, is the property management company responsible for, and what responsibilities will the rental property owners retain for themselves?

Important elements to include in the scope of work include the following:

• Basic services the property management company must perform every month
• Who screens tenants and how they are approved
• Rent collection responsibilities
• Maintenance and repair responsibilities, and how both are approved
• How repairs and maintenance will be funded
• What reports will be sent to the rental property owner, and how often those reports will be sent

The broader the scope of work, the higher the fees necessary to keep the project profitable for the property management company. The narrower the scope of work, the lower the fees. This is common sense, but rental property owners often don't quite grasp the inputs that go into fee calculations.

#2: Labor Estimates and Fee Structure

No property can be managed without the cost of retaining qualified employees and contractors. Any good property management contract administrator is going to estimate man-hour expenditures, including benefits.

The property management company must also consider the costs of "on-ramping" a new customer. These can include the following:

• The cost of drafting up a new contract
• The salesperson must be compensated for the new business
• Staff must be trained on the new property
• New staff must be recruited, interviewed, hired and paid during training
• If management takes place on-site, the management company must furnish a new office with computers, furniture, office supplies, etc.

There are many more costs for the property management company than this, and most of them are invisible to the client. Property managers must therefore make significant investments into each property they add to their portfolios, often before they see a dime in fees.

This is why cancellation provisions are so important. If the landlord wants to cancel early, the property management company will want to include provisions that ensure they will recoup their initial investment. Once you understand that, the fee structure property management companies ask for makes a lot more sense.

For example, in some markets, it's common for property managers to ask for a specified percentage of collected rents, plus a "leasing fee" of, for example, half of one month's rent. The leasing fee quickly reimburses the property manager for at least part of the on-ramping expenses, commissions, contract drafting, screening, credit checks, and other expenses.

Landlords can manage their units on their own, but that doesn't mean they should. Request quotes from local property managers and learn why.

#3: Contract Amendments

What happens if it's necessary to change the terms, services, fees or conditions in the contract before it expires? A good property management contract allows for both parties, when acting in good faith, to make amendments to it. Increasing a contract's flexibility also improves its longevity. It's undesirable for everyone involved to have one party be eager to end the contract at the first legal opportunity.

#4: Contract Duration and Cancellation Procedures

Generally contracts specify a beginning and an end date, as well as renewal procedures. The contract should also specify how either party may end the contract. Cancellations are generally allowed by property management contracts when notice to the other party is provided a certain number of days in advance. In the event of a contract cancellation, deposits, reserves, and other money the property management company is holding on behalf of the rental property owner must also be accounted for.

#5: Indemnification

Property management contracts typically specify that rental property owners must "hold harmless" the property manager for any liability that arises as a result of the reasonable, competent and diligent exercise of their responsibilities as outlined by the scope of work. There are two exceptions to this rule:

• Gross negligence on behalf of the property manager
• Acts or omissions that are not within the scope of the contract

Rental property owners are responsible for keeping adequate homeowners insurance coverage and liability umbrella coverage in place to cover themselves against claims made by tenants and others, both against you and your property manager. But property management companies should maintain errors and omissions insurance and liability insurance of their own, as well. This protects tenants, landlords, and the property management companies themselves.