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Washington Real Estate Fundamentals

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1 Washington Real Estate Fundamentals
Lesson 16: Property Management © 2011 Rockwell Publishing

2 Introduction Property manager: Someone other than property owner who supervises operation of income-producing property. Real estate firms often engage in property management as well as brokerage. © 2011 Rockwell Publishing

3 Investing in Real Estate
Income-producing property typically owned as an investment. Property manager hired to help owner achieve investment goals. Manager needs to understand basic investment principles. But real estate agent should not give investment advice. Refer clients to experts instead. © 2011 Rockwell Publishing

4 Investment Basics Investments and returns
Investment: Asset expected to generate a return (or profit) for investor. Depending on type of investment, return on investment may take various forms, including: interest dividends appreciation rents © 2011 Rockwell Publishing

5 Investment Basics Types of investments
Ownership investments: Investor takes ownership interest in asset. Examples: real estate, stocks Returns: rents, appreciation, dividends Debt investments: Investor loans money. Examples: mortgage loans, bonds Returns: interest on principal © 2011 Rockwell Publishing

6 Investment Basics Diversification
Diversification: Investing in different types of investments instead of only one. Mix of investments held is called investor’s portfolio. Mix chosen in hope that loss on one investment will be offset by profit on others. © 2011 Rockwell Publishing

7 Investment Basics Investment income vs. earned income
For income tax purposes, distinction between: investment income (such as interest, dividends, or rental income) earned income (such as salaries, wages, or self-employment income) Different rules may apply to the two categories. © 2011 Rockwell Publishing

8 Investment Basics Characteristics of investments
Three fundamental characteristics used to evaluate and compare investments: Safety: Risk of losing money originally invested. Liquidity: How quickly asset can be converted to cash. Yield: Total return on investment (ROI). © 2011 Rockwell Publishing

9 Investment Basics Characteristics of investments
Liquid assets are generally safest, but do not offer high yields. Savings accounts and certificate of deposits: liquid and safe, but with low yields. Real estate: can generate higher yields, but at somewhat greater risk and without much liquidity. © 2011 Rockwell Publishing

10 Investing in Real Estate Advantages
Advantages of investing in real estate include: appreciation leverage cash flow © 2011 Rockwell Publishing

11 Advantages of Real Estate Appreciation
Appreciation: Increase in value of property due to outside factors. May be due to inflation, other general economic forces. May be due to increased demand for type of property. Example: when buildable property in good location becomes scarce, value increases. © 2011 Rockwell Publishing

12 Appreciation Hedge against inflation
Real estate values fluctuate, but tend to increase at a rate equal to or greater than inflation rate. So real estate considered effective “hedge” against inflation. © 2011 Rockwell Publishing

13 Appreciation Owner’s equity
Appreciation increases owner’s equity. Equity: Difference between value of property and liens against it. Equity adds to owner’s net worth. Equity can be used as collateral for loan. © 2011 Rockwell Publishing

14 Advantages of Real Estate Leverage
Leverage: Using borrowed money to invest in an asset. If asset appreciates, investor earns return on borrowed money as well as own invested funds. © 2011 Rockwell Publishing

15 Advantages of Real Estate Cash flow
In addition to appreciating, real estate investment may generate positive cash flow. Cash flow: Spendable income remaining after all property’s expenses paid. Including operating expenses, mortgage payments, and taxes. Cash on cash: First year’s cash flow divided by amount of initial investment. © 2011 Rockwell Publishing

16 Cash Flow Sale-leaseback
Rental income is one way real estate can generate cash flow; sale-leaseback is another. Sale-leaseback: Owner of commercial building sells it to investor for cash, then leases it back from investor. Frees up capital. Rental payments tax-deductible. Parties often also enter into buyback agreement. © 2011 Rockwell Publishing

17 Types of Managed Properties
Four main types of income-producing properties: residential rental properties office buildings retail properties industrial properties © 2011 Rockwell Publishing

18 Types of Managed Properties Residential rental properties
Residential rental properties include: single-family rental homes apartment buildings Key aspects of residential management: compliance with landlord-tenant laws marketing and leasing Short-term leases (month-to-month, one-year) mean high turnover. © 2011 Rockwell Publishing

19 Types of Managed Properties Office buildings
Office buildings frequently: get constant traffic and use require constant maintenance Office space is leased: by square foot on longer-term basis often with escalation clause © 2011 Rockwell Publishing

20 Types of Managed Properties Retail properties
In managing retail space, tenant selection important. In mall or shopping center, right mix of stores necessary to draw shoppers. Tenant’s rent often tied to income from retail business. © 2011 Rockwell Publishing

21 Types of Managed Properties Industrial properties
Industrial properties are very specialized. Expensive to build-out and operate. Leases usually long-term (for example, ten years). © 2011 Rockwell Publishing

22 Summary Investing in Real Estate
Property management Investment Return on investment Diversification Portfolio Investment income Earned income Safety Liquidity Yield Appreciation Equity Leverage Cash flow Sale-leaseback © 2011 Rockwell Publishing

23 Management Agreement Property management agreement: Contract between property owner and property manager. Creates agency relationship. Parties: owner and real estate firm. Firm appoints affiliated licensee to act as manager and execute contract. Agreement must be in writing and signed by both parties. © 2011 Rockwell Publishing

24 Management Agreement Scope of authority
Agreement should define scope of manager’s authority. May or may not include authority to: collect and disburse funds hold and disburse security deposits set rental rates execute leases undertake major repairs hire and fire employees © 2011 Rockwell Publishing

25 Management Agreement Other basic provisions
Term of agreement Type of property and legal description Number of units or square footage Manager’s compensation percentage of property’s gross income commission on new rentals fixed fee combination of methods (continued) © 2011 Rockwell Publishing

26 Management Agreement Other basic provisions
Manager’s reports to owner on property’s operations (frequency and level of detail) Statement of owner’s goals Description of manager’s duties Allocation of costs (for expenses such as office help and advertising) © 2011 Rockwell Publishing

27 Management Plan Management plan: Property manager’s plan for property’s operations. Sets out manager’s strategies for achieving owner’s goals. Addresses financial management and physical maintenance issues. © 2011 Rockwell Publishing

28 Management Plan Owner’s goals
Different owners have different goals. For example: maximizing monthly income, vs. increasing property’s value for resale Different goals dictate different management strategies. Owner’s goals may change over time, requiring updated management plan. © 2011 Rockwell Publishing

29 Management Plan Preliminary study
To create management plan, manager studies the property and its context. Four levels of analysis: regional analysis neighborhood analysis property analysis market analysis © 2011 Rockwell Publishing

30 Preliminary Study Regional analysis
Regional analysis: Concerns characteristics of metropolitan area where property located: occupancy rates market rental rates employment levels family size and lifestyles © 2011 Rockwell Publishing

31 Regional Analysis Occupancy rates and rental rates
Law of supply and demand governs relationship between occupancy rates and rental rates. Demand for rental units exceeds supply: rental rates go up. Supply of rental units exceeds demand: rental rates go down. © 2011 Rockwell Publishing

32 Regional Analysis Occupancy rates and rental rates
Technical oversupply: More units than potential tenants. Economic oversupply: More units than tenants who can afford current rents. When there are more tenants than units, it’s either a technical shortage or an economic shortage. © 2011 Rockwell Publishing

33 Regional Analysis Employment levels
Employment rate in area affects ability of potential tenants to afford rents. Manager should keep track of events affecting employment levels. For example, arrival or departure of large company. © 2011 Rockwell Publishing

34 Regional Analysis Family size and lifestyle
Residential rentals strongly affected by average family size. Demand for units with certain number of bedrooms changes over time. Manager should pay attention to national and local trends. © 2011 Rockwell Publishing

35 Preliminary Study Neighborhood analysis
Neighborhood analysis takes property’s location into account in management plan. Neighborhood may be several square miles or only a few blocks. Factors considered include: how well properties are maintained whether population increasing or decreasing economic status of residents © 2011 Rockwell Publishing

36 Preliminary Study Property analysis
When manager evaluates property itself, factors considered include: number and size of rental units or spaces appearance of property and rental spaces physical condition of building physical condition of rental spaces (continued) © 2011 Rockwell Publishing

37 Preliminary Study Property analysis
amenities provided (laundry room; recreational facilities) services provided (janitorial; security) relationship between site and building current occupancy rate and tenant composition size and efficiency of current staff © 2011 Rockwell Publishing

38 Preliminary Study Market analysis
Market analysis: Analyzing properties that the client’s property competes with. First step is identifying pertinent market. For example, small multistory apartment buildings. © 2011 Rockwell Publishing

39 Preliminary Study Market analysis
Factors considered: number of competing units or rental spaces available in the area average age and character of buildings quality of average unit or space in market number of potential tenants in the area current price for average unit or space average occupancy rate © 2011 Rockwell Publishing

40 Management Plan Management proposal
After completing preliminary analysis, manager prepares proposal for client. Proposal includes: rental schedule income and expense projections schedule of day-to-day operations suggested physical changes to building © 2011 Rockwell Publishing

41 Management Proposal Rental schedule
Rental schedule: Lists rental rate assigned to each type of unit or space in building. Manager sets optimum rent that can be charged while maintaining optimum occupancy. Rental schedule should be reevaluated periodically, to make sure it’s in line with current market rates. © 2011 Rockwell Publishing

42 Management Proposal Budget
Budget in management proposal includes: total rental value of all rentable space bad debt and vacancy factor income from miscellaneous other sources estimated operating expenses fixed: property taxes, insurance, salaries variable: utilities, maintenance, repairs cash flow (projected revenues minus projected expenses) © 2011 Rockwell Publishing

43 Management Proposal Day-to-day operations
Proposal also includes plans for property’s day-to-day operations. Manager suggests: staffing needs employment policies © 2011 Rockwell Publishing

44 Management Proposal Physical alterations
Proposal may also present manager’s recommendations for remodeling, rehab, or other physical alterations. Changes that will increase property’s value by responding to demand in current market. © 2011 Rockwell Publishing

45 Management Plan Approved by client
Manager submits proposal to property owner. When approved by client, proposal becomes management plan. © 2011 Rockwell Publishing

46 Summary Management Agreement and Plan
Management plan Regional, neighborhood, property, and market analysis Technical oversupply or shortage Economic oversupply or shortage Management proposal Rental schedule Budget © 2011 Rockwell Publishing

47 Management Functions Functions of a property manager can be divided into three main categories: leasing and tenant relations recordkeeping and manager/owner relations property maintenance © 2011 Rockwell Publishing

48 Management Functions Leasing and tenant relations
Leasing and tenant relations includes: marketing the rental units or spaces negotiating leases addressing tenant complaints collecting rents © 2011 Rockwell Publishing

49 Leasing and Tenant Relations Marketing rental space
Manager’s strategy: advertising to greatest number of potential tenants at lowest possible cost. Amount of advertising needed depends on property type, location, etc. Effectiveness of advertising evaluated based on cost per prospect. © 2011 Rockwell Publishing

50 Leasing and Tenant Relations Marketing rental space
Marketing methods that might be used: signs newspapers classified ads display ads Internet radio and TV direct mail © 2011 Rockwell Publishing

51 Leasing and Tenant Relations Negotiating leases
Manager shows property to prospective tenants who respond to advertising. Points out features and advantages. With commercial tenant, discusses alteration of space to suit tenant’s needs. © 2011 Rockwell Publishing

52 Negotiating Leases Screening applicants
Manager screens applicants based on: financial qualifications whether likely to be responsible, cooperative tenants Checks credit report and references, contacts previous landlord. Must not violate antidiscrimination laws. Once suitable tenant found, lease executed. © 2011 Rockwell Publishing

53 Negotiating Leases Renewals
Managers generally prefer to renew leases rather than find new tenants. Avoids vacancies between tenancies. Greater stability for property as a whole. Existing tenant easier and less expensive to satisfy than new tenant. Automatic renewal clause: Lease renewed on same terms unless one party gives notice of termination. © 2011 Rockwell Publishing

54 Leasing and Tenant Relations Tenant complaints
Key factors in retaining tenants: keeping property clean and in repair responding to tenant complaints promptly and professionally © 2011 Rockwell Publishing

55 Leasing and Tenant Relations Rent collection
Careful selection of tenants best way to avoid delinquent rents. Lease should clearly state: how, when, and where rent is to be paid penalties for late payment © 2011 Rockwell Publishing

56 Leasing and Tenant Relations Rent collection
Rent collection procedures should: be consistent include adequate recordkeeping provide for immediate notification of late payment If rent collection efforts fail, manager should be prepared to take legal action to evict tenant, following client’s policies. © 2011 Rockwell Publishing

57 Management Functions Manager/owner relations
Property manager required by law to account for all money received and disbursed in connection with client’s property. Beyond that, how often and in what detail manager reports to owner is matter of owner’s preference. © 2011 Rockwell Publishing

58 Manager/Owner Relations Statement of operations
Manager’s report to owner often made in a monthly statement of operations. Statement typically includes these sections: summary of operations rent roll statement of disbursements narrative report of operations © 2011 Rockwell Publishing

59 Manager/Owner Relations Statement of operations
Summary of operations: Brief description of property’s income and expenses, included at beginning of statement of operations. © 2011 Rockwell Publishing

60 Manager/Owner Relations Statement of operations
Rent roll: Report on collections included in statement of operations. Lists all occupied and vacant units. For each unit, shows previous balance, current rent, total received, and balance due. Info in rent roll obtained from separate ledger sheet kept for each tenant and rental space. © 2011 Rockwell Publishing

61 Manager/Owner Relations Statement of operations
Statement of disbursements: List of all expenses paid during period covered by statement of operations. Disbursements grouped by type (maintenance expenses, administrative expenses, etc.). © 2011 Rockwell Publishing

62 Manager/Owner Relations Statement of operations
Narrative report of operations: Letter explaining information presented in other sections of statement of operations. Particularly useful in months involving poor cash flow or unanticipated expenses. © 2011 Rockwell Publishing

63 Management Functions Property maintenance
Manager supervises maintenance, including: Preventive maintenance: Preserving physical condition of improvements. Corrective maintenance: Repairs to keep property in working order. Housekeeping: Routine cleaning. New construction: Remodeling and redecoration for new or renewing tenants, or to improve property. © 2011 Rockwell Publishing

64 Management Functions Property maintenance
Manager should: inventory building’s physical elements and equipment create schedule for inspections and repairs keep records on when elements of property were inspected, repaired, or replaced © 2011 Rockwell Publishing

65 Summary Management Functions
Marketing and leasing Automatic renewal clause Tenant complaints Rent collection Statement of operations Preventive maintenance Corrective maintenance Housekeeping New construction © 2011 Rockwell Publishing

66 Landlord-Tenant Law Landlord-tenant relationship governed by:
terms of contract forming the relationship (lease) rules set by state landlord-tenant law © 2011 Rockwell Publishing

67 Landlord-Tenant Law Requirements for a valid lease
Lease: Contract that allows tenant to have possession of landlord’s property for period of time, in exchange for rent. Also called rental agreement. Must have all essential elements required for valid contract. Also must have property description. © 2011 Rockwell Publishing

68 Lease Requirements Written lease
In Washington, lease for a fixed term must be in writing and signed by landlord. If term over one year: must be notarized. Periodic tenancy doesn’t require written lease, unless rental period over one year. However, any lease for property managed by a real estate firm must be in writing. © 2011 Rockwell Publishing

69 Lease Requirements Written lease
Written lease does not have to be signed by tenant (although it almost always is). Management agreement commonly authorizes manager to sign lease as landlord’s agent. Without this authorization, written lease signed by manager not valid. © 2011 Rockwell Publishing

70 Landlord-Tenant Law Lease provisions
Best to use standardized lease form with specific rules that will govern tenancy. However, landlord-tenant law may trump lease terms. © 2011 Rockwell Publishing

71 Landlord-Tenant Law Lease provisions
Issues often addressed in lease: payment of rent use of premises security deposits entry and inspection renewal maintenance assignment and subleasing © 2011 Rockwell Publishing

72 Lease Provisions Payment of rent
Rent is the consideration that makes lease a valid contract. Most leases require rent to be paid at beginning of rental period. If not specified, rent due at end of rental period. © 2011 Rockwell Publishing

73 Lease Provisions Use of leased premises
Use of rented property must be legal. Use may also be limited by lease terms. For example, lease of retail space might limit tenant to operating certain kind of store. Without clear restrictive language, tenant can use property for any legal purpose. © 2011 Rockwell Publishing

74 Lease Provisions Security deposits
Security deposit: Money tenant provides in trust at start of lease in case of default. Most leases require a security deposit, as protection against tenant: moving out without paying rent owed leaving property in poor condition In Washington, deposit can be required from residential tenant only if lease in writing. © 2011 Rockwell Publishing

75 Security Deposits Written checklist
In Washington, at start of residential tenancy, tenant must be given written checklist regarding unit’s condition. Landlord and tenant both sign checklist. Tenant entitled to: copy of signed checklist receipt for security deposit During tenancy, deposit must be held in trust account. © 2011 Rockwell Publishing

76 Security Deposits Refund or retention
Within 14 days after end of tenancy, landlord must: return entire deposit to tenant, or send tenant written explanation as to why all or part of deposit was retained. Security deposit may be used for unpaid rent, cleaning, or repairing damage. Not for ordinary wear and tear. © 2011 Rockwell Publishing

77 Security Deposits Nonrefundable fees
Landlord may charge a nonrefundable cleaning fee at beginning of tenancy, but this: must be designated “nonrefundable” cannot be called a “deposit” © 2011 Rockwell Publishing

78 Lease Provisions Entry and inspection
Lease typically provides for inspection of premises by landlord during term. In Washington, residential landlord may enter leased unit to: inspect unit perform repairs provide other agreed-upon services show unit to prospective buyers or tenants © 2011 Rockwell Publishing

79 Lease Provisions Entry and inspection
Unless emergency, landlord must provide advance notice before entering. Repairs or services: two days’ notice. Showing unit: one day’s notice. © 2011 Rockwell Publishing

80 Lease Provisions Option to renew
Lease may give tenant option to renew. Typically requires tenant to notify landlord of intention to renew by specified date. © 2011 Rockwell Publishing

81 Lease Provisions Maintenance
At end of lease, tenant must return leased premises to landlord in original condition, with allowances for normal wear and tear. Landlord generally responsible for maintaining common areas, such as hallways and elevators. © 2011 Rockwell Publishing

82 Summary Leases Written lease requirements Written checklist
Payment of rent Use of leased premises Security deposit Normal wear and tear Nonrefundable cleaning fee Entry and inspection Option to renew © 2011 Rockwell Publishing

83 Landlord-Tenant Law Transferring leasehold estates
Landlord may sell leased property in middle of lease. Buyer takes title subject to lease. © 2011 Rockwell Publishing

84 Landlord-Tenant Law Transferring leasehold estates
Tenant may transfer leasehold interest by: assignment, sublease, or novation. Tenant has right to assign or sublease property without landlord’s consent, unless lease specifically requires consent. But consent always required for novation. © 2011 Rockwell Publishing

85 Transferring Leasehold Estates Assignment
Assignment: Tenant transfers possession to someone else for entire remainder of lease term. Assignee (new tenant) takes on primary responsibility for rent. Assignor (original tenant) secondarily liable. © 2011 Rockwell Publishing

86 Transferring Leasehold Estates Subleasing
Sublease: Tenant transfers possession to someone else for only part of remaining lease term. Also called sandwich lease. Sublessor (original tenant) remains liable to landlord for rent. Sublessee (new tenant) liable to original tenant for rent. © 2011 Rockwell Publishing

87 Transferring Leasehold Estates Novation
Novation: When new contract created and old contract terminated. Landlord may accept new tenant in place of old tenant, creating new lease. Original tenant released from liability. © 2011 Rockwell Publishing

88 Landlord-Tenant Law Termination of a leasehold
How lease ordinarily terminates depends on type of tenancy: Periodic tenancy terminates at end of period if one party gives the other proper notice. Tenancy for fixed term terminates automatically at end of term. © 2011 Rockwell Publishing

89 Landlord-Tenant Law Termination of a leasehold
Tenancy can also terminate through: surrender breach of covenant of quiet enjoyment breach of implied warranty of habitability failure to pay rent illegal or unauthorized use destruction of premises condemnation © 2011 Rockwell Publishing

90 Termination of a Leasehold Surrender
Surrender: Landlord and tenant mutually agree to terminate lease before term ends. © 2011 Rockwell Publishing

91 Termination of a Leasehold Covenant of quiet enjoyment
Implied covenant of quiet enjoyment: Landlord’s promise that tenant’s exclusive possession will not be disturbed: by landlord by third party with lawful claim Covenant part of every lease as a matter of law, even if not explicitly stated in lease. © 2011 Rockwell Publishing

92 Termination of a Leasehold Covenant of quiet enjoyment
Covenant breached if tenant wrongfully evicted. Breach can take the form of: Actual eviction: Landlord actually expels tenant from property. Constructive eviction: Landlord causes or permits substantial interference with tenant’s possession. © 2011 Rockwell Publishing

93 Termination of a Leasehold Warranty of habitability
Implied warranty of habitability: Landlord’s promise that premises comply with building and housing codes related to health and safety. Warranty part of every residential lease, even if not explicitly stated in lease. © 2011 Rockwell Publishing

94 Termination of a Leasehold Warranty of habitability
Warranty breached if leased premises become unsafe or unsanitary. Tenant must notify landlord of problem. Landlord must correct problem within a certain time after receiving notice. If landlord fails to respond, tenant has several options, including terminating lease. © 2011 Rockwell Publishing

95 Termination of a Leasehold Failure to pay rent
Failure to pay rent doesn’t automatically terminate lease. Landlord must: give notice of nonpayment file unlawful detainer action against tenant obtain writ of restitution from the court (also called writ of possession) “Self-help” eviction illegal. © 2011 Rockwell Publishing

96 Termination of a Leasehold Illegal or unauthorized use
Other grounds for termination by landlord, even if tenant pays rent as agreed: illegal use of leased premises use in a way not authorized by lease If tenant continues use after being told to stop, landlord can terminate tenancy. © 2011 Rockwell Publishing

97 Termination of a Leasehold Destruction of premises
If tenant leases space in a building that is destroyed by fire or other disaster, lease is terminated. If land as well as improvements were leased, destruction of building does not terminate lease. © 2011 Rockwell Publishing

98 Termination of a Leasehold Condemnation
Lease may terminate if leased property condemned by government entity. © 2011 Rockwell Publishing

99 Summary Landlord-Tenant Law
Assignment, sublease, and novation Surrender Implied covenant of quiet enjoyment Actual eviction Constructive eviction Implied warranty of habitability Unlawful detainer Writ of restitution or possession © 2011 Rockwell Publishing

100 Types of Leases Five major types of leases: fixed leases
graduated leases net leases percentage leases ground leases © 2011 Rockwell Publishing

101 Types of Leases Fixed lease
Fixed lease: Tenant pays same amount of money each month. Also called flat lease or gross lease. Landlord pays for operating expenses (maintenance, taxes, and insurance). Type of lease used for most apartment rentals. © 2011 Rockwell Publishing

102 Types of Leases Graduated lease
Graduated lease: Contains escalation clause, so rent may increase during lease term. Also called step-up lease or index lease. Escalation clause: Provides for periodic rent increases, usually tied to Consumer Price Index or other measure of inflation. © 2011 Rockwell Publishing

103 Types of Leases Net lease
Net lease: Tenant pays a fixed rent, plus some or all of property’s operating expenses. Includes property taxes, insurance, maintenance costs. Commercial leases are often net leases. © 2011 Rockwell Publishing

104 Types of Leases Percentage lease
Percentage lease: Retail tenant pays: minimum rent, plus percentage of gross or net income generated by tenant’s business. Most common in shopping centers. © 2011 Rockwell Publishing

105 Types of Leases Ground lease
Ground lease: Commercial tenant leases vacant land and constructs building on the land. Typically long-term lease. © 2011 Rockwell Publishing

106 Summary Types of Leases
Fixed lease Graduated lease Escalation clause Net lease Percentage lease Ground lease © 2011 Rockwell Publishing

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