Managing the Management Company: Cash

When you own a real estate project, affordable or not, you will have to determine how you are going to manage it.  The majority of owners look to third party management companies to assist in the collecting of rents, paying of expenses and dealing with tenant issues.  In addition, for affordable housing units, a third party management company can assist in meeting compliance requirements around income and rent limits and other items.

Selecting a management company is always a challenge.  An investor I work with has commented that every time there is a hot, new, really good management company, everyone will switch their projects, they will get too busy, and then they won't be as good anymore.  I always thought that observation could apply to a lot of small businesses.

Assuming that you are going to use a management company, there are a few things that you should know.

The management company is going to report to the budget.  In the management world, asset managers are held acountable to an operating budget.  In fact, they are often paid bonuses based on their portfolio's performance to budget.  And they are trained to move around expenses until they meet that budget.  I urge you to look closely at the budgets you approve, because that is a map of the results (assuming no unusual events).

I worked with one management company that put any items not on the budget in capital expenditures (balance sheet).  I once found a billing for marketing brochures in the fixed asset account.  Obviously, this is to meet their bonus guidelines, and is not really useful for your internal reporting and analyzation of financial benchmarks.

The management company can not be trusted with cash.  I am not saying that they will steal the cash (although fraud is always something that you should be on the look-out for); rather, I am saying that if a property is performing and there is a lot of cash sitting around, well, operations will eventually decline.

It's human nature to pay closer attention to expenses and make decisions based on cost/benefit when the cash situation is tighter.  If a project has a lot of cash in it, then the asset manager is saved from having to worry about it too much and may not watch expenses as closely.  This same attitude may affect the owner's side as well.

I generally recommend that owners sweep cash above a certain amount out of the management company trust account.  This ensures that current expenses are being paid from current operations.  If, for some reason, there is not enough cash to pay one month's expenses, you will know it immediately.  If you have a pile of cash, you may not realize there has been a change in operations for quite some time.

I work with one company that had a lot of developmental money locked into a project.  By locked, I mean, they forgot to take it.  One of the first things we showed them was the project's negative operating cash flow.  In fact, this project had been operating at a deficit for a few years.  This had not been closely monitored before, because the project had a $100,000 in the bank, so no one worried about it.

Had this owner swept the cash, they would have been able to implement some changes to the budget in a much more timely manner and been able to recover all of the development money that they forgot to take.  As it was, they left money on the table.

SWEEP THE CASH
In affordable housing, sweeping the cash does not mean that you have come into a windfall.  There are generally provisions in your Operating or Partnership agreement with the investor that stop you from taking cash until the annual audit is complete.  So, in this case, the owner should have a bank account in the entity's name where they keep the sweep of money from the management company.  That bank account would show on the project's books at the owner level (after recording activity from the management company).

The management company will reflect this sweep as one of two things:  an owner distribution (most common) or an other expense (I've seen this too).  In fact, it is merely a cash transfer, so you would record the cash received and credit whichever account the management company used to ensure that this sweep does not erroneously show up as revenue, expense, or a change in equity.