An Introduction to Property Management Accounting
Real Estate and Property Management are strong stable markets. Purchasing investment properties or managing those properties for others is a smart move in today’s economy. Making a move towards property management comes with infinite questions about how to handle the transactions, though. All businesses rely on an accounting function to keep them afloat, but property accounting requires specific skills to drive a successful property management venture.
What is Property Accounting?
Property management accounting is essentially landlord accounting. Real Estate structures that contain leased spaces include commercial retail buildings, office buildings, industrial spaces, and residential properties. Property accounting records the transactions that deal with the revenues earned from rents and all the expenses that go into running the property.
Property management accounting is unique from other types of accounting because property management often means multiple properties, so the accounting must be done separately for each entity. Each property requires that accounts be kept for the property itself and for each of its tenants. This means multiple charts of accounts, bank accounts, and financial reports. Investors or small companies that have one or a few buildings may not start out with separate companies for each, but growth will mean setting up multiple legal entities.
Accounting for properties that generate income can be overwhelming, so it is best to break the cycle into steps, or phases. While the demands of properly accounting depend on the specifics of the business, there are four basic phases to the accounting cycle. A property management cycle typically occurs over a period of one month.
1. Collect Rent Revenue
In property management, spaces are leased, or rented, to tenants. The accounting cycle begins with receiving rent and depositing the funds into the bank account.
2. Accounts Payable
Accounts payable is the accounting function that pays and tracks invoices received for products and services needed to run the business. Property management invoices may include those for maintenance, utilities, property taxes, and other operating expenses.
3. Bank Reconciliations
Bank reconciliations are done monthly once the bank statements are received to verify that all rental revenue and operating expenses have been recorded correctly and there is no unexpected or unexplained cash transactions
4. Financial Reports
To complete the accounting cycle for property management, financial reports must be generated. The reports are required for external users including taxing authorities, lenders, and investors. Financial reports are used internally to monitor the financial position of the property and make decisions about future operations.
Property Accounting Terms and Tools
Many of the terms used in property management are similar to general accounting terms, but there are some that carry more weight or are unique to this specific industry. Understanding the meaning of property accounting vocabulary will make a journey into property management much smoother. There are also tools that can be used to make property accounting more efficient. Some common property management terms and tools are described in the list below.
Cash Basis/Accrual Basis
An accounting method must be chosen when starting the books for any business. A cash basis accounting method records transactions as the money comes into or out of the company. In a company that uses cash accounting, rents are recorded onto the ledger as income at the time the funds are received.
Property accounting using an accrual basis means recording transactions when they are due to occur. In a company using the accrual basis, rent would be recorded to the ledger as income on the date it is charged or due, usually the first of the month.
Triple Net/Gross
Triple Net and Gross are both terms that describe lease types. In a gross lease, the tenant pays a monthly base rent, as agreed upon in the lease. The tenant does not share the cost of operating expenses.
A triple net lease, or NNN lease, means that the tenant pays their pro-rata share of operating expenses and real estate taxes in addition to their base rent. With a NNN lease, operating expenses and property taxes may be paid monthly with base rent based on an estimate provided by the landlord. Some landlords choose to only collect base rent monthly, and bill tenants, following an expense reconciliation, annually.
Trailing 12
A trailing 12 is a term used to describe a format of an income statement. The income statement is also referred to as the profit and loss statement of a business and lists the revenues and expenses to calculate the Net Income. A trailing twelve shows twelve months of income and expenses in one report so that landlords and accountants can see trends from month to month. It is an important tool in analyzing property accounting records because it quickly shows any change in rents or expenses.
Budget/Forecast
A budget lays out the financial plan for a period, usually one year. The budget lists the revenues and expenses that are reasonably expected to happen. A complete and thorough budget is an important analysis tool in monthly reviews of financial statements because it allows the accountant or property owner to track if rents and expenses are occurring as expected.
A forecast is another financial planning tool often used in conjunction with the budget. Proper forecasting gives cash flow expectations for the near future and changes as time goes on. A forecast essentially updates a twelve-month budget with actual data as the months conclude changing the cash flow and income expectations in future months.
Rent Roll
A rent roll is a report that lists each unit in a property. The report lists the tenant, the square footage, the base rent, and important dates. A rent roll is an acceptable way to show current occupancy when working with accounting firms and lenders.
1031 Exchange
The term 1031 Exchange is taken from the IRS Code Section 1031. The 1031 exchange allows real estate investors to defer tax on capital gains by exchanging like-kind property. Basically, when one property is sold, the owner can defer the income tax by purchasing another property within the allowed timeframe. Anyone in the business of buying or selling real estate should speak with their tax advisor regarding the benefits and applications of the 1031 Exchange rules.
Property Management Software
Quite possibly the most important property accounting tool is property management software. Smaller property management companies or individuals owning one or a few buildings may be able to document their financial transactions using a spreadsheet, like Excel. However, because accounting for property management often includes multiple entities and separate accounts for the tenants and the property, good software simplifies the process.
Accounting software that is dedicated to property management, like AppFolio or Onesite, saves time, frustration, and money on generating financial reports, recording rents and expenses, and tenant communications. Purchasing software can be confusing and expensive but using an accounting service to access great property management software is another efficient way to have the best tools in the business.
Final Thoughts
Property management is not for everyone, but many business owners and individuals find that it is a great way to invest in long-term assets while generating income. Accounting for property management requires patience and an overall understanding of the industry-specific terms and expectations beginning with the accounting cycle. For all types and sizes of property management, there are software packages or outsourced accounting services available to aid in the process. One such accounting service is My OC Bookkeeper. We love working with property management companies all over Southern California (and beyond). So if you are looking for a partner to help with your books reach out to us today.
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