Controlling Your Risk
A risk-management strategy addresses any problems that could become liabilities, and is a must for property managers.
This article discusses the following topics of risk management for property managers:
Identify Your Sources of Risk
- Property Risks
- Tenant Risks
- Administrative/Management Risks
- Market Condition Risks
Control Your Risk
- Seek Professional Advice as to How to Legally Structure Your Company
- Consistent and Documented Use of a Policies and Procedures Manual
- Knowing Local, State, and Federal Laws That Apply to You
- Know Your Scope of Authority
- Understand the Agency Relationship (As a Property Manager and As a Client of a Property Manager)
- Reducing Liability Exposure
- Keep Losses to a Minimum
Obtain Proper Insurance
- Contractor Insurance
- Errors and Omissions
- Other Types of Insurance
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It may not be possible to eliminate every potential risk in property management, but you must have a risk-management strategy that mitigates risk and addresses any problems that could become liabilities.
1) First Identify Sources of Risk
First identify potential issues at each property you manage.
Sources of risk may include risks related to the location and condition of the property itself, risks related to tenants, risks related to management the property, risks related to market conditions, and more. Below are some sources of risk you will want to identify when managing properties, but be sure to consider any others that affect your specific circumstances as well.
Risks Related to the Property Itself (Location and Condition)
- Chain of Title
- Construction Projects (Is it Quality Work? Does it Comply with Current Construction Codes? Was a Permit Obtained? Was Proper Insurance Obtained?)
- Foundation Issues
- Roof Condition
- Plumbing Leaks
- Exterior Wall Conditions
- Electrical Wiring
- Wildfire Risks
- Flood Risks (Can You Secure Insurance? Is it Cost Prohibitive?)
- Ground Conditions (Contaminated Soil, Unstable Ground, Underground Water, Other)
- Stormwater Runoff Issues
- Problems with Remote Properties (Can Utilities Be Connected? Are Repair Services Available?)
- Vegetation Protection Orders
- Historic Property or Historic Neighborhood Requirements
- Underground Tanks
- Is the Property Located Near the Owner or Property Manager
- Other Risks Related to the Property Structure and Location
Risks Related to Your Tenants
- Tenant Screening and Reference Checks
- Fair Housing Laws
- Lease Strength
- Holding Security Deposits
- Detailed Record Keeping of Tenant Interactions
- Tenant Rental Insurance
- On-Site Safety Precautions for Fire, Icy Walkways, Accidents, Criminal Activity, Window Guards, Other)
- Building Safety Measures (Locking Doors, Smoke and CO Detectors, Security Cameras, Fire Extinguishers, Building Keys, First Aid Kits)
- Emergency Preparedness
- Security Services (Licensed Security Company, Off-Duty Police or Security Guards)
- Disruptive or Destructive Tenants and Their Guests
- Holdover Tenants
- Squatters’ Rights for Roommates or Family Members
- Short-Term Rental/Vacation Rental Squatters
- Other Tenant Related Risks
Risks Related to the Management of the Property
- Detailed Record Keeping of Maintenance Schedules
- Fair Housing Laws Related to Marketing, Leasing, and Sales
- Contractor Management (Managing Workers, Time, and Costs)
- Contractor Insurance (Including Sub-Contractors) – General Liability, Work Comp or Work Comp Waiver, Builder’s Risk, Subcontractor Default Insurance, Others)
- Contractor Liens
- Equipment Rental Insurance
- Asbestos Abatement Liability Insurance or Pollution Liability Insurance
- Business Interruption Insurance
- Cyber Insurance
- Legal Documents, Operating Agreements, and Service Contracts
- Marketing (Fair Housing Law Requirements, Drone Liability Insurance, Automobile Insurance if Company Owned Cars or Ads for Company Placed on Any Cars, Other)
- Operating Budget and Emergency Funds for Repairs and Unforeseen Issues
- Property Tax Increases
- HOA Fee Increases and Special Assessments
- Directors and Officers (D&O) Insurance for Board Members
- Other Administrative and Management Risks
Risks Related to Market Conditions
- Market Value Fluctuations
- Loans and Rate Fluctuations
- Ability to Sell or Rent
- Unexpected Events (Such as Covid-19 Affecting Tenants’ Ability to Pay Rent)
- Other Market Related Risks
2) Second, Control Your Risk as Much as You Can
To reduce risk, choose the best legal structure for your property, be consistent with your treatment of all tenants, use documented policies and procedures, know your local, state, and federal laws, use only qualified contractors and business professionals, obtain sufficient insurance, know your scope of authority, and have your attorney review all contacts before signing.
Avoid Risk When Possible
Follow set procedures with every tenant and property, and repair or eliminate physical property issues as soon as possible to reduce your risk.
If a problem is reported by a tenant, take care of it promptly! Not responding promptly increases your potential risk and could lead to a much bigger problem.
Consult a qualified real estate attorney before any issues arise so that you have proper paperwork, insurance, and procedures in place. This will help ensure you are less likely to have problems. An attorney is a necessary expense that will reduce your chance of much larger expenses in the future.
Other Risk Mitigation Strategies
Risk cannot be completely avoided, and other strategies to mitigate your risk include transferring your risk, and controlling your risk.
Transferring risk to a third party is another way to reduce your risk exposure. One common way this is accomplished is by purchasing insurance. Insurance policies transfer some of the risk to the insurance company.
Another way to transfer risk is through the use of proper legal clauses in agreements for contracted services, and in all tenants’ leases. Property management contracts may include an indemnification clause, for example, to protect the property manager from some types of liability and damages that are beyond the property manager’s control.
When you cannot eliminate risk entirely, you must try to control it.
You will want to reduce your liability exposure for property management clients, or for yourself as a property owner, by controlling your exposure to risk as much as possible.
One specific example of controlling risk and reducing your liability would be installing a sprinkler system in a multifamily building, and having it inspected annually as per your Policies and Procedures Manual. You will also want to put new fire extinguishers in each unit annually, install multiple smoke and carbon monoxide alarms in each unit, and document that these detectors are tested on a regular schedule. Even if you have such policies and procedures already in place, documenting them is necessary to further reduce your risk.
If your property is not located near you, then hire a licensed property manager located near the property. You cannot properly monitor and maintain your property if it’s too far away to check on regularly.
You may also want to have all tenants sign a paper when they move in stating they were provided with a working smoke alarm installed their unit, and a requirement that they test them monthly.
It’s best to keep meticulous documentation of your maintenance records and implement consistent management procedures to protect you and your employees from liability.
Letting tenants know that they need to purchase a rental insurance policy to protect their belongings is also important, because most landlord policies do not cover the renter’s possessions within the tenant’s unit. Have your lawyer provide you with the proper wording to include this requirement in your lease so that your tenants know they must purchase their own renter’s insurance policy.
A qualified attorney will also include other clauses in a lease to help protect both the property owner and the property manager from liability and risk. Always use a competent attorney who is familiar with your local laws to help you write your leases, because if the lease includes clauses that are at odds with federal or state laws, then the property manager and/or property owner may still be found liable in court. You should also check that your attorney is experienced in landlord-tenant law, and any issues you could face as a property manager.
NOTE: Arbitration clauses have become more common lately, and can play an important role in contracts, but they can also hurt property owners in many situations. (For example, an arbitration clause may slow down evictions.) Be sure to understand exactly what these mean in various scenarios if you decide to include this type of clause in your contracts.
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How to Structure Your Company
Part of controlling your risk is also having the proper structure for your management business and property holdings, as determined by your attorney.
Consult a qualified real estate attorney who can advise you as to how how to best legally hold your properties.
Many investors hold each of their properties in individual LLCs, then may have a separate LLC for their management company if they manage their own properties. Other property owners may hold their properties in their own name, then have a written contract with their own or another property management company. Be sure to work with an attorney to help you set up your business in an appropriate manner for your particular situation.
It’s also important to consult with a qualified accountant to know how to best manage your assets and to understand the tax implications of your company structure.
However you decide to structure your company, be sure to follow the rules carefully. Even if you are a single owner of an LLC, you must remember to renew your registration with your Secretary of State on time, and make notes of annual meetings and decisions about disbursements, or fulfill whatever requirements are specified for LLCs in your state.
There are many different ways to arrange the legal ownership and structure of your real estate holdings, so one solution does not work for all situations.
If you are a property manager, you should also be sure to structure your company in the best possible way for liability protection and tax advantages. Be sure to use a reputable real estate attorney who can help both you and your clients reduce liability and have the best legal and tax set up for their investments. Having a relationship with an attorney is also important if any legal issues arise.
Consistent and Documented Use of a Policies and Procedures Manual
As a property manager, you must have documented policies and procedures that you and anyone working on your behalf always follows.
In order to control your risk, property managers need a definitive Policies and Procedures Manual that all employees and owners of the company adhere to, and there must be consistent and documented use of this manual.
Knowing Local, State, and Federal Laws that Apply to You
Always keep up to date on local, state, and federal laws that affect your business.
This includes all Fair Housing Laws!
Reducing Financial Risk
Reducing risk also includes keep losses to a minimum by maximizing profits and cash flow, increasing wealth through appreciating assets, and reducing costs through timely maintenance, good marketing, and good tenant screening.
Efficient and effective property management creates a functional property with a healthy income and operational budget, as well as a rainy day fund for the inevitable unexpected issues.
Scope of Authority of Property Managers
As a property manager, your scope of authority may vary greatly depending on the circumstances. If you are also the property owner, you will be fully responsible for all aspects of the property management. If not, then the terms of your contract with the property owner will determine the limits of your scope of authority. Your risk and responsibility varies greatly depending on your contract.
Consult your attorney to help you create a strong contract for use with property owners whose properties you will be managing.
Agency Relationship and Duty of Care
When acting on behalf of another, there are special considerations in the law.
Licensed real estate agents and property managers have fiduciary duties that are required of them. These include such duties as the duty to investigate and disclose, the duty of reasonable supervision, the duty to exercise reasonable care, the duty of loyalty through the prohibition of self-dealing, and the duty of honesty.
Licensed real estate brokers and property managers, as well as other licensed professionals such as insurance brokers, are given authority by the person who hired them or entered into an agreement with them, to act in some way on their behalf. The broker or manager is referred to as an agent, and the person who requests their services is referred to as the principal. This legally recognized agent-principal relationship can be established not just in writing, but also simply by actions and behaviors.
When this agency relationship is established, it requires the agent to always put the best interests of their client first, above their own.
Agents are duty-bound to complete the job given to them by the principal, and also have a duty of care to their principals. This duty requires that certain tasks are performed with care and reasonable diligence and judgement.
Landlords also have a duty of care to their tenants, even if they’re not licensed real estate brokers or licensed property managers.
Under tort law, landlords have a responsibility to act in such a way that is not negligent or reckless. If they act in a negligent or reckless manner, they’re liable for any harm to others that their actions or inactions cause.
For property owners, this means there’s a duty of care to anyone entering their premises. They must take reasonable care to avoid any dangers to tenants, guests, workers, mail carriers, and anyone else who sets foot on their property.
This applies to any regular homeowners who have guests or workers on their property as well!
If you have a friend over for dinner, and know that your entry floor is slick marble, you will want to take steps to reduce the risk of falls such as putting down a rug. If your guest walks in with wet boots and falls on your slick floor, you may find yourself liable for their medical expenses from an injury. The same would apply if you have exposed electrical wiring in your property, mold issues, or other known hazards that could cause harm to your guests.
Some of these duty of care requirements may even apply to trespassers or squatters! However, the law would likely not require the same level of care as it would for tenants and guests. Be sure to check your specific state laws for details about this issue in your area.
3) Third, Purchase Sufficient Insurance
Since no matter how diligently you try to avoid, transfer, or control risk, you will still have risk exposure as a property owner or property manager. Because of this, it’s important to have proper insurance coverage.
This insurance is not just for replacement value in case of issues such as fire or vandals, but also for liability coverage in case of an accident, such as a slip or fall by a tenant or their guest, or even just someone walking by the property on an icy day.
Insurance for property managers and landlords can include coverage for leasing related activities, repairs, accidents, administrative mistakes, and more.
Insurance for Property Management Businesses May Include:
- General Liability
- Property Insurance
- Erros and Omissions
- Contractor Insurance
- Workman’s Compensation
- Tenant Discrimination Insurance
- Umbrella Policies
General Liability (or Business Liability) policies can cover a wide range of issues, so be sure to understand what you need and what your policy will and will not cover. Here are just a few things that general liability policies can cover:
- Bodily Injury
- Property Damage
- Reputational Harm
Property insurance is for repairing or replacing the physical structure, and may include special cases such as flood, earthquake, or other additions.
Landlords may want to require that all tenants obtain a rental policy that covers their possessions inside their unit, since tenant’s possessions are not usually covered by the landlord’s policy. Rental policies also include some liability coverage for their guests. Landlords may wish to require their name be added as an additional “named insured” party to these policies.
Insurance should also be required for all contractors working at the property, and if they use sub-contractors, property managers should require proof that they also are covered. General contractors should have workers’ compensation insurance in place, or property managers may require them to provide waivers from all workers.
Property managers will also want to ask landlords to add them as additional named insured parties on the landlord’s insurance policy.
Errors and Omissions (E&O) policies may cover claims made for inadequate work, misrepresentation, or negligence. If you do not meet the standard of care required when managing tenants and property owners, you could be faced with a lawsuit. E&O insurance is necessary to help protect you from professional liability issues.
But obtaining this insurance does not mean you can act in a negligent or inadequate way! It just provides you with some coverage for mistakes and oversights, accusations of negligence, and may also include coverage for missed deadlines or undelivered services. Coverage could provide funds for judgements against you, legal defense expenses, loss of earnings, and disciplinary actions by a licensing agency or other regulatory body.
As a property manager, you must make sure all properties you manage have a sufficient risk management plan and sufficient insurance coverage, as determined by your attorney, so that both property owner and property manager are properly protected.
If you’re considering managing a property for someone else, taking on this responsibility of risk management should be one of the most important factors in your decision.
Evaluate owners carefully before accepting the responsibility of managing their properties.
You do not want to put yourself at risk of liability by managing properties for an owner who’s not willing to include proper wording to protect you in their leases, not willing to implement proper safety procedures, not willing to comply with Fair Housing laws, or not willing to purchase proper liability insurance.
Again, consult your attorney to make sure you have the proper coverage, not just for properties you manage, but also for your management business.
Tip: There are some certifications available for safe buildings in some states, so as an extra step to mitigate risk, look into certifications available from a recognized third-party to verify your property’s safe conditions.
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Problems May Arise, But You Can Be Prepared!
If you own or manage a property and have tenants, it’s likely at some point that you will have a legal issue. You need to have a relationship with a real estate attorney that’s already established, so that evictions or injuries on the premises, or any other legal issue, can be handled swiftly and properly. Not handling an issue swiftly and properly can lead to a much bigger problem for you.
Proper state specific forms, timelines, and procedures for evictions MUST be followed.
If you do not follow these guidelines, you may have to start over again from scratch, and the tenant will take longer and cost more to evict. If you take matters into your own hands and ignore these requirements to remove a tenant, you could face an expensive judgement against you even if you originally had a case to evict the tenant.
If you do have a legal issue with a tenant, a lawyer may be able to help you settle out of court for back rent or other issues, and that can save you a lot of time and money in court. In some cases where a tenant decides to fight even though they are in the wrong, you may decide it’s not worth going to court, especially if the tenant has no resources to pay for any judgement against them.
If the dollar amount you are trying to collect is not worth the time, effort, and legal costs to collect it, or if you know they tenant cannot pay it, then it’s often best to just cut your losses and move on as quickly as possible. For example, if a tenant owes less than the fee required to file a case in small claims court, it may not make sense to pursue the issue.
Property Management Lease Tip: Consult a local real estate attorney for your specific lease needs, but make sure that your lease is not too brief. If you use a lease that you just downloaded from an internet site without specifics about your property, you may run into trouble later.
Nothing can be enforced if it’s not in the lease!
Remember to Reduce Risk with Good Documentation
Communicate with tenants in writing whenever possible, whether it be email, text, or regular mail, and be sure to save copies all of these communications. Have tenants initial notes about their complaints and requests that were communicated via phone or in person, then follow up in writing with a summary of what was discussed.
This simple practice will not only help you remember what you told your tenants and when, but will also provide proof of your responses when needed.