Property management accounting is no more difficult than any other accounting. The Ascent guides you through a system for accounting for rent and related expenses.
Property management is stressful. Earlier this year we had an earthquake here in Utah. I quickly checked my water heater and furnace to make sure there were no gas leaks. Next, I had to make sure our rental properties were correct.
A tenant immediately texted saying that he had checked everything and that everything was fine. It was a relief. The other tenant said he was out of town and couldn’t check out, so I left work to run to the condo and make sure he wasn’t about to explode. Turns out it was pretty close.
When I arrived I found that the furnace had completely detached itself from the wall. I quickly turned off the gas and called the gas company. Several hundred dollars, an irate tenant who came home early to a 50 degree apartment, and a few days later with high blood pressure, the furnace was fixed. I was reasonably sure the condo wouldn’t explode anytime soon. But was it the cigarette smoke I smelled in the living room?
Accounting for your rental property doesn’t have to be so stressful. Read on to learn how to set up a system for your property management accounting.
Overview: What is Property Management Accounting?
Property management accounting is owner accounting. You recognize revenue for all rent received and expenses for maintenance, landscaping, and other cash outflows.
How to set up a property management accounting system
Here are the steps that I have personally used for a few different situations that I have been involved in.
1. Determine your tipping point
I do property management accounting in two different ways. I personally own two condos that are rented to tenants that I found on a local classifieds website. In my daily work, I manage 20 to 30 units belonging to the owners of my company.
For both condos, I keep a yearly updated financial statement spreadsheet for when I do my taxes. Each month, I check that the rent payment has been made and I keep the receipts for the year in a physical file. I only do an income statement. Keeping an up-to-date balance sheet would be more work than it’s worth for these small units.
For rental property accounting in a professional capacity, I use our accounting software to do monthly bank reconciliations and maintain the rent register (we’ll get to those terms in a minute).
There is no rule as to when you should switch from back-of-the-envelope accounting to a complete system with double-entry accounting. If you only have a few transactions per year, you can probably stick with a spreadsheet. If you process multiple invoices each month, you probably need to purchase accounting software.
2. Buy accounting software
You won’t need to find any proprietary software. Check out our accounting software reviews and pick the one you like best – it will work for property management.
Property management accounting is done best when it’s like every other business. So a normal accounting software will have all the features you need.
3. Configure each property
Each property will need to have several items configured for it:
- Entity: If you have a commercial property with multiple units, put it in its own LLC to protect yourself from liability.
- Software account: Your accounting software must allow the creation of several companies. Create a separate one for each entity.
- Bank account/credit card: The easiest way to track expenses for each property is to use a bank account or credit card for that property only. Then each month you go through the statement and add each journal entry into the software.
- GL and chart of accounts: Establish a general ledger and chart of accounts for each rental property. The better you build them upfront, the easier it will be to quickly process transactions each month.
- Rental Roll: Create a spreadsheet with a row for each unit. Each month when the rent is paid, add the payment. The graphic below shows what the rent register should look like.
4. Do the monthly accounting cycle
Here are the steps for each month’s accounting cycle.
- Receive rents: Many accounting software will integrate with your bank account and make it easy to set up automatic monthly bills with Automated Clearing House (ACH) payments. If your software doesn’t, meet with your bank’s cash management representative to set up monthly ACH drawdowns with your tenants. Alternatively, you can ask your tenants to set up automatic bill payment or an ACH push on your account. The key is to take the responsibility for the monthly rent out of your tenant’s hands and make it an automatic payment.
- Process invoices: You will receive monthly bills for utilities, landscaping, maintenance, and other random expenses. Many of them can be paid automatically by electronic transfer. Use your accounting software to print other people’s checks.
- Perform bank reconciliation: Traditionally, a bank reconciliation is performed to ensure that the cash amount on the balance sheet matches the bank balance. We still want to do it, but we’re going to do it a bit backwards. Enter all transactions from the bank statement into the software (unless the transaction is from a check you have already entered). When this is done, compare the book balance (software amount) of cash to the statement balance. If not the same, review the statement and your GL to determine what was entered incorrectly.
- Print financial statements: You can do this every month, quarter or year. For larger properties, it might be a good idea to do this monthly to ensure you don’t burn a ton of cash. As long as you have built the GL correctly and entered all transactions into the correct account, your property management financial statements will only need to be printed.
This is the cycle I follow for properties in my professional life. We print financial statements every year for taxes and keep the bank balance current throughout the year to ensure there is no cash burn.
With the two condos that I personally own, I use a website called Comfortable to pay monthly rent and have a credit card that I only use for investment properties. I typically have four or five non-HOA (homeowners association) expenses per year, so it’s pretty easy to put it all together on a spreadsheet at the end of the year.
Tips and tricks for setting up a successful accounting system for property management
Setting up an accounting system for managing your properties will help ensure that you don’t miss any due dates and ideally it will save you a lot of time.
1. Link accounts
If you can link your accounting software to each entity’s bank account, it will ease the monthly cycle by at least 240%. Instead of struggling to enter each line of the statement, you can simply verify that the imported transactions are applied to the correct accounts.
2. Do annual reviews
There is always an opportunity cost to owning investment property. Get in the habit of getting a price opinion from a broker (BPO), or even doing your own annual valuation of properties, to decide if you want to keep them or try to sell them.
3. Analyze financial statements at least once a year
There are four ways to make money on investment properties:
- Capital appreciation: When the value of the property increases and you can sell it for more.
- Rental cash: The real money that ends up in your pocket at the end of the year.
- Tax shelter: Tax deductions on items such as depreciation (non-cash) or interest.
- Debt refund : Ideally, you’ll buy a property with as little down payment as possible and then charge more rent than is owed on the debt. When this works, you are effectively asking a tenant to pay off the mortgage and receive the asset for free. The best of both worlds is when the tenant easily wipes off the debt payment, but the interest and depreciation cause the property to show a loss on your tax return.
When you run your annual financial statements, work on preparing a cash flow statement. The cash flow statement and appraisal will allow you to rate each property annually on these four key metrics.
4. Understand lease types
Most commercial leases are so-called triple net leases (NNN). This means that tenants are responsible for paying their share of all common area expenses such as landscaping or snow removal. If you have NNN leases, you should track common space expenses and bill tenants annually.
5. Don’t forget the rent register
If you want to get a loan on the property or sell it, the first thing you will be asked for is a rent roll. Having an accurate and up-to-date one will go a long way to facilitating interaction with third parties, not to mention helping you identify delinquent tenants more quickly.
(Earth) lord of the flies
If you’ve spent any time in property management, you’ve probably experienced the same stressful times (or weeks) as I did. However, accounting for your properties doesn’t have to be earthquake-level trauma.