Owner leaving property management company. Where does deposit go?

Question

Hi,
I've got a general question that I could not find on here. I apologize if it has been asked previously.  Generally speaking, if a rental owner decides to end his/her professional relationship with a property management company at the end of the tenant's lease, who deals with the security deposit? Does the property management company assess the house, and fix damages, and then return the leftover money to the tenant, or does the property management company sign over the security deposit to the home owner, and they deal with it?
Each company could handle it differently, however I wanted to see what some of the experienced investors have to say about what protocol is in this situation.
Thanks,
C

Bill Gulley · Answer

I've said before that Jon would have made a great accountant if he had chossen that path instead of engineering, he may not take that as a compliment but it's meant to be.

As we all know, RE is local, what is done in practice in one state or area may not be as it is elsewhere and it may not be proper but might be accepted.

You're right Jon, the proper way for a property manager to collect amounts owed by an owner is to bill the owner outside the escrow account and transfer the entire balance held in trust.

The most common and serious violation, besides theft of the money, is comingling of funds, mixing any other money with funds in trust. An escrow account may not have any more in the account than the total balance of funds held plus costs to maintain that account, any amount over that is comingling of funds. While that sounds easy enough, it can be difficult to ensure at times as bank charges may vary. So, it's important that the bank is consistant and the account holder is aware of any charges. Some states and RE Commissions allow a minimal amount, like ten dollars to be on hand for the maintenance of the account, that makes life easier if allowed.

What happens when you withdraw part of the funds, not the exact amount held, is that the remaing amounts immediately upon such transaction could be seen as income earned by the account holder, if so, you have just comingled earned income with your escrow account! That remaining amount still remains funds in trust for the tenant as well, so you are actually collecting a contractual obligation made between the PM and the owner from the tenant, that being a misapplication of funds. If this is allowed by law, the best way to cover the missapplication of funds issue is to have consent to do so in the lease agreement, but it still does not address the comingling of funds issue. The closest way to address that is to write checks required, in sequence, one to the owner or tenant and the other to the PM operating accounts. If Handy Dan made or is maiking a repair, a check can be written to him. Sequencial checks written is an acceptable way to clear escrowed funds from an account, allowing amounts to remain in the account, or executing another transaction prior to clearing those funds out can be construed as comingling funds. So, when clearing funds from escrow, clear that account entirely.

A damage deposit is for any damage and not for normal wear and tear or cleaning of the leased premises.  While most leases mention costs of cleaning, a lease agreement does not determine or provide a justification using funds held for damages to clean the property. Some agreements combine damage and cleaning deposits, while it may be customary it could be difficult to allocate what amount is for one issue or the other unless stated.

Another way to address the issue is to include financial damages arising out of the lease as a damage to be covered by the damage deposit, such needs to be customary and allowed by law. It's my experience that judges don't see costs of cleaning as a basis for any financial damage, it's a cost of doing business.

Unless you take the money in an escrow account, I don't know of any escrow jail. RE brokers have been put on probation, had suspensions and have lost a licence over the issues mentioned above, such actions being based on the degree of infractions and repeated infractions. A small property owner isn't usually held to such standards, they may not be required to have an escrow account.

While tenants get upset over keeping deposits, I'd have to say few will ever sue you over it. While an owner may not be required to escrow funds they will be held liable to follow the intent of funds held in trust and the use of funds. IMO, unless it's a large sum this only comes up when there are other issues, like an eviction to get the matter before a judge. However, if an owner or PM simply sees deposits as expected income making petty claims that may motivate a tenant to take action.

I'll also mention that it's not a good idea to use deposits to leverage any other transaction. When you purchase a property you may receive a credit in the transaction by the settlement agent and those amounts need to be set aside by the new owner.

All of this really doesn't apply to the OP's situation.

If you hired that individual in his company, basing your hiring on his expertise and personal attention, you can probably terminate the agreement for his services and receive all the funds back that are unearned to date, together with all escrowed funds, you need to read your agreement. He is withdrawing from the company and will be unable to perform. But, if this is a larger PM company, say there are six agents managing, and your contract is with the company and they are saying your account will be taken over by another manager, you may need to continue under your contract unless you can show good reason why you were relying on that manager's expertise. In that case, you can terminate the contract but you may have penalties in doing so.

Bryan's transaction mention above is the proper way to conduct that transaction, IMO. :)

Bryan H. · Answer

I recently went though this in Michigan. The old PM company had me sign a form stating I received the deposit and sent me a check for the full amount of deposit. I then turned around and had my new PM company sign a form that they received the deposit and sent them the money. The new PM company then notified the tenant which bank their deposit is being held in trust.

Not sure about legality as I'm not a lawyer, but that's how it was handled.

Jon Holdman · Answer

I have trouble seeing what possible justification a PM could have for retaining the security deposit.  It belongs to the tenant.  If the owner terminates the PM or vice versa, the security deposit goes to the owner.  Otherwise, this is effectively a charge the PM is making on the owner for the amount of the security deposit.

Tevis Verrett · Answer

Go Super Bill Gulley Go! Welcome to the noobs and I am learning a great deal, as I have a property mgr here in Cali holding onto the security deposit of a property I am getting make ready, and he is acting like the past tenants best friend. . .

. . . to the financial detriment of the owner!

Buhring the knowledge,

Tevis

Nate Garrett · Answer

Bill Gulley, as managing broker of a property management firm I'm well aware of the laws governing the application of security deposits. I'll assume your post was directed toward the original poster.

You are correct that security deposits cannot be retained for normal wear and tear. However, let's say a tenant drops a glass of wine on the carpet and there is a large stain at lease termination. The property management firm would likely retain a portion of the security deposit to repair the damage during the make-ready process.

The original poster stated that the management contract would terminate simultaneously with the lease. He was asking whether the property management company or he, the owner, would be responsible for determining how much, if any, of the security deposit to retain and distributing the remainder back to the tenant. If I'm understanding correctly, the issue was not how to determine the disposition of the security deposit, but who would be responsible for doing so once a management agreement ends.

State landlord-tenant laws differ widely. My advice is to consult the state tenant-landlord laws. If the issue is not directly addressed there, look to the management agreement. If the issue is not addressed by the management agreement, work it out with the property management company.

Regards,

Nate

Bill Gulley · Answer

Jack'em up Tevis, the tenant might be cute, never know out there in Cali! Just saw the time, been on and off here over 18 hours, I think that's enough! You're doing great Tevis!  :)

Bill Gulley · Answer

Whooo Nate, 17 posts, kinda new here. I suggest we try another foot.

I already pointed out the implication I read but you cleared it up. I didn't attack you over it. And don't worry, I'll never be asking you to enlighten me.

BTW, there are several young'ns here that try to get me to dig up statutes, without any luck.  I also don't get baited into writing books because someone trys to make some petty point, especially when it's unwarranted.

Click on my name, you'll see why I don't need to look things up, burden of proof isn't on me. I didn't start RE yesterday or the day before, or even 5 years ago...But, I don't know everything and I do make mistakes, made my 5th error in 4 months already this morning, I'm slipping :)

Escrow accounting is an accounting aspect under GAAP and conforms uniformily in all states, I don't need to look up how funds are to be treated, if your escrow account is in a bank (which it is) I already know the laws. Was a broker as well, so I got both ends of the subject covered.

Able to leap tall buildings in a single bound too!  LOL  :)

Bill Gulley · Answer

Well, had a much longer description, but never mind, I'll leave part of it.

if it is addressed in the mgt agmt, it's IAW state law for escrowed funds, if it isn't, it's IAW state law for escrowed funds.

All states have escrow account laws, all property managers who hold a broker's license are required to hold an escrow account, some states require landlords to hold escrow accounts, those that don't may not require a owner landlord to do escrow accounts and accounting, but the liability is the same, even for individuals. The funds become available to the owner or his agent upon the forfeiture of funds per contractual agreemenrts. Additionally, damage deposits may not be used for back rents unless allowed by law, regardless of contract terms. They are not for make ready expenses from normal wear and tear.

The misapplication of escrow accounts or escrowed funds by a licensened property manager can be grounds for the suspension or revocation of thier license.

Which means, it ain't your money to spend until the deposit is forfeited as agreed by contract and as allowed by state law :)

Nate Garrett · Answer

That's what I thought you would say.

This is how we would handle the situation in Oklahoma. If the owner does not hire a new property management company and decides to self-manage, he/she would be responsible for handling the security deposit in accordance with the landlord/tenant act.

Nate Garrett · Answer

Perhaps you would be willing to cite the section of the Kansas statutes (I'm assuming that's where the property is located based on the original poster's profile) that directly answers the original poster's question:

And while you're at it, maybe you could enlighten me as to what, in accordance with Oklahoma law, you find inaccurate in my original post on this topic.

Owner leaving property management company. Where does deposit go?

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