Key Takeaways
- Payments from tenants fail to settle or are processed incorrectly from time to time, and this can cause significant issues for sponsors and property managers.
- Commercial real estate sponsors can use two controls to prevent tenant payment issues: daily oversight of tenant ledgers and month-end bank reconciliations.
- Tenant ledgers should be monitored by a team member who understands the rent roll, lease terms, and is aware of any one-off charges across the tenant base.
- The bank reconciliation process functions as the second line of defense and confirms that the property accounting system agrees to bank transaction history.
For middle-market commercial real estate sponsors, designing and implementing well-thought out accounting controls is understandably not top of mind. Newer sponsorship groups tend to have smaller portfolios, so it may be possible to keep tabs on tenant charges and payments in the early going. But, as the portfolio grows and the business becomes more complex, it’s easy for missed payments to slip through the cracks. It’s more common than many in the industry might believe, and this is an area where oversights can be costly.
Missed payments don’t always mean a tenant failed to pay. More often, the problem lies in internal processes: payments that go unapplied, software nuances that cause delays or failed payments, or cash receipts that never get flagged when they fall short of the charged amount. As a fund administrator serving middle-market CRE sponsors, we see these issues all too often, and even well-run sponsorship groups can fall victim without strong accounting controls.
This article outlines two of the most effective controls real estate sponsors can use to prevent tenant payment issues: daily oversight of tenant ledgers and month-end bank reconciliations. These simple practices can protect revenue, reduce the need to pour through historical ledgers, and maintain healthy tenant relationships.
Why Tenant Payment Issues Occur
Sponsors often assume that if rent is due, a lease is in place, and property accounting software is being used then payments will follow. But the reality is more complex. Tenants use different payment methods, payment memos are often vague, and rent schedules can include reimbursements, escalations, and one-off charges like utilities or maintenance pass-throughs. Without a system in place to monitor these nuances, it’s easy to miss discrepancies.
Some of the most common issues we see include:
- Payments that are received but not applied to the correct tenant.
- Delinquencies that go unaddressed because of poor ledger management.
- CAM reimbursements or pass-throughs that are underpaid or unpaid entirely.
- Funds that are misapplied due to unclear transaction descriptions or manual data entry errors.
These problems can reduce net cash flow, disrupt investor distributions, and raise red flags during audits or investor reporting. Fortunately, these issues can be avoided by working with the right personnel to implement two key accounting controls.
Control 1: Daily Oversight of the Tenant Ledger
The tenant ledger should be reviewed daily, not only during the monthly close process. If managed properly, the ledger serves as the real-time source of truth for tracking what each tenant owes, the amounts they’ve paid, and charges that remain outstanding.
Property accounting software typically includes the following information in the tenant ledger module:
- Detailed rent schedule by tenant, showing base rent, reimbursements, and other charges.
- Running log of payments received, with dates, amounts, and payment methods.
- Aging of outstanding balances, including partial payments and overpayments.
- Notations for any tenant communication regarding delays, disputes, or alternate payment plans.
To mitigate the risk of missed or misapplied receipts, tenant ledgers should be monitored by a team member who understands the rent roll, lease terms, and is aware of any one-off charges across the tenant base. This person, often a member of the property management team, should reconcile tenant payments against charges on a daily basis. The review should focus on three core questions.
- Have all charges been posted correctly?
- Have all expected payments been received in the correct amount?
- Are there any misapplied or unidentified bank deposits?
- Are any tenants delinquent?
Reporting functionality within modern property accounting software can help the team to review ledgers efficiently, but automation is not a replacement for active oversight. In our experience, sponsors who manage strong control environments treat the ledger as a live tool and understand the importance of ongoing monitoring.
Control 2: Month-End Bank Reconciliations
The key to building a strong accounting control environment is to implement multiple lines of defense. In the context of tenant payments, daily monitoring of tenant ledgers should be supplemented by a comprehensive, monthly reconciliation of every bank account that receives payments from tenants.
The reconciliation process functions as the second line of defense and confirms that the property accounting system agrees to bank transaction history. A bank reconciliation process should include the following steps:
- Match every deposit and withdrawal on the bank statement to a transaction in the general ledger.
- Investigate discrepancies, including entries that appear in the accounting system but not in bank history and vice versa.
- Verify that security deposits received during the month match the tenant’s contractual obligation and are received into the correct bank account. As a best practice, we recommend receiving security deposit monies into a different account than rent monies.
- Confirm that beginning and ending monthly cash balances match bank statements.
The value in performing a comprehensive bank reconciliation is that it ensures that all discrepancies in tenant receipts are identified. Reconciliations should be completed within fifteen business days of month end. It is a best practice to have an independent party perform bank reconciliations, and at the very least, it should be performed by someone other than the person responsible for monitoring tenant ledgers.
Final Thoughts
Missed tenant payments can impact a sponsor’s ability to make distributions, affect DSCR compliance, raise questions from financial statement users, and complicate future month-end closing procedures. By implementing a daily tenant ledger review and enforcing monthly bank reconciliations, sponsors can steer clear of these issues. Sponsors who build robust accounting controls around tenant payments can mitigate risks associated with missed payments, misapplied receipts, and related issues.
Lexcraft Advisors is a CFO services firm that supports middle market real estate funds and syndications. Our team takes pride in providing sponsors with reliable financial operations solutions that mitigate risk and facilitate growth. To learn more about our services, schedule a complimentary meeting with our Managing Partner.