The ethical line in preferred vendor programs isn’t whether money changes hands. It’s whether the arrangement is disclosed, documented, and still serves the owner’s best interests.
Nothing annoys me more than a property manager accusing another property manager of unethical behavior purely because they have a different view of fees and revenue. BetterWho’s Matthew Tringali was recently on Peter Lohmann’s podcast talking about a preferred vendor program he had at his property management company. Matthew’s program was a bit unique, but preferred vendor programs are not at all unusual in the industry. To my surprise, some people in social media conversations related to the episode stated that “kickbacks” of any sort are not allowed when you are a fiduciary. That assertion is simply not true.
There is a lot of bad information out there on what a fiduciary relationship is and what is not allowed, so I wanted to clear this up and make sure everyone knows what is and is not allowed as far as compensation from vendors, because this is a major source of potential revenue for your company.
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Why Preferred Vendor Programs?
First, if you aren’t familiar with preferred vendor programs, this is an important concept to understand. Property managers are not simply work order distributors, sending work orders to random vendors. Part of the value of a professional property manager is that PM’s vendor network, the priority service that the PM is able to get, the bulk discounts, and the PM’s knowledge of which vendors in the area provide quality and speedy service for a fair price. Owners get a lot out of having a professional property manager handle this for them. On another recent podcast, Peter was talking with Mark Brower about how there are different categories of vendors, and laymen landlords and homeowners all too frequently are choosing from the flashy companies with giant billboards and fancy painted trucks all over town who are charging 50% more than everyone else. While I disagree with Mark’s assertion that there is something unethical about these companies (I’m a strict “buyer beware” free market kinda guy), I do feel that avoiding these companies and having a database full of legitimate vendors who provide just as good of service for a fraction of the cost is a major benefit of using a professional PM.
On the other hand, with the vendor, they are receiving an enormous benefit by partnering with a property manager. Even a small PM company, let’s say 75 doors, is exponentially more business in a single relationship than a vendor gets on the open market as a consumer-facing vendor from a lone homeowner. Getting that business and potential business in one fell swoop from a PM is gold to the vendor. That’s why vendors frequently offer discounts and priority service to property managers. They want your business. Bad.
With that in mind, a lot of property managers have rightly come to the conclusion that the immense value they’re bringing here deserves some compensation. There are multiple ways to monetize this, and one of them is a preferred vendor program of some sort. While programs do vary widely (as evidenced by Matthew’s very unique design), most programs are generally pretty simple and come down to a cash rebate that the vendor pays to the PM on a monthly or quarterly basis, usually tied to the gross value of the work orders the vendor completed in that time frame for the PM.
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Because property managers are almost all real estate licensees, we’ve long heard of the evils (and illegality) of “kickbacks.” But the problem is, the kickbacks we’ve all been taught are wrong and illegal are related to very specific laws centered around financed real estate transactions. Specifically, this is governed by the Real Estate Settlement Procedures Act (RESPA), and similar state laws. At the federal level, it’s overseen by the CFPB. And even in financed transactions, it only applies to federally related mortgages (FHA, VA, etc.).
RESPA has no control whatsoever over property management, leasing, or maintenance operations. None. That’s the first thing to remember. There is no federal law that governs this question.
At the state level, though, there are many states that do regulate disclosures of financial incentives. In other words, many states will say that if you’re receiving a financial incentive from anyone, you need to disclose that to your principal (the owner). This also conforms to NARPM’s Code of Ethics.
The reason for these state laws is simple: a hidden payment that may or may not distort your judgment is unethical; but a disclosed rebate that helps fund your business to provide excellent service that the owner finds no fault in is perfectly kosher under both the law and every ethical standard of fiduciary duty I can find from reputable authorities on fiduciary ethics. The key is disclosure.
Conflict of Interest
The main point of contention here is the perception of a conflict of interest. If a vendor is paying a rebate or a “preferred vendor fee” or something of the sort, the idea is that the PM may choose that vendor specifically because of that instead of choosing the vendor that would be the best option for the owner. I don’t want to completely dismiss this out of hand, because it’s certainly arguable, although I’ve never in all of my years in this business seen a property manager actually do such a thing. Repairs and maintenance are such a pain in everyone’s ass that nobody is willing to choose worse vendors and deal with the fallout simply because they’ll get a few extra dollars. But let’s pretend that this is something that really happens for the sake of argument.
Property managers do have a fiduciary obligation to their owner clients (at least in most states). This is no different than a financial advisor or a doctor having a fiduciary obligation to their clients. You are expected to put the client’s interests ahead of your own. But those other examples of fiduciaries should be your first clue that legal and ethical authorities have no problem with disclosed financial incentives. Financial advisors frequently get paid 12-b-1 fees, front-loads, etc. from mutual funds to encourage them to put their clients’ money into their funds. Doctors routinely get speaking fees, consulting arrangements, research funding, etc. from pharmaceutical companies and medical device manufacturers for prescribing their products. There is no greater fiduciary relationship than that between doctor and patient. That’s the pinnacle of fiduciary obligations. But still, these things aren’t illegal, and generally aren’t viewed as unethical among ethicists.
The key here is disclosure, and in some cases, informed consent. For example, a financial advisor discloses up front that they get paid 12-b-1 fees, and the client is signing off on that. For doctors, because this is the peak of fiduciaries, there is even a federal database of incentives that doctors receive from drug companies. But you’ll notice the key point here: none of this is prohibited by law, and ethics professionals are not out there raising a ruckus about it. Why? Because disclosure and informed consent eliminate the ethical concerns.
So I’m not arguing that you should hide anything. To the contrary, I’m quite consistent in this publication that transparency is paramount. If you are hiding financial incentives that you are receiving, that is, by definition, a “kickback,” and not only highly unethical, but also likely illegal under your state’s laws. DO NOT do this. Disclose, disclose, disclose! And many ethicists will push further and say that disclosure is not enough, and you need “informed consent,” which is a higher standard where you need to make sure the principal actually understands and isn’t just informed.
The 6-Point Ethics Standard
When you’re evaluating any program at your business, including financial incentives from vendors, you should run it through the following six questions to make sure it passes the test:
Has the incentive been disclosed? Ethical compensation is disclosed compensation. This is the most basic of the tests, and you should handle it by putting your disclosure right in your property management agreement so it’s well-documented
Is the owner still getting market pricing or better? A vendor paying an incentive is not a license to overcharge. Your owner client should always be getting at least fair market pricing, preferably better. If the vendor wants to raise prices above fair market in response to the incentive payment, then that’s not a vendor you want to work with.
Are you still selecting vendors based on performance? Make sure you have internal processes and standards for how vendors are selected for work. If it’s simply “this vendor pays an incentive so we’re going to use them,” then that is an ethical problem according to the experts. But if you’re getting a financial incentive while still applying reasonable standards, you’re clean.
Is the fee revenue tied to real value? Does the owner get real value from how you run things, despite you getting the financial incentive? If an owner is getting quality vendors at a fair price, and you’re the gateway that is providing them, then the owner is getting real value.
Is there an exception process? If you are using that vendor every single time, regardless of circumstances, just because they’re paying an incentive, then that’s a big no-no. When pricing, availability, or specialty dictate it, you should be using a different vendor. You should have internal rules for how vendors are selected for jobs that are completely divorced from the financial incentives.
Is it documented? Disclosure just means you told the person. It doesn’t mean that you documented their consent. You need to have this in writing. And you also need to have your policies in writing for how vendors are selected for work and for the preferred vendor program. None of this should be left up to interpretation.
The Owner Benefits
If you’re following the above checklist and your program meets all of those criteria, then not only are you doing nothing wrong, but I would argue that you’re doing your clients and your other stakeholders a disservice by not implementing it. A good program creates benefits for the owner clients, because it creates a more reliable maintenance system that ultimately benefits both owner and tenant.
Preferred vendor programs, when properly crafted, don’t just hand out preferred status to any vendor willing to pay the incentive. Instead, the PM sets up a list of standards that vendor must meet just to be eligible. This should include cost, speed, and quality of work. Only after the vendor proves their worthiness do you even approach them with the preferred vendor offer.
Remember, owner are not simply hiring you to be a gopher who gets property management tasks done. They’re hiring you for your judgment, speed, risk reduction, and experience. A preferred vendor program that is well-designed and meets the above standards provides those things for the owner. Keep that PM Trends report in mind that I wrote about a few weeks ago: owners want peace of mind, not just the cheapest PM and the highest rate of return.
Best Practices for Preferred Vendor Programs
I’m not going to tell you exactly how to structure such a program, as that will vary significantly by market, by your company’s size, by the availability of vendors in your area, etc. But your program should meet the following general criteria:
Disclosed in your PMA
Vendors are still selected based on non-incentive criteria
Vendors still have to be properly licensed and fully insured
Vendors are required to provide better than fair market pricing
For large projects, multiple bids should be solicited
Vendor performance should always be tracked, and every vendor held to the same standards regardless of financial incentives
Vendors should only be invited to the program after a significant period of proven high performance
Get it approved by your lawyer!
Final Thoughts
I’m in full agreement that undisclosed “kickbacks” are wrong. But not every incentive arrangement is an unethical kickback. In fact, the vast majority are not. I’ve actually never seen a PM offer a preferred vendor program that wasn’t disclosed, and I’ve talked to a hell of a lot property managers and seen under the hoods of a lot of PM companies with all of the consulting that I’ve done.
In reality, this is just not a real problem. Some people are just really skittish about this kind of stuff, some people are just ignorant of what the law actually is and what actual ethicists have to say on the matter, and then there is a small group of people who are just farming clicks, views, and “engagement” by calling everything they can think of “unethical” as rage-bait. Ignore that stuff. Focus on what actually matters: informed consent. As long as your clients understand what you’re doing, and you have a well defined process in place to select the best vendors, not only are you doing nothing wrong, but you’re doing something very right for all parties involved.
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