Many real estate owners are so caught up in the preparation of their annual budget that they forget the value of creating a budget. Budgets are not passive tools to look at once every year, they are active tools in which real estate owners must use to make proactive decisions to manage their real property.
As a real estate owner your budget should be used to:
1 – Determine controllable versus uncontrollable costs
2 – Play what if analysis
3 – Measure the success of your strategy and planning
4 – Prioritize your decisions.
1 – Determine Controllable vs Uncontrollable Costs – After the final budget is prepared it’s a good practice to review the revenue and expense line items and determine which line items can be influenced by your short-term and long-term decisions. For example, real property taxes can’t be altered by a short-term decision. Therefore they are an uncontrollable short-term expense, but may be a controllable long-term expense by challenging your real property assessment. Alternatively, deciding to increase your insurance policy deductible to lower your premiums, repair rather than replace a major building component , institute tighter controls over staff overtime are actions that can control short-term costs. Categorize all your line items into short-term/long-term controllable versus non-controllable. This exercise allows you to focus and brainstorm on what line items you can positively effect and also gives you insight on how difficult it is to positively influence many real property expenses.
Note, each decision you make will come with consequences (increasing a deductible will lower monthly premiums but subject you to higher out of pocket costs if an insured loss occurs, it may be more costly in the long-run and disruptive if the component you keep repairing finally breaks down for good, increased staff over-site may cause employee resentment & turnover.) but these discussions should occur.
2 – Play What If Analysis – What do I mean by “what-if analysis”? After the budget is done assume everything goes wromg. Assume that 90%, instead of 100%, of the billing revenue is collected. Assume a major building component fails. Assume utility prices skyrocket. What is your plan to keep things afloat? Where are you getting the money to pay your bills, pay for repairs, pay staff? After going through these scenarios it may prompt you to get a line of credit or forgo lump sum payments to vendors (to get a discount) and choose longer term payment options.
3 – Measure the Success of Your Strategy and Planning – Review your budget each month to determine if you have deviated off of your expectations. If you have , why? Routinely monitor the variances between the actual and budgeted amounts. This exercise is not to criticize or point fingers at the creators of the budget but to facilitate a discussion on actions to take. Too often real estate owners judge the quality of a budget by the size of the line item variances between actual and budget. This is a waste of time. If the purpose of budgeting was to guess how accurately one could predict the future than this measurement would be justified. This is not to say that accurate budgeting is not important and time should be invested in the process of making a budget as close to reality as possible; but line item accuracy resulting in no variances is unrealistic. I’ve seen and heard of numerous stories of people needlessly spending money because they were “supposed to spend” an amount, and never did. They needlessly spent the money anyway because they wanted to make sure the line item wasn’t cut in the subsequent year’s budget. Additionally, don’t get caught up in constantly revising the budget to show people the accuracy of your budgeting prowess. Don’t waste your time on window dressing accuracy. Focus on game planning your next moves if large negative variances occur.
4 – Prioritize Your Decisions – Real estate owners are like everyone else, we have unlimited wants and limited resources. Budgeting helps you consciously prioritize your wants and your needs. By looking at where the money is spent you can see your priorities. Are most funds being spent on maintaining the status quo, increasing the market value, or improving cashflow? Is raising revenue a goal or keeping revenue flat? Are long term plans put on the back burner? Repair or replace, which do you side with? It’s interesting to find real property owners who say one thing and have their budget show a totally different point of view. Numbers don’t lie. See if your money does actually go where your mouth is.
After the budgeting process is over it’s a good idea to review the budget and ask yourself if the budget reflects your ideology as an owner. If it doesn’t then consider redoing the budget so that you’re not faced with making conflicting decisions when reality hits you. You don’t want to find yourself authorizing expenses that enhance market value when your budget reflects only spending funds on the nuts and bolts.
In summary, budgeting is an important best practice that should be followed annually and reviewed at least monthly. When it’s finally done you must understand the final product. Without a true understanding you simply have a bunch of numbers on a sheet of paper.