Where to begin
Oftentimes, the first step in the budget preparation process is to review what happened in the previous year. A thorough review of occupancy rates, vacancy trends, grounds, and physical plant item like roofing, fascia, elevators and HVAC systems should be completed. Getting this information involves research. Budget preparers should speak with on-site managers and maintenance teams to get a clear understanding of the state of each of these budget items. Getting solid answers now means avoiding the pitfalls of shortages or overages and the chore of re-forecasting later in the year.
This due diligence is crucial every year. While some management companies simply take recent actual expenses and apply a percentage increase, oftentimes 3-5%, this approach can fall short by under-budgeting areas that need attention (like a new roof) and over-budgeting for commodity items like janitorial supplies. Most of us know that not every type of expense increases each year, and those that do, do not necessarily increase by an arbitrary percentage amount.
An alternative approach to the crude incremental cost approach to budgeting is zero-based budgeting (ZBB). While this methodology includes analyzing recent actual expenses, it starts each income and expense account at zero dollars and is increased based on actual rent schedules in the leases, conversations with vendors regarding pricing for the following year and by being aware of publicly announced tax and utility rate increases, etc. The benefits of this approach, while a little more complex, are numerous. For instance ZBB means allocating resources efficiently, based on actual need rather than historical expenditure, it deflates budgets and provides a more holistic approach to budgeting. If you’ve never heard of ZBB before, McKinsey & Company does an excellent job of laying out five myths (and realities) about zero-based budgeting.
Things to consider
Regardless of which approach you follow, in order to monitor actual income and expenditure in the property, versus the established and approved budget, you’re going to need to be comprehensive in identifying cost and income centers. Use the following as a punch list of important categories to consider during your budgeting process.
- Gross potential rental income of the facility – the maximum income from a property assuming all available space is leased.
- Pass-through incomes, expense reimbursements, and recoveries – these might include operating expenses, taxes or insurance charges.
- Expected vacancy rate – these will detract from gross potential revenue.
- Miscellaneous income – sources of income other than that derived from rental or lease such as vending machines, event rental, exterior advertising, rebates from solar power and the like.
- Operating expenses – anything that’s associated with keeping the building running. Utiliities, Internet, telephone, and grounds maintenance are just a few.
- Debt service – the amount of money left on the mortgage represents the property’s debt service which is used in determing return on investment (ROI).
- Common area charges – if tenants are sharing in certain expenses, thoughtful budgeting can greatly reduce the likelihood of tenants being hit with large balance-dues at year end
- Capital expenditure (CAPEX) estimates – typically one-time costs associated with building improvements like new HVAC systems or re-paving parking lots.
Effective budget management means being fastidious in your approach, but if done right will pay dividends in near and long term. Always be sure to fully chronicle the budgeting process, you may not recall in a year your rationale for certain budgetary items and documentation will help refresh your memory. Finally, remember that a budget is an estimate of income and expenses. Monitor performance to budget carefully, so that in the event there’s unforeseen changes to income or operating expenses, you’ll be prepared to adjust as needed.