In this post we outline key financial components that should be analyzed and assessed to properly prepare an operating budget for a commercial property. This is no easy task, and certainly not for the faint-hearted. It is, however, a standard and fundamental process that is generally conducted on an annual basis for commercial property.
In the simplest of terms, this budget serves as a guide for sustaining the cash flow and net operating income (NOI) expectations of the property. It is based on projected income and expenses. Annual budgeting allows for property managers and owners to identify patterns in expenditure activity, take note of unexpected items and create practical future financial projections. Think cost control and cash management.
When not managed properly, this budget can be the catalyst of significant financial casualties. Remember, budgeting is a proactive process. Think of the annual operating budget as a financial “forecast” for the coming year. Poor preparation will leave you out in the cold.
Below are items that should be addressed and assessed when organizing the annual operating budget:
- Has the income for the property over the forthcoming year been determined? This is needed to establish rent roll and escalations.
- Are there any capital improvement plans to be completed in the forthcoming year, and if so, do these improvements coincide with the property owner’s goals and expectations? These large expenses can increase value to the property, whereas regular maintenance/repair expenses maintain and preserve the condition of the property. Note: These expenses are handled very differently and reserve funds may be required for future capital improvement expenditures.
- Will there be any shifts in routine repair and maintenance expenses? (For example: pest control and landscaping services) Any increase or decrease in pricing should be depicted accordingly in the vendor contract and recorded in the budget.
- Have property taxes and insurance been estimated? Property taxes are paid biannually, while property insurance can be paid upfront or on a monthly basis. Insuring proper reserves for these large expenses is highly recommended if these costs are not paid through mortgage reserves, and even then, the debit service for the mortgage will need to be adjusted.
- Have funds for any possible emergencies/unexpected expenses been accounted for and set aside? Think saving for a rainy day. Reserve accounts to the rescue.
- Have all other expense reimbursements or recoveries been estimated? This includes expenses related to administration such as accounting and property management fees.
- Has the debt service of the property been reviewed? This will help establish the cash flow and the owner’s return on investment.
- Has the net operating income (NOI) been determined? This step is crucial for establishing the budget and measuring if it is working efficiently and meeting the owner’s financial expectations.
How to manage this budget
To provide quality management of this operation, it is best to have a systematic practice in place for annual review of the property’s performance to make note of any future goals or improvements for the coming year. Remember to also keep comprehensive reports of the operating budget for future reference.
By returning to these reports, a property manager is able to analyze and compare results year over year based on previous expense patterns. Take note: This helps with cost control and maintaining cash flow. The property owner should also review and approve the property manager’s operating budget before it is applied to confirm that all financial expectations for the year are aligned.
Lastly, accuracy is the most significant component. Think of this budget as the backbone of how the property’s performance and operations are measured.
Need help with budgeting for your property? Get in touch with us today. We’d love to help!
