Real Estate and Accounting: A Matched Pair
By Cliff Hockley, CPM, CCIM, Senior Advisor
Bluestone and Hockley Real Estate Services
SVN | Bluestone and Hockley
Real Estate investors forget how important accounting is to their investment success. Most Investors just look at one thing, how big the check is at the end of the month.
But in fact, in addition to inspecting your property on a regular basis, keeping it well maintained and having great communication with your property manager, accounting for your income and expenses and tracking it is critical to your success in real estate.
I have been involved with property management for over thirty-five years and it still astounds me that the vast majority of our clients do not read their financial reports, and I think I have figured out why. They just don’t have the training and the confidence to dig deep into the numbers.
I think I can help.
Accountability and Planning
Most of us are real estate investors because we are trying to build our retirement and wealth, or we have inherited a home or investments from a family member and there are important memories tied to the history.
One of my best friends told me a couple of stories about his grandfather who bought a farm in east Texas. His Grandfather worked the farm, had children and those children had children and here we are now, four generations later. Unfortunately, the hundreds of acres of farmland has gone to waste and the farm has high tax costs, but no one lives close by to actively manage the land. In addition, no one is accountable to its costs, and it is just sitting there, because there is no accounting, or will to sell it. In addition, this family has another house in east Texas that was a rental but has now deteriorated because no one is in charge or accountable. Regular accounting could have kept the family focused on the bottom line.
Monthly Accounting Serves Many Purposes – Most Importantly it Creates Visibility
We tend to get stuck with the myth that we were terrible with math in high school, and we can never figure out the numbers on a financial report. We are afraid and delegate the task to our bookkeeper, tax preparer or CPA. But in fact, reviewing monthly and annual financial reports is critical to your success as an investor.
We can simplify this process and take the fear out of it for you
In my mind, understanding financial reports is a matter of looking for patterns. Accounting reports are like police body cameras, they shed light on your investments.
Like crossword puzzles or the game Tic Tac Toe, we just need to learn how to recognize the patterns, and this takes a little practice. For the layperson, I should also mention that it is easier to review financials that are prepared using the cash method (as required by the Oregon Real Estate Agency and the Washington Department of Licensing) rather than the accrual method.
The differences are that with the cash method you see income and expenses as they occur in the timeframe (month/quarter/year). With the accrual method, large expenses are spread out over a year in equal buckets. Both methods are correct, just the cash method is easier to track for non-accountants.
I start by looking at income. Did the rent/s come in? Who paid and did not pay? Were any units vacant? And I look at the aging report to see how far back some tenants might be with their rent or utility billings. This year was an unusual year since the government jumped in and helped pay rents for some tenants due to COVID – 19 and variations thereof. But nevertheless, we need revenue to pay our bills.
Then I like to review monthly and annual expenses (which I do every month for my investments) to track for patterns. I compare month to date and year to date to see if the numbers look consistent. I look for numbers that are not the same, then I ask why they are not in a consistent range. Most of the time everything looks great, but sometimes there is a water bill that is too high (broken line or leaky toilet), or a tax bill that seems weird, or a maintenance bill that is strange. On a monthly basis, our company supplies a 12-month income and expense summary report which merges the actual expenses and the future budgeted expenses to make the comparison easier.
In this industry most properties of the same size run very consistently with similar expenses. The biggest variations are the taxing districts. In other words, taxes are lower in Benton County as compared to Multnomah County due to bonds approved by the local electorate. Next, the biggest is the cost of labor and utilities. It’s typically more expensive in the big cities than it is in the rural areas. If you only have one property you can always ask your property manager to help you benchmark against another property that is similar.
For larger properties, there are benchmarks you can check against. For example, for many apartment-style properties expenses range from 40 – 50% of income depending on many variables. For commercial buildings, the expenses tie to the kind of lease you have in place (i.e., gross, net, NN, NNN).
Putting Theory Into Practice
A final story relates to a building I looked at in Maine a few years ago. It was a beautiful 14-unit property located in a college town. The owner of a wood products factory had remodeled the property and added a few extra units. Maine is a little unusual on the expense side because due to the cold winters, it seems the Landlords have gotten stuck with the heating bills and snow removal. In any case we got down to reviewing the numbers with the owners and there was not enough income for the owners’ to live on. Her kids were responsible for managing the property for their Mom ( the property owner) because she lived in assisted living.
Unfortunately, it was only spinning off $20,000 a year. Now bear in mind the property had no debt, and the rents were $1,400 a month per unit for a total of $19,600 a month. A reasonable expense level should have been 50% of income or $9800 a month all in maintenance, utilities, insurance and taxes. And there should have been $9,800 x 12 or $117,600 in income to send to Mom (because there was no loan on the property). Where did the money go? It went to the trusted maintenance man who kept three people busy on this property year-round. No wonder the property looked perfect. The kids had no idea. The property was on the market for years and the realtors who only had experience with houses could not figure it out. If they had paid attention to the monthly accounting reports, they might have had better results.
It pays to review your monthly financial reports and not delegate it to the CPA. Just look for patterns. Have your CPA or property manager help you compare. Join a group of investors like Multifamily NW or The Rental Alliance of Oregon, BOMA, ICSC or an association like the Post Office Owners Association to get the information you might need and finally, never be afraid to ask questions! Investing is about making money after all, and who to better check on the results than the owner of the real estate.