by Theresa Bradley-Banta
A multifamily real estate annual operating budget allows you to compare the actual financial performance of your property to your long-range projections for future income and expenses.
It’s important to prepare an annual income and expense forecast for your property whether you manage it yourself or if a professional third-party management company manages it for you.
Important: Do not prepare an annual operating budget for your multifamily property or apartment building and then file it away and ignore it. This article will give you some great ideas for using a budget to your advantage.
Benefits of Creating an Annual Multifamily Investment Property Budget
A budget allows you to establish or identify:
- Performance targets.
- A baseline for property management reviews.
- Income and expense projections based on market drivers and assumptions.
- Capital improvements planning and projections.
- Problems that need to be resolved.
Importantly, a budget can help you maximize profitability and avoid unforeseen major repairs and expenses.
Third Party Property Manager Performance Baseline
The best use of a property budget is to track how your manager is performing.
Ask your third party property manager to prepare an annual budget forecast with side-by-side comparisons of actual vs. budgeted income and expenses.
This budget then establishes a baseline for your property manager’s performance reviews. It’s a great idea to have regular meetings with your manager to review these comparisons. How are they doing in meeting projections? What can be done to course correct when and if your targets are not being met?
Some of the items to review are:
Multifamily Property Income:
- Vacancies against leasing projections: Is your manager on target for leasing new units or maintaining the average occupancy rate in your market?
- Lease renewal (rollover) projections: These are leases that are due for renewal during the budget period. Make initial contact with residents no later than 60 days prior to lease expiration. If there is not a renewal commitment from your tenant there should be a follow up in 45-days.
- Future profit projections from increased revenue: This could include rent increases, laundry revenue increases, the introduction of a utility reimbursement program (tenant pays utilities), etc. Where are you able to increase revenue at your property?
- Future revenue projections from new sources: Where can you find previously untapped revenue? Can you charge for amenities such as parking, storage, recycling or business/entertainment centers? Can you install vending machines in your common areas?
- Cash flow projections: With accurate cash flow projections you’ll be able to make strategic decisions about the allocation of revenue for improvements.
- Replacement reserves: Determine what percentage of gross scheduled income can be put aside for future use. For example, you might want to hold back 5% of all scheduled revenue or you can allocate a certain dollar amount annually per unit in your property.
Multifamily Property Expenses:
- Projections for lowering current expenses: Are your mechanical systems operating at peak efficiency? You may be able to lower utility bills with systems that operate efficiently. Can you contest your current property tax payment amount?
- Review third-party vendors and service providers: Conduct annual reviews of your property vendors such as services that provide lawn care, cleaning, trash removal and property insurance. Let them know they will be up for annual review for cost and service. Do your service providers have pending increases?
- Utilize the know-how of your service providers: Ask your vendors for efficiency/cost saving suggestions (property improvements or services they can provide) and budget accordingly.
- Property management: Review all fees such as leasing, maintenance and on-site management (if applicable). Are you satisfied with the performance of your manager? Are their fees as projected?
Most multifamily and apartment building management software programs will generate a budget-to-actual income and expense report for comparison. Ask for this report. A budget is nice but you must compare it to the actual property financials.
Investment Property Analysis Assumptions (Drivers)
Using the following or similar assumptions, you or your property manager can project all income and expenses over a 12-month period beginning with the current month. You can change these variables at any time. It’s a good idea to run several scenarios using both conservative and aggressive assumptions.
The following assumptions are used for example only. You will need to determine your own variables based on your particular investment market.
- Vacancy (7%)
- Income Growth (5%)
- Expense Growth (3%)
- Cap Rate (7%)
- Expense Ratio (40-45%)
These assumptions will help you determine the best and worst case scenarios and will assist you in planning budgets for the long term. You can create 24-month, 36-month or 48-month projections using assumptions. For example, you can predict your property value over the long term at different cap rates and net operating income. This can help you set targets for increasing revenue and lowering expenses.
For national averages read or download the National Apartment Association 2015 Survey of Operating Income & Expenses in Rental Apartment Communities at this link.
Investment Property Capital Improvements Planning and Projections
In addition to predicting regular, recurring expenses your budget should include projections for major capital improvements. For example, you might want to paint your common areas (halls, stairs, entry, mail room, laundry, etc.) every three years.
Planning for long-term improvements allows you to stagger the improvements over time. By doing this you can avoid surprise expenses. These funds are commonly referred to as replacement reserves and include:
- Common area improvements such as new paint, lighting, vinyl, carpet, parking lots and driveways.
- Major building systems repair or replacement such as windows, roof, boiler and air conditioning.
- Individual unit upgrades.
A Final Note on Your Annual Operating Budget
Use your annual operating budget as a tool. Plan to hold quarterly budget reviews with your property manager and/or your team at the very minimum. An annual budget can drastically maximize your profits when used as designed.