It’s budget season!  For many companies, this is a several month-long process of fact finding, planning, and negotiations.  Your budget and budget process can have an enormous impact on your operations, so we’ve outline several different methods of creating budgets, their pros and cons, and how to prepare for implement such methods in the future.

Method 1: Increasing last year’s budget by X% – Problematic if the prior budget is off

The easiest way to setup a budget is to look at last year’s budget and actuals and then increase a combination of those numbers by a certain percentage based upon expected market conditions.  However, what it makes up for in simplicity, may cause problems down the road.  Did last year’s budget create the optimal operational incentives to achieve your goals?  Does it provide the right incentives for your star performers?

Pros:

• Simple to implement if you have a prior year budget

Cons:

• May not be accurate
• May create disincentives for strong performers and reward weak performers

What if your best property manager has managed to optimize the performance of their property.  Occupancy is high, rents are strong, and expenses are kept at a minimum, and their next year’s budget is based upon their stellar performance.  You are essentially rewarding them with a more challenging budget due to their great prior year performance, which could cause them to not make the effort to meet the less achievable numbers, or worse, they could decide such unfair treatment is a reason to quit. 

At another property, occupancy is below market and expenses are high.  Every year, this property manager continues to perform below what they should, but without much effort they are able to operate within budgets and are rewarded the same as your stellar performer.  Their peers see that they are given easily achievable goals, and see that they are being treated unfairly.  As a result, your low performers stay and continue to perform at a low level, and your strong performers leave because they do not like being treated unfairly. 

Such outcomes are a common occurrence if you don’t get your budgets right.  If last year’s results were not optimal and you modify them by a certain percentage to create this year’s budgets, you may run into these types of problems.

Method 2: Setting Budgets based upon comparable property benchmarks

Good if the benchmarks are accurate, but doesn’t account for inertia

Using benchmarks based upon similar properties is another method. This method can work if the data is available and accurate; however, it doesn’t account for the current inertia of a property’s current performance.  To implement this method, a company takes expected occupancy rates and expenses for various categories or specific GL codes for a typical property and normalizes them per unit.  Then, the company applies those normalized amounts based upon average rent and unit count to comparable properties to come up with their budgets.

 This method can provide a fairer long-term benchmark for the property to follow, and uncover some important revenue generating or cost cutting strategies; however, it doesn’t account for the current performance at the property.  Different properties may have different infrastructure, processes or tools in place that given them a performance advantage.  The property may already be performing at a high level with good occupancy and efficient expense management.  On the other hand, the property may have a lot of deferred maintenance and capital projects that have kept expenses in check, but the day of reckoning for when immediate repairs are required is imminent.

Pros:

• More accurate representation of how the property should be performing

Cons:

• May be difficult to get accurate comparable budget info for a property
• Does not account for the current performance at the property

Sometimes, best practices haven’t been implemented across the portfolio.  Implementing the best practices takes education, time and effort, which needs to be accounted for when setting up the long-term budget targets.

 Several years ago, I reviewed painting practices at various properties in a large multifamily portfolio.  I found that there was a wide variance in the costs for interior painting at different properties.  The biggest difference I found in the performance of some of the properties versus other properties was the fact that a small set of properties had a significantly lower paint and painting spend than any of the others.  When I visited the property, the maintenance supervisor showed me how doing a partial paint (light paint on the walls up to 3 feet) with some touch up not only took 30 percent of the time, it took even less paint and required less drying time!  While this practice didn’t work at all properties (some had oil furnaces), it worked at many and led to significantly lower costs.  However, educating the other properties on the new process took training, implementation time and follow-up, but once implemented, improvements could be accounted for within the budget.

Method 3: Prioritizing and Accounting for Major Projects

Could take a bit of work if you don’t have the right tools

Things age, need to be updated or need to be replaced over time.  While preventative maintenance is ideally done regularly to minimize catastrophic failures, there are always upkeep items and renovations that require a lot of expenses.  By inspecting your property, getting quotes for or forecasting the expenses related to each major project, and prioritizing, you can figure out what to include in your budget.

 Gathering quotes and tying them to projects and then prioritizing the projects doesn’t necessarily require lots of data entry and paper shuffling if you have the right tools.  Just make sure you are using a system that helps you gather all the right information and put it all together in a budget.

Pros:

• Helps prioritize and budget projects to accomplish during the year

Cons:

• Takes some work to gather quote, prioritize and schedule the projects if you don’t have the right tools

Fortunately, there are software tools available that can be of help.  With some software, you can perform an inspection, create quote requests / gather and enter budget amounts based upon your inspection results.  You can even review pictures, notes and estimates during budget negotiations and organize your transactions within different projects.

There are merits for using past budgets, benchmarks and prioritizing expenses for major projects.  Ideally, you have the tools and time to incorporate all three methods into your process.  If you don’t have the time or tools, you may want to spend this upcoming year making a few changes that will help improve your budget process moving forward.

Method 4: Combining the Approaches – the most accurate, but also the most work

The best but most difficult method of creating budgets is to combine the best from all three of the above approaches.  Start with historical budgets and actuals and budget amounts per unit from comparable properties.  After blending those results, add in market factors.  Finally, add budget amounts based upon the high priority projects that you expect to accomplish in the upcoming year.

Pros:

• Provides an accurate view of upcoming budgets

Cons:

• Requires the most work to accomplish

By providing accurate budgets, your staff will be incented to accomplish the goals you set out for them.  Plus, by providing fair numbers, you will challenge and reward your star performers, and identify your weak performers.

Long Term Planning

While combining all three approaches is the ultimate goal, you will need to do some prep work to get your organization ready to adopt this approach.  Here is a list of items that you should do to help make your budgets more accurate and easier to prepare in the future:

• Set policies for GL code usage and make sure you enforce them – this will normalize your data.
• Find comparable properties to which you can compare your properties’ performance, and gather budget data for those properties.
• Create best practices so your staff knows the best way to lease and operate your properties.
• Create standardized sets of products to use at your properties.
• Negotiate contracts with your best suppliers in high volume categories and regions.
• Use software that will allow you to document necessary projects, gather cost estimates, and modify budgets.