When its budget time in commercial property management, it is time to look at the client’s property in greater detail as well as the investment plans that the client may have. The client is likely to have changed focus when it comes to the property and or the financing arrangements for the asset may have changed. The budget for the property impacts the ‘bottom line’ and in that case the net income.
Things shift and change over 12 months and certainly the direction of the asset will have shifted given the levels of income, expenditure, and tenant mix opportunities. The budget looks at the differences in actual cash flow, and compares it to the expectations of the property given the size of the tenant mix, the terms and conditions of leases, and a number of other important factors.
So budget time in commercial and retail property management is a busy time leading up to the process and moving through it; it is the job of the asset manager or the property manager to control the process in an accurate way.
If you have been monitoring the budget over the previous year for your client, the budget should have been adjusted each quarter or month given market conditions and cash flow. In other words a property budget is not fixed; it is a target to be chased and adjusted to over time. The budget is set before the beginning of the financial year, and is adjusted to throughout the year given known and established variables.
In most of the larger office buildings and retail shopping centers, the performance of the asset is a monitored event each month taking into account the major property indicators including some of the items below:
- Current year’s activities – The history of a property is a valuable indicator to work from. When you look at the levels of occupancy in a property, the operational costs such as energy, water, gas, air conditioning, and maintenance you can see how they are all impacted. It is then easier to do an estimate of operational costs for a property based on occupancy expectations for next year.
- Capital works estimates – These are the bigger items of maintenance replacement. In any large building, capital works programs are structured for larger items of plant and machinery when the building is under less occupational or seasonal pressure. Items of this type are generally handled separately from the normal building running costs, so they have a special treatment in the property budget.
- Planned maintenance – When you look at the average property certain factors of maintenance will be routine and regular. That may for example be the costs of the service process applied to fire hydrants and sprinklers. The works in that case would occur monthly or quarterly and the timed expenditure budget should be set accordingly.
- Unplanned maintenance – The older a property gets, the less predictable it will become from a maintenance perspective. Some things will fail or breakdown unexpectedly. Some items are easier to fix and are less critical to property performance; the repair in that case can be delayed. Other items however may impact occupancy and rent immediately and on that basis the repair will need to happen whilst the property is in use. You should have systems in place to fix critical items that could derail the tenant mix, property use, or customer access.
- Essential systems – A property will have a permitted use and a certificate of occupancy. The property will be used in keeping with those classifications and building codes for safety and occupancy will apply. Understand the essential systems of machinery and plant in the property and when they will need to be serviced. The timing of the service or maintenance should be fed into a timed cash flow.
- Tenant mix and vacancy factors – Look at all of your tenants and understand their leases. See how the rent reviews detailed in the leases could impact rental income; you will need to set benchmarks and key performance indicators as targets to work towards with each tenant and known rent review depending on its type. Within the tenant mix, also assess the timing of any lease expiry dates and determine whether vacancies will occur with expiring leases. If vacancies are expected, it pays to load into the budget a rent reduction for that ‘vacant’ period of time; you may also like to allow for a let up period or incentive as part of a new leasing expectation. The let up period is something that would be estimated given market supply and demand for the property type.
- Income results – The rental income for a property is driven by the tenant mix, existing leases, and the occupancy expectations. Given that the budget is only an estimate and is set at a particular period of time, therefore it is very important to keep your notes and assumptions for each stage of the process; that then makes it a lot easier to go back and look at why rents and expenditures achieved particular levels. A spreadsheet is a good tool to use in drafting up the property budget and all of your notes can be kept on the spreadsheet for later reference.
- Expenditure results – From a point made earlier here, it was said that the history of the property will have a big impact on setting new cash flow expectations. The costs to run the building are a good example of that assessment. You can split the operational costs of the building up into categories of costs and then easily see cost categories that are showing escalations beyond the average for the property type or location.
- Property life cycle – Any property will deteriorate over time, and that deterioration should be assessed in a life cycle review prior to budget creation; in any large investment property the lifecycle review involves other consultants such as engineers, architects, and quantity surveyors. In the review, the property and its age is being compared to others in the local property market. Rental expectations are set for the property and the results can then be merged into the property business plan for the building.
So there are plenty of things to do here when it comes to establishing a budget for any commercial or retail investment property. Preparation and accurate information are key factors in getting the rental and expenditure expectations set for the property budget.