4 Areas to Focus on to Better Understand Financial Budget Variances
Being able to manage the leasing, residents and staff are critical functions of a good property manager, but often I hear from regional managers and other leaders in the multifamily housing industry that managers are good at running properties, but don’t fully understand how to read a financial statement.
Understanding financial budget variances in property management
Usually, the reason is that no one has invested the time to teach them to read the numbers and to better understand how their impact on the bottom line. Have you ever heard a manager say, “the property is sitting at 97 percent occupancy, but I don’t understand why we are not making our budget?”
Understanding financial variances to the budget will improve a property manager’s ability to reduce waste, seize opportunities to increase income, and forecast in changing environments. Here are four areas to focus on:
Understanding how income impacts cash flow is critical. The property owner with the most heads on beds is not always the financial winner. If new leases or renewals are not signed at an optimal lease rate, that loss in rental value is felt for a year or sometimes even longer.
One common misconception managers believe is that if they are full, they are doing great. Lesson one is to learn the difference between physical and economic occupancy. Buying occupancy with concessions, lower rental rates, and maintaining the lower rates at renewal drive the value of an asset down. While it may be an easier lease at a discount, higher concessions or poor lease management frequently can have an adverse impact on the financial health of the property. It is important to be proactive in understanding leasing and renewal trends to anticipate opportunities to raise rents.
Ancillary income can boost monthly cash flow and help increase a property’s financial returns. Review all the current “other income” opportunities to ensure that this revenue source is being maximized based on client base. If imposed properly, pet rent, utility billing, late fees, NSF fees, move-out charges, and trash, pest control and application fees are a few of the ways to boost revenue.
Ensure money is not being left on the table and communicate the importance of this to the entire team. When revenue in these areas decrease, follow up with team members who have the responsibility to collect these fees. Using your financial variance to track these trends will ensure adherence to collection policies by staff by being aware of sudden changes.
Equally important to the financial health of a property is the cost of bad debt and delinquency. Poor applicant screening, loose collection policies or enforcement, and allowing delinquent residents to stay too long has a direct impact on cash flow. If an apartment is occupied but delinquent it might as well be vacant. The cost is significant. Watch bad debt write-off trends and review screening practices regularly.
Explaining expense variances need to be broken into two areas of importance: Operational vs non-controllable.
A property manager has the greatest influence on operational expense control and timing. Areas of focus in income generation also affect the control and timing of many operating expenses. A resident who moves out impacts not only the revenue line but also turnover and marketing costs.
It is important for managers to understand that move-outs in one month will most likely impact the expense costs for the following 60 days. To best understand the financial variance, managers should be able to look backward and forward.
In addition to turn costs, other operational variance trends are a call to action. For example, significant increases in gas and water costs could be a sign that there is a leak. Unexplained increases in general maintenance costs with a low service request ratio could mean that maintenance is over ordering or preventative maintenance is not being completed. Or worse, theft may be occurring. Payroll and overtime can also play a big factor in expense overages. Keeping control of salaries and possibly staggering staffing could be a major reduction in expenses.
3. Cost of non-operating expenses
While non-controllable expenses are fairly static, it is important that managers understand there are other expense lines such as debt service, insurance, partnership fees and taxes below the net operating income (NOI) line. A manager should understand that it’s possible to have a budget-to-actual NOI but negative cash.
Managers can, however, play a big role in the use of capital dollars. It’s not unusual for managers to fail to see the bigger picture of return on investment (ROI) of capital investments that include money spent for furthering business objectives like improving physical infrastructure.
Can rent be increased if you replace “X” and by how much? How long will it take to see a return? The ROI of some capital expenditures may not always been generated based on an increase in revenue, but either a reduction in expenses or just maintaining competitive balance.
For example, capital dollars spent to remain competitive with a neighboring property may not be measured in income realized by raising rents, especially if there is no room to raise rents. Rather, it may be quantified by ensuring that the property maintains occupancy or reduces vacancies.
Most managers are afraid that if they don’t use their capital dollars they will lose them. This myth needs to be dispelled and the lesson needs to be geared toward impact and return.
4. NOI versus cash flow
The final lesson for property managers is really helping them understand the big picture. It can be difficult for some to understand that while a positive variance on the operating NOI to budgets may exist, cash flow could be negative due to an unexpected increase in taxes, insurance or other major factors.
Understanding how to manage all the way down to the cash flow level of the financial statement will improve a property manager’s ability to understand how every dollar counts, whether it is increasing revenues or managing expenses.
The financial health of a property is a balance. Knowing what factors cause a financial variance to budgets will help elevate a good manager to great.