Let’s Not Forget the Expenses

When either forecasting, underwriting or simply checking the figures on a deal, it is important to account for expenses. The mere mention of the word expenses immediately brings certain images to the mind of most real estate professionals, such as taxes, labor and materials. Proper accounting for such expenses, however, can make or break a financial model and skew underwriting assumptions. That said, it is important to employ the following practices to ensure that your expense estimates are accurate and reflective of the market.

Watch the Market

The market always is always newsworthy, but for real estate professionals certain metrics will indicate expense tendencies. One such metric or indicator is Housing Starts. Housing Starts are an indicator that closely predicts the residential real estate market. It tracks the number of construction projects that have started construction after filing for a building permit. This data is tracked by the Census bureau, which conducts random surveys of building permit filers. Other such indicators are the prices of timber, copper, steel and raw materials. Movement in the Futures for these materials is even more indicative of how the market believes these materials will fare, as these are the prices that people are willing to pay in order to make sure that they are not hurt by pricing changes.

Speak with Professionals

No one is more up to date on the trends of expense pricing than the very people whose livelihoods depend on them. Below is a short list of some real estate professionals that could be helpful:

Accountants: These number crunchers are great general resources for expense pricing, as they are usually deal with many different types of business and are privy to the costs amounts of many different markets. 

Contractors: Few professionals are as heavily affected by material and labor prices as contractors. As such, they are usually keenly aware of pricing trends. 

Local Governmental Employees: Assessors and other county, state and local staff are usually awesome resources for filing and governmental fees. They are also usually aware of any upcoming changes in these fees. 

Local Vendors/Suppliers: No one knows prices and pricing trends like the professionals selling materials.

Remain Flexible

Flexibility is crucial to proper prediction. Whenever forecasting or modeling, it is important to build in fluctuations into your expense assumptions. I typically account for an ambitious 5% year over year increase, with the understanding that if prices increase by a lesser amount or drop, my projected performance will only improve. Once notified of a significant change in a particular expense, it is important to update your models or calculations accordingly to ensure accuracy.

Accounting for expenses is an ongoing process that takes attention to detail. Accurate expense assumptions, however, can make or break your deal, so the effort is well worth it. That is my take on expense accounting. Please leave your thoughts below.