Critical real estate accounting concepts for developers to understand
Real estate developers need to understand a few essentials of real estate accounting so they can track the success of their business
They need to know which reports to focus on and which accounts to create
They should understand the difference between hard and soft costs
They should be able to make pre-project projections
During the project, they need running cash flow projections
They also should use their budgets to refine project designs
Real estate developers need to track their numbers closely to understand the profitability of their projects, attract investors, obtain financing, and stay compliant with income tax reporting requirements. They also need to ensure they approach real estate accounting in a way that improves their ability to run their business successfully.
Real estate accounting has a lot of moving parts. Developers need to keep a close eye on the following six factors if they want to run their businesses as effectively as possible, and understanding how to use accounting software is a critical part of this process.
1. Focus on the right reports
The reports real estate investors should focus on vary based on their objectives and their project’s progress. Investors who plan to develop and flip a property typically focus on the balance sheet, which provides an overview of the development’s profitability based on the developer’s assets and liabilities.
In contrast, someone who uses their real estate to generate rental income should focus more closely on the profit-and-loss (P&L) report, which helps you see the expenses versus revenues during any time period.
By extension, if you’re developing a property to rent out, you should focus more heavily on the balance sheet during the development stage and on the P&L when you rent out the units. Good accounting software will generate both reports as well as many others, but your real estate activities dictate which reports you should study most carefully.
2. Set up the optimal accounts
When you set up your real estate accounting software, ensure that you choose the accounts that give you the most efficient insights into your development operations. For example, a land or building developer may need to set up accounts for accounts payable, cash, construction in progress (CIP), work in progress (WIP), deposit receivables, equity, long-term debt, short-term debt, retainage, and more.
A landlord, of course, doesn’t need to track WIP or CIP, but they may need to add additional accounts that allow them to track specific expenses related to their rental operations.
3. Track cost of goods sold
When you’re developing real estate, you need to track the cost of goods sold (COGS), which is the total of several different expense accounts in your real estate accounting records. COGS refers to all direct expenses involved in developing your property, including paying electricians, hiring architects, obtaining permits, and buying building materials. Indirect expenses, such as paying an administrative professional to run the office for your real estate development firm, are not included.
You may want to break down COGS per square foot or use this number to create profitability ratios. This allows you to compare the profitability of different development projects, and the better you understand your costs, the more effectively you will be able to generate projections and estimates for future projects.
4. Understand hard versus soft costs
COGS for real estate developers includes both hard and soft costs, and you need to track these expenses separately so you can understand how different elements affect the overall budget of your project. Hard costs are associated with the physical construction of the project, and they include labor, materials, hazardous materials abatement, and equipment such as trash systems or elevators.
Soft costs, in contrast, are related to the development of the real estate but not the physical building. They include consultants and architects, permits, inspection fees, and financing costs. Every project varies, but as a general rule of thumb, hard costs make up 70% to 80% of a project’s budget while soft costs make up 20% to 30%.
5. Make financial projections
Real estate accounting starts long before you ever break ground on a project. You need to be able to make accurate financial projections about prospective property acquisitions based on market data, construction costs, and your proposed schedule. You also need to make assumptions about the sources and use of funds from your initial cash requirements to the end of the project.
As the project gets moving, you will need to simultaneously track real costs while also continuing to make estimates and projections about the future. In particular, you will need to keep an eye on your burn rate and create rolling cash flow projections so you can identify potential shortfalls early and make a plan to avoid them.
6. Use budgets to refine design decisions
As your project moves forward, you will need to find a balance between your design and your budget. Throughout the project, you are likely to produce numerous budgets, and you may need to refine your design choices to stay in line with them. Ultimately, you need to strike a balance that allows you to minimize both delays and cost increases while maintaining the quality of your project.
Design costs are just one element — real estate accounting requires you to manage multiple costs and constantly identify strategies for savings. For example, you may want to find ways to reduce costs in the vendor procurement process.
Real estate accounting software helps you stay on top of all of these elements in the most effective way possible. It also helps you analyze everything from line-item variances to aggregate costs versus aggregate projected costs. But learning how to implement and utilize real estate accounting software can be challenging, and you may want to work with a specialist.
Contact Franco Blueprint today
At Franco Blueprint, we provide multiple real estate accounting services, including accounting software implementation and training. Whether you need guidance setting up the software or a more hands-on approach with controller and CFO services, we can help.
At Franco Blueprint, we offer a range of services for real estate developers as well as startups and seasoned businesses in multiple other industries. To learn more, contact us today.