Budgeting looms as an onerous undertaking for some people, mostly due to the size and complexity of the task. Because of sheer volume, budgeting must be broken down into parts, and each part must be completed in full before progressing to the next. When developing an income budget, use the following steps.
Step One: Gather Information
Before you can begin budgeting income, you must have a firm handle on existing tenancy. Prior to beginning the budget period, you must thoroughly review the rent roll to update:
- New leases not yet abstracted
- Extensions, expansions, contractions, and other changes to the space requirements of your existing leases
- Amendments, addenda, and other changes to the terms of your existing leases
You must have available all current information relating to your existing tenancy. Your tenant base is likely in a dynamic state. Changes always occur, and it can be easy for a busy property or facility manager to overlook these changes. Take the time before beginning on your income budget to review the changes that have occurred over the past year to ensure you have incorporated them into your rent roll.
Step Two: Budget Base Rent
Now that you have a complete picture of the terms and conditions of your existing tenancy, you can begin to piece together an income budget. Several steps are involved in budgeting base rent, progressing from the most reliable information—existing leases—to the most uncertain predictions—new leasing.
- Schedule base rent monthly throughout the year for each existing tenant, keeping in mind expiration dates.
- Increase base rents for any stepped rent increases which may become effective during the year.
- Identify a success ratio in obtaining renewals for any leases expiring during the year, quantify the renewal rate, and include the new monthly rate on a base rent worksheet.
- Quantify leasing efforts needed to market current and upcoming (nonrenewal) vacant space, project any anticipated lease-up, and account for the anticipated base rent.
Step Three: Refine the Escalatable Cost Pool
Before additional rent calculations can be budgeted, you must identify the escalatable cost pool. This pool can be derived from the operating expense budget. The operating expense budget will be affected by projected occupancy levels. Several expense categories, including janitorial and utilities, vary with the level of occupancy.
Step Four: Budget Additional Rent
Now that we have refined the escalatable pool, we can use it to budget the additional rent provisions in each tenant’s lease.
Prepare a worksheet that reflects existing tenancies. Include the tenant name and pro rata share as abstracted from the lease. Include only those new tenants whose leases have a base amount less than the budgeted escalatable cost pool. The remaining variables are each tenant’s base amount and the amount of the escalatable cost pool. By comparing the escalatable cost pool amount to the base amount and multiplying the difference by the pro rata share, one can obtain the annual escalation amount. Dividing that amount by 12 will result in the budgeted monthly operating escalation income.
Budgeting for CPI increases is a little more complex. The objective is to anticipate the increase in inflation for the coming year. Theoretically, the CPI should increase at the same rate as inflation. Therefore, our best estimate of the inflation percentage can be used to estimate the anticipated increase in the CPI index. Before calculating the CPI increase, obtain the following from each tenant’s lease:
- Base CPI index
- Prior year’s CPI index, if any
- Allowable increase percentage
- Base rent amount
CPI increases are effective on the anniversary date of the lease. For the months before the anniversary date, the CPI amount would remain the same as the prior amount. If this amount is not known, it can be calculated (based on the information available) by using the following steps:
- Calculate the percentage changes between the base index and the prior year’s index.
- Multiply the allowable increase percentage by the percentage change from step one.
- Multiply the resulting percentage by the base rent to arrive at the increase amount.
In calculating the anticipated change in the CPI for the change month and each subsequent month, apply the projected inflation factor to the prior year’s index, then continue through the calculation above.
Step Five: Budget Other Income
Additional items requiring a monthly tenant-by-tenant schedule may include:
- Antenna/satellite dish rental
These amounts can be obtained from the lease abstract or through comparisons with the prior year.
Step Six: Review for Reasonableness
Keep in mind that a budget is simply an estimate of the future performance of the property. These estimates will obviously be an approximation and may not reflect the exact activity as it will occur in the coming year. Your goal is to fine-tune the estimates within a reasonable tolerance of error. Your success as a property or facility manager may be based on your ability to accurately budget and to operate within your budget. Great care should be taken to ensure that the budget is reasonable.
A budget can serve as an operating plan. Variances from the plan assumptions are explained each month in the variance analysis. Owners will generally accept budget variances within 5 percent and maybe even more when dealing with large vacancy factors. Don’t assume this, however; consult with your owner(s) to determine their expectations in this area. Because the majority of the income budget falls under base rent, the likelihood of material variances arising from inaccurate budgeting for the other items is small. In other words, your time is best spent on refining and developing realistic leasing and renewal assumptions, with correspondingly less time spent on immaterial items such as parking, storage, and other miscellaneous income amounts.
This article is adapted from BOMI International’s course Budgeting and Accounting, part of the RPA designation program. More information regarding this course or the new High-Performance certificate courses is available by calling 1-800-235-2664. Visit BOMI International’s website, www.bomi.org.