Accounting for real estate developers has always been a rather sensitive subject to broach. With the volatility of the economy and the inflated housing market, developers have their hands full managing their accounting affairs and staying on top of things. To that end, accounting for real estate is the subject at hand today. In this blog, we will be discussing what real estate accounting is, the essentials of real estate accounting for developers, and how to effectively leverage real estate accounting to their advantage.
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What is Real Estate Accounting?
For all intents and purposes, real estate accounting procedurally is hardly any different from regular accounting and bookkeeping. The difference comes in how you interpret and leverage the financial data gleaned from your books of accounts. For developers, the goal is to track their numbers very, very carefully to gain a thorough understanding of the viability and profitability of their development projects. Beyond that, developers need to focus on building up investor interest in their projects, figuring out ways to obtain financing, and keeping in line with the latest tax and property laws and regulations.
Leveraging real estate accounting for real estate developers is, to put it bluntly, quite vital to meet their goals. If they fall short of any of these goals, the business could be in jeopardy. Especially with how unpredictable the housing market can be, it’s always a matter of being safe rather than sorry.
Accounting Essentials for Real Estate Developers
Organizing the Chart of Accounts
When it comes to real estate accounting for real estate developers, there are a number of sections in the chart of accounts that are more important and provide relevant insights than others. Optimizing your accounting software to focus on these accounts can make things go far more quickly and efficiently.
Take for instance a property developer. The relevant accounts for this case would be all the Relevant accounts payables, available cash, Work or Construction in Progress, equity, debt, and so on. For a landlord who develops properties to rent out, accounts like work in progress are far less relevant compared to rental property expenses and rental income.
Organizing and categorizing your chart of accounts to give you the data you need and nothing extraneous is an essential part of real estate accounting for developers.
Monitoring Cost of Goods Sold (COGS)
When engaging in real estate development, it is essential to monitor the Cost of Goods Sold (COGS), which represents the cumulative sum of various expense categories within your real estate accounting records. COGS encompasses all the direct expenses associated with property development, such as payments to electricians, fees for architectural services, permit acquisition, and the purchase of construction materials. Notably, indirect expenses, like compensating administrative professionals for office management within your real estate development firm, are not factored into COGS.
You may consider dissecting COGS on a per-square-foot basis or utilize this figure to establish profitability ratios. This enables you to assess and compare the profitability of various development projects. A comprehensive understanding of your expenses equips you to create more accurate projections and estimates for future undertakings.
Differentiating Between Soft and Hard Costs
In accounting for real estate developers, the COGS can be further divided into soft costs and hard costs. Knowing the difference between the two allows for better budgeting and planning. Soft costs account for around 20-30% of the budget, and these include the cost of everything other than the physical development of the project. So, building planners and architects, permits and licenses, inspection fees, and financing costs are all considered soft costs.
Hard costs are where the majority of the budget will go, and these include the cost of construction workers, building supplies, equipment such as bulldozers and cranes, etc.
Utilizing Budgets for Design Refinement
As your project progresses, it becomes crucial to strike a harmonious balance between your design aspirations and budget constraints. Throughout the project’s lifecycle, you are likely to generate multiple budgets, necessitating potential adjustments to your design choices to align with these financial parameters. Ultimately, the goal is to strike an equilibrium that minimizes both project delays and cost escalations while upholding project quality standards.
Design expenses represent just one facet of real estate accounting, which entails the management of various costs and the continual exploration of cost-saving strategies. For instance, you may seek avenues to reduce expenses within the vendor procurement process.
Real estate accounting software serves as a valuable tool in efficiently managing all these aspects. It facilitates the analysis of everything from individual line-item disparities to the comparison of actual costs against projected costs as a whole. However, mastering the implementation and utilization of real estate accounting software can present challenges, making it advisable to consider collaborating with a specialist in this field.
Essential Real Estate Accounting Services for Developers
Regular Bookkeeping and Record Maintenance
Developers have a lot of activities clogging up their schedules. Regular meetings with investors and bankers, contractor negotiations, managing personnel, and so on. Amid all this hullabaloo, bookkeeping, and record maintenance typically end up becoming a secondary responsibility with low priority, given it is comparatively mundane work.
Mundane though it may be, is nevertheless vital to the functioning of the business. Having a dedicated real estate accounting expert on your team would not only lift the load from your shoulders, but you will also have the peace of mind of knowing that you have an expert maintaining your books and staying on top of things like accounts payable and receivable. With risk management and compliance being one of the primary advantages of real estate accounting for developers, the bookkeeping and record maintenance part of the job is definitely the most crucial part of the process to get right, and real estate accounting professionals can get that job done with no problem.
Tailored Financial Reporting
When it comes to accounting for real estate developers specifically, knowing where to look for information is critical to success. Think of your financial statements as treasure maps with multiple X marks symbolizing various end goals. A real estate accounting professional can look at these maps and tell you exactly which data you need to make your way to a specific goal.
For example, if you are an investor looking to develop a property and then flip it, you will be most concerned with the balance sheet, which can tell you the profitability of the project based on your assets and liabilities.
Or, if you are a landlord who develops property for rental use, you would be most concerned with the profit and loss statement, as it would show you the cost of property maintenance versus the rental revenue generated.
Whatever the goal may be, without knowing where to look and what data to parse out, you may as well be flying blind. But with the right real estate accounting solution for developers, things become far clearer and the business can chug along with peace of mind.
Financial Forecasting
Accounting for real estate developers commences well before the commencement of any construction project. It necessitates the ability to create precise financial forecasts based on market data, construction expenses, and your proposed project timeline. Additionally, it requires you to formulate assumptions regarding the origins and allocation of funds, spanning from the initial cash requirements to the project’s conclusion.
As the project gains momentum, it becomes imperative to concurrently monitor actual expenses while continually refining future estimates and forecasts. Notably, you must vigilantly observe your expenditure rate and establish ongoing cash flow projections to promptly identify potential deficits and devise strategies to mitigate them. All of this and more can be successfully achieved through real estate accounting, especially when a professional is involved.
Conclusion
Real estate accounting for real estate developers is a crucial tool for success. Developers need to start looking for real estate accounting professionals to stay on top of things, or leverage outsourced real estate accounting services as an alternative solution. Either way, the fact of the matter is that real estate accounting can get really messy, really quickly, and developers need to be consistently making use of their financial data to adapt to the dynamic nature of the industry, lest they be swept away into the chaotic currents of the market.