We have previously discussed the importance of budgeting and financial forecasting on this blog. In short, maintaining a strong understanding of your business’s present financial position and its future potential is a vital part of ensuring its long-term health and success.
Real estate businesses need to understand their current financial status and what their projected inflows and outflows are likely to be over the upcoming months and years. This ensures that necessary expenditures will be covered and that the business is growing in the right direction.
Budgeting and forecasting are informational and planning tools. In today’s post, we will take a closer look at recoveries and how they connect to the budgeting and forecasting processes.
What Are Recoveries?
In the real estate world, recoveries—also referred to as escalations, outgoings, or Common Area Maintenance (CAM) charges—are shared expenses that a landlord passes on to tenants. Typically, the landlord will invoice each tenant for their share of these expenses. Common examples include utility bills, repairs and maintenance, property taxes, and insurance, though recoveries can take many different forms.
When a tenant rents a property, their lease agreement should detail any recoveries that will be payable. It should also specify whether recoveries are payable on a net basis (paid separately from the rent) or a gross basis (paid as a flat rate that is rolled into the overall monthly rent).
Virtually every company that deals with commercial real estate has to deal with billing back recoverable expenses. The notable exception is companies that use triple net leases. In a triple net lease, the tenant assumes responsibility for all expenses associated with the property, including taxes, maintenance, and insurance. But these types of leases are relatively uncommon, and the majority of owners and operators of commercial real estate will need to calculate recoveries.
Automating Recoveries, Budgeting, and Forecasting
As commercial real estate experts, we find that many of our clients deal with hundreds if not thousands of units and leases. Those leases also tend to vary in their terms, which greatly increases the complexity of these processes. There is some commonality, but a client with 200 tenants might have up to 40 different ways of calculating recoveries.
Real estate companies have traditionally calculated their recoveries using Microsoft Excel. Excel certainly has several benefits: It is inexpensive, flexible, and easy to use.
However, Excel also has significant downsides. It is vulnerable to user error, particularly when entering redundant information captured in the property management software. There is also risk when somebody leaves the organization and a new team member comes on board who does not understand all the nuances of a particular spreadsheet. Another problem is that an Excel spreadsheet will be stored on an individual’s hard drive and therefore not visible to the entire organization.
This is where real estate software systems such as Yardi and MRI come into their own. A good real estate software will not only take your company beyond the ways that things are traditionally done, but will likely also save you significant time and increase accuracy as well. Both Yardi and MRI, as well as other software products in this category, are set up to help real estate companies automate these processes.
With these tools, everything you need to calculate recoveries is built into your property management system. You will have access to all pertinent information about the lease, the tenant’s details, the date from which occupancy begins, and the monthly rent. On the expenses side, you will also have access to the details on any recoverable costs incurred as part of the lease, from cleaning to elevator repairs to repaving the parking lot. With these tools, you can also specify the parameters on which recoveries will be calculated.
This is a one-time process and for each lease. You simply have to tell your real estate software system those recovery terms, and each year the system will make all the calculations for you with the touch of a button.
Short-Term Pain for Long-Term Gain
The ideal time to automate your recoveries process is when onboarding the properties to your system. This is when the lease agreements are typically reviewed and the source data supporting the recovery calculations is entered into the system.
We have noticed that clients may resist leveraging their system to automate recoveries due to the upfront investment in time. However, once this is properly set up and configured, you will gain tremendous efficiency year after year. While the temptation might be to keep using Excel, especially if you already have it set up, this has the potential to cause significant problems and end up costing more time in the long run.
Real estate software systems are typically able to handle 80-90% of the types of recoveries that a lease will include. Occasionally, leases will include qualitative clauses, one example being snow removal costs in the event that there is more than a certain amount of snowfall in a given year. This would require human intervention, but this type of scenario is relatively rare and likely impacts just a small portion of your tenant portfolio.
There are opportunities to get close to 100% automation with leading real estate systems such as Yardi and MRI. Each system handles a little differently. For example, MRI offers a custom formula builder for recoveries, offering absolute flexibility when calculating recoveries for leases with unique or unusual terms. This allows the landlord to plan for all eventualities and to provide completely customized reports to tenants when the charges are reconciled at the end of the year.
How Recoveries Intersect With Budgeting and Forecasting
Robust budgeting and forecasting takes into account every aspect of your business’s financial processes. This includes recoverable income. However, we have noticed that recoveries are an often overlooked part of our clients’ budgeting and forecasting systems.
While it is not essential to complete recoveries before budgeting and forecasting begins, the major advantage of doing so is that, when using budgeting and forecasting in conjunction with recoveries, your system will pull the recoveries information into your budget. This means that your software will calculate your projected revenue based on the following year’s predicted recoverable expenses. This includes the incremental year-on-year increases to the costs of relevant services.
If a company does not have the time to implement a recoveries automation solution before budgeting and forecasting begins, it is still possible to make strong financial predictions based on projected revenues, expenses, and scenario modeling. However, implementing recoveries ahead of budgeting and forecasting adds a useful additional dimension to their data. It also saves time by eliminating the need to make those calculations for each tenant outside of the main system and then return to the budget to add them in at a later stage.
In addition, every time you use multiple systems simultaneously, the potential for human error or out-of-sync data increases. This can cause significant headaches down the line.
Need Some Additional Support?
If you are just starting out with automating your recoveries processes or looking to use it to take your financial budgeting and forecasting to the next level, the experienced team at REdirect can help. We have decades of combined experience in assisting clients with getting the most out of their real estate investments using Yardi, MRI, and leading systems.
If you would like to learn more about how we can work together, get in touch and we will reach out to see how we can help you.