Clay & Company » A Texas Commercial Real Estate Blog

By Marty Kramer | Consumer columnist for TexasRealEstate.com

Have you ever protested your property-tax appraisal? I have. Twice.

The first time was easy. We had bought our home six months earlier, and the appraisal district thought it had appreciated 20%!

I attended an informal meeting with an appraisal-district employee. When she looked at the copy of our closing documents, she immediately adjusted the price down to our purchase price. Simple as that. She said I could have handled the whole thing over the phone.

My second appraisal protest was only slightly more complicated. I came to the informal meeting with appraisals of comparable homes in my neighborhood and pictures of my house.

The appraisal district employee and I went back and forth over the details, and after 10 minutes, she dropped the appraisal. Not as much as I’d requested, but still a helpful amount.

So, I didn’t make it to the formal hearing with the appraisal review board either time. I hear from a friend of mine that’s a little more stressful, but still a fairly easy process if you do your homework.

Here are a few things to keep in mind if you decide to protest your appraisal.

Meet the deadline

According to the Texas comptroller, you have to file a written protest (for single-family residences) “by April 30 or no later than 30 days after the appraisal district mailed a notice of appraised value to you, whichever date is later; however, an owner may file a notice before June 1 if the ARB has not approved the appraisal records. Note that it is 30 days after mailing the notice, not its receipt.”

Depending on when your district mailed notices or approved the appraisal records, you may still have time to file.

Follow the rules

You can’t protest your appraisal on the basis that your tax bill is too high. Not successfully, anyway. You have to show that your property has been appraised higher than what it’s actually worth … or higher than other similar properties in your neighborhood.

Bring evidence

Your opinion doesn’t carry much weight. Whether at an informal hearing or in front of the appraisal review board, you should focus on factual information supported by documentation.

Be nice

Some people come to an appraisal protest ready to do battle. I’ve heard some loud, nasty folks while I was there to protest my appraisal. I don’t think that works. Just my opinion, but I bet appraisal-district employees and the appraisal review board members will probably respond better to homeowners who are polite and respectful.

You can find more specifics about how to protest your taxes from the state comptroller’s website.

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Kirksey Architecture recently released its Annual Construction Cost Update for 2012 compiled by statistics from over 20 area construction firms.

Their findings show a slight increase in per square foot construction costs for each category including: one-story flex office buildings, low-rise office buildings, mid-rise office buildings, high-rise office buildings, medical office buildings, and parking structures. Commercial tenant improvements for a typical 25,000-square-foot, full floor office buildout are $27 to $45 per square foot, up $2 per square foot since 2011.

The report says, “construction costs have stabilized at a low point over the past year and have started to move upward while a few material costs and transportation costs have risen.”

Competitive construction costs and low interest rates make now a favorable time to build.

See the specific costs for each category and the full report here.

By David John Marotta, Contributor

Question: I would like to see your take on paying off a house faster (extra principal payments) so that overall your house hasn’t cost you all the extra interest; or investing your money, taxable or non-taxable. I’ve heard arguments on both sides, some for rental property some for personal property. I own a duplex, live in one half, rent out the other half. So I’m a little torn between arguments.

I feel like society has been brainwashed to not make extra payments, or if you do, only do a little extra.(IE…bi-weekly payments bring in your payoff date.) Mainly because the argument is “you get tax deductions!”

Owners of rental property claim: get a 30-year, make sure you have cash flow, don’t make any extra payments. The tax deductions offset your income.

Debt free “gurus” say: Why would you pay $10K in interest only to get a $2.5K deduction? The faster you pay it off, the faster you’re not paying an extra $10K each year while getting a measly deduction.

I could go on and on with all kinds of arguments. Thanks for your time,

Duplex owner

Answer: Great question! Financial advisors disagree because there are some things more important and some things less important. My advice is based on a millionaire mindset and not just a get-out-of-debt mindset.

In 2003 I wrote a column “Using a mortgage wisely” in which I listed seven rules for handling a mortgage. I started that column by saying, “Most Americans have a home mortgage. The rich often have two. Only the poor can’t take advantage of this ‘good’ debt.” Here are the seven rules:

1. 1. Have a home mortgage
2. Borrow a 30-year fixed rate mortgage
3. Don’t buy down the interest rate by paying points
4. Keep your mortgage debt under 30% of your net worth and under 80% of the value of your home
5. Invest significantly in taxable investments each month
6. Diversify your investments between stable fixed investments and growth stock investments
7. After 8-11 years, pay off your mortgage or refinance depending on interest rates.

Having a mortgage at even as high as 6% means it is only costing you 4% and the government is paying the other 2% if you are in the 33% marginal tax bracket. Additionally, I don’t think you will ever see interest rates as low as they are right now. Just as the government will benefit from devaluing the buying power of the U.S. dollar because it will make it easier to pay off the national debt, so it will make it easier for you to pay off your mortgage with cheaper dollars over the next 30 years.

Bert Whitehead writes in “How to Get the Best Mortgage“, “A 30-year fixed rate mortgage is your best protection against inflation.” His article is worth reading and in it you will find much of the same advice.

Another way to look at a home mortgage which of the following is better:

1. Having a home worth $360,000 which is appreciating with inflation
2. Having a home worth $360,000 appreciating with inflation PLUS a $300,000 fixed 30-year mortgage on which you are paying 3% interest and the government is paying 1% interest by lowering your taxes AND $300,000 in taxable investments earning an average of 9-10% over the next 30-years.

Clearly (2) is advantageous. Any time you wanted you could slap your investments over your mortgage and be debt free. In fact, if your investments appreciate by 10% they should double in about 7 years. That means in 7 years you could pay off your mortgage and still have $300,000 in investments left over.

One more advantage, if you ever do need the money, if you have a mortgage you have a $300,000 cushion of an emergency fund. If you don’t have the mortgage and you get in financial trouble. NO ONE will loan you money once you are in financial trouble.

And this leads us to the reason for the mixed advice. If you are already living hand to mouth and unable to live within your means, you are not able to handle a mortgage well. If you can’t save money, then having $300,000 sitting around able to be spent will result in you spending it. Those with a millionaire mindset can have a mortgage. Those apt to spend and not save should work at being debt free and learning to save.

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In a market featuring rock-bottom building prices and record-low interest rates, now is an ideal time for businesses to consider purchasing instead of leasing their real estate.

That was the consensus of the panelists on the most recent episode of the “Commercial Real Estate Show,” which provided a look at the factors making owner-occupied real estate a more attractive option for businesses.

Show host Michael Bull, the president and founder of Bull Realty, said the possibility of rent spikes is one reason to consider buying.

“These prices are so low, it’s incredible,” he said. “With the lack of new construction [in recent years], I think we’re going to see some huge rents in about five years.”

Banks also are enthusiastic about owner-occupied real estate, noted Brant Standridge, a state president for BB&T.

“It’s very, very attractive for banks,” he said. “Financing is readily available, and banks are requiring less and less equity.”

Firms that own their own buildings have a valuable tool for acquiring the funds needed to grow their operations, panelists observed.

“Businesses that are looking to expand, particularly small businesses, often use their real estate,” said Brent Baker, a managing partner with CIB Partners LLC. “It’s an attractive way to get long-term financing and to accomplish some things: expansion of marketing programs, adding equipment, any number of things they may want to do.”

Companies also can dramatically increase their wealth by buying a distressed building, occupying it and then later doing a sale-leaseback.

“The sale-leaseback market and the single-tenant net lease market are as hot as firecrackers,” Bull said. “The value and the demand for these fully occupied properties are just huge.”

Possible changes in accounting rules provide yet another reason for firms to consider buying real estate. The Financial Accounting Standards Board has proposed changes that would classify leases as liabilities on balance sheets.

“What happens when your liabilities go up but your equity doesn’t change?” said Jeff Olson, a partner with Babush, Neiman, Kornman & Johnson. “Your leverage ratios go off the charts.”

Implementation of the changes could spur some businesses to buy instead of lease their buildings.

“They’ll say, ‘I’ll put the debt on my books but I’ll get the asset, and I’ll have an investment,’” Olson added.

He predicted that, if passed, the new rules wouldn’t be implemented until 2014 at the earliest.

Daniel Latshaw, a partner with Bull Realty, said markets such as Atlanta, Phoenix and Las Vegas could offer particularly good opportunities for purchasing buildings. “But don’t generalize,” he cautioned listeners. “Look closely at your market or submarket.”

The full show is available for download at CREShow.com. The next “Commercial Real Estate Show” will be available April 12 and will provide an update on the U.S. office market.

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If you are  involved in property management, the below videos featuring Texas Association of REALTORS® Associate Counsel Kinski Leuffer share a few important things you should be aware of.

Owners and developers unearth opportunities through creative land leases
By Philip “Fred” Himovitz, CCIM
Reprinted from From CIRE Magazine, Mar-Apr 2012

Editor’s note: Originally published in 2006, “Ground Control” is one of the most popular articles in CIRE’s archive. Author Philip “Fred” Himovitz updated the article for republication.

Commercial real estate developers and investors often favor total fee ownership of income property. The propensity to own — and the emotions attached to it — sometimes can result in misguided decisions and strategies and lost opportunities. Relinquishing ownership of income property is really a question of when, not if.

Once developers move beyond the notion of ownership as an investment goal, new opportunities that may not have been visible before, such as ground leases, become apparent. In its most basic form, a ground lease, or land lease, separates the ownership of land from the ownership of the improvements on the land, such as an office building or a shopping center. The landowner leases the land to the developer of the improvements, who pays rent for use of the land.

Typically ground leases are long-term and include set rent escalations, eviction rights should the lessee default, and a reversionary right, which means improvements on the property revert to the landowner at the end of the lease term. While such lease terms do not particularly favor developers, ground leases offer some distinct advantages to them.

The two most prevalent types of ground leases are subordinated and unsubordinated. Each provides benefits that can enhance the developer’s yield and turn dismal or modest returns into more attractive and risk-mitigated ventures. They also give developers the opportunity to involve multiple partners without negotiating formal partnership agreements.

Ground leases transfer control — not ownership — of a property and, for the landowners, they are considered one of the most secure forms of real estate investment. But landowners may be considered preferred investors and may be open to developers who offer them a stake in the improvements erected on their land, in exchange for other considerations such as rent abatement for vacancy. Such a quid pro quo can substantially reduce risk to a lender.

Lease Structures

In a subordinated ground lease, the landowner offers the land as collateral for the developer’s mortgage, giving the landowner a significant stake in the development risk. The subordinated ground lessor is considered a secondary lender with junior rights behind the primary lender, usually a bank or other financial institution.

Normally the ground lessor has a future claim on the improvements, as most ground leases require improvements to the land to revert to la

ndowners at the end of the lease. As such, ground lessors usually consider the downstream value of the improvements in establishing a rental rate. On the other hand, a ground lease that provides for the removal of any improvements at the end of the lease, such as relocatable metal buildings, modulars, portable plants, or parking lot appurtenances, would factor that eventuality into the rate as well.

The subordinated ground lease rental rate is usually a few percentage points above long-term permanent loan rates applied to the land value, which would correctly calibrate the risk-reward equation, including the risk of foreclosure, for the ground lessor.

The unsubordinated ground lease offers the landowner a more desirable role, comparable to that of the primary lender. This makes long-term permanent conventional financing more challenging for the developer, since the lender must assume the risk of lease termination and default. However, due to the senior position of the unsubordinated ground lessor, the ground lease rate can be lower and therefore much more attractive for the developer. The permanent lender recognizes the ground lease payments as an annual expense that will be factored into its loan underwriting. In total, the cash required in the deal by the developer is reduced while his yield is increased.

In both cases, the developer’s requirement for cash in the deal is reduced because of the value that the landowner brings to the deal. The reduction in cash usually required causes the investment yield to increase when the income stream is extended into the future. The value of the future cash stream will be determined by a threshold discount rate, resource availability, and underlying assumptions — the same general market and economic model assumptions that apply to fee-simple land ownership deals.

Other considerations include the length of the remaining lease term, reversion covenants, and extension and renewal rights and options. Occasionally the ground lessor will participate in the cash flows by applying a lease rate as a percentage of the income that the rental property produces. This strategy can have the positive effect of averting a monetary default in the event of a “dark” project. It also has the positive effect of mitigating the risk that a first mortgage lender perceives if the lease is unsubordinated. For example, if prevailing long-term interest rates are 6 percent, a comparable subordinated ground rental rate might be 8 percent, whereas an unsubordinated lease might be priced at par or 6 percent.

Ground Lease Benefits

The potential to form a joint venture with a building developer can be attractive to the primary ground lessor. The yield values are enhanced by the security of the future improvements. Provisions against wasting the property, requirements to maintain the improvements, cure and notice rights, certain reasonable approval conditions, and the ubiquitous hazardous materials covenants are standard.

Clearly, an unsubordinated lease presents possibilities that offer an alternative investment vehicle that provides security to patient investors and can be traded, sold, or transferred in creative ways. For example, tax-deferred 1031 strategies are possible by trading into an income investment as a sandwich ground lessee-ground sublessor. The usual threshold is that the lease term be greater than 25 years. Since these instruments can take on the color of a security, real estate professionals who enter into these deals should carefully document all aspects of the transaction and seek advice from qualified securities professionals.

In addition, opportunities exist in some municipal ground lease situations wherein, under certain conditions, property taxes are completely or virtually eliminated. Likewise other tax benefits accrue to these sanctuaries because of the reversionary character of building improvements and the incentive-rewarding jobs creation. These areas of investment can offer a spectacular advantage over neighboring competing properties in pricing and yield.

Lease term and length influence the acceptability of ground lease deals. The current climate is cautionary because of the parochial need to own; however, institutional managers realize that it is all factored into the risk and yield and accept the challenge with appropriate lease drafting and terms that are favorable to the asset managers’ objectives. The environment is changing as the pressure for yield performance and risk mitigation goes begging. The challenge is pioneering in an area where heretofore only the creative and adventurous have explored.

The National Association of Realtors® annually surveys recent home buyers and sellers to gather detailed information about their experiences buying and selling a home. This report provides real estate professionals (and sellers) with insights into the needs and expectations of their clients (and buyers.)

Characteristics of Home Buyers

• Thirty-four percent of recent home buyers in Texas were first-time buyers, compared to a national level of 37 percent – a drop from 50 percent in 2010.
• The typical buyer in Texas was 46 years old, while nationally the typical buyer was 45-years- old, a jump from 39-years-old in 2010.
• The 2010 median household income of buyers was $92,300 in Texas and $80,900 nationally. The median income was $65,000 among first-time buyers and $108,700 among repeat buyers, compared to $62,400 among first-time buyers and $96,600 among repeat buyers nationally.
• Nationally, 64 percent of recent home buyers were married couples—the highest share since 2001. In Texas, the figure was 67 percent. Eighteen percent of recent home buyers were single females nationally—the lowest share since 2004; 15 percent were single females in Texas.

Characteristics of Homes Purchased

• Only 16 percent of all recent home purchases on a national level were new home purchases. This is not-reflective of conditions in Texas, where 31 percent of homes were new.
• Nationally, the typical home purchased was 1,900 square feet in size, was built in 1993, and had three bedrooms and two bathrooms. In Texas, the typical home purchased was 1,800 square feet, built in 2001 and had 3 bedrooms and 2 baths.
• The quality of the neighborhood, convenience to job, and overall affordability of homes are the top three factors influencing neighborhood choice; however, neighborhood choice varies considerably among household compositions.
• When considering the purchase of a home, heating and cooling costs were at least somewhat important to 86 percent of buyers and commuting costs were considered at least somewhat important by 73 percent of buyers nationally, compared to 91 percent and 78 percent of buyers in Texas respectively.
• The typical home buyer in Texas searched for 10 weeks and viewed 10 homes, compared to 12 weeks and 12 homes on a national level.

Financing the Home Purchase

• On a national level, 87 percent of home buyers financed their recent home purchase. Among those who financed their home purchase, the buyers typically financed 89 percent. In Texas, 88 percent of buyers financed their recent purchase and 91 percent of the purchase was financed.
• The share of first-time buyers who financed their home purchase was 95 percent compared to 82 percent of repeat buyers, nationally. In Texas, that share was 92 percent of first-time buyers and 85 percent of repeat buyers.
• Nearly half (46 percent) of home buyers nationally reported they have made some sacrifices such as reducing spending on luxury items, entertainment or clothing. This also holds true in Texas.
• Nationally, 23 percent of buyers reported the mortgage application and approval process was somewhat more difficult than expected and 16 percent reported it was much more difficult than expected. These numbers are equivalent to the Texas numbers, where 23 percent of buyers reported the process was somewhat more difficult than expected and 16 percent reported it was much more difficult than expected. Home Sellers and Their Selling

Sellers

• Nationally, recent sellers typically sold their homes for 95 percent of the listing price, and 61 percent reported they reduced the asking price at least once. In Texas, recent sellers sold their homes for 96 percent of the listing price and 60 percent reduced the asking price at least once.
• Forty-one percent of sellers offered incentives to attract buyers nationally, most often assistance with home warranty policies and closing costs. In Texas, 48 percent of sellers offered incentives.
  
  Source

The following comes from the Legal FAQ section of TexasRealtors.com:

After the sale of a home [or other property] occupied by a renter, it was discovered that the security deposit was not transferred from the seller to the buyer as part of the closing. Now the parties can’t agree on who is responsible for the security deposit when the rental ends. Who is responsible for the security deposit?

Both buyer and seller could be responsible. Under the provisions of Section 92.105 of the Texas Property Code, the seller and the buyer may be liable for the security deposit and any refund of the deposit to the tenant upon termination of the rental. The new owner is liable for the return of the security deposit from the date he acquires the property. However, the seller also remains liable for the security deposit he received from the tenant until the buyer delivers to the tenant a signed statement acknowledging that the buyer is the new owner and has received and is now responsible for the tenant’s security deposit.

The transfer of the security deposit upon closing is now specifically addressed in the TREC One to Four Family Residential Contract. Paragraph 9(B)(5) now expressly states:

“If the Property is subject to a lease, Seller shall (i) deliver to Buyer the lease(s) and the move-in condition form signed by the tenant, if any, and (ii) transfer security deposits (as defined under §92.102, Property Code), if any, to Buyer. In such an event, Buyer shall deliver to the tenant a signed statement acknowledging that the Buyer has received the security deposit and is responsible for the return of the security deposit, and specifying the exact dollar amount of the security deposit.”

Texas Association of REALTORS® form 2210, Notice to Tenant of Change in Management and Accountability for Security Deposit, could also be used for this purpose with a few obvious changes.

Note: Section 92.105 of the Texas Property Code does not apply to a real estate mortgage lienholder who acquires title by foreclosure.

The article below addresses something all property owners must deal with. See this post for a video on fighting your taxes.

By Amy Wolff Sorter

DALLAS-In North Texas, it’s the time of year during which the frigid, 55-degree temperatures give way to the more temperate weather and the Bradford trees begin to flower. And, for commercial real estate owners throughout the Lone Star State, it’s that time of year to ensure the right paperwork, numbers and other information are on hand and ready in the event a property tax appeal need to be filed.

Experts tell Globest.com that, no matter when the assessment date or appeal date in a particular taxing jurisdiction, the best way to beat unfair tax rates is by having information ready. “What we’re doing at this point in time is assembling support data from our clients to build cases so we can determine if appeals are warranted,” says Jeff Kurz with locally based Kurz Group Inc. In other words, from the moment a commercial real estate owner receives his or her notice of appraised value, it’s a race against the clock to determine if a value is fair, and if an appeal is necessary.

Let’s take a look at Texas. January 1 is assessment day for the coming year with CRE owners receiving valuations by spring. After those valuations are received, commercial real estate owners have an eight-week window to file any kind of appeal, with that window snapping shut in July. Overall, it seems as though owners with commercial property in Texas are in luck — Rick Kurz, also with the Kurz Group says that, during the past three years, tax values have trended downward, with most of the county appraisal districts recognizing the impact of the economic downturn on real estate values.

But Texas seems to be an anomaly. On average, across the nation, “property owners of commercial real estate continue to see their taxes increase,” says David B. Wolfe, a partner with Skoloff & Wolfe PC in New Jersey. The reason is pretty straightforward: Cash-strapped municipal and county governments need a way to get revenue. So, despite the decline in value of commercial real estate, municipal and county taxes increase. “It’s a competing situation,” notes Peter Foster Kelsen, a partner with Blank Rome LLP in Philadelphia. “Since the economic downturn, cities are becoming more desperate for revenue, while property owners are feeling the pinch because rents in the commercial sector have dropped.” As a result, “assessments may not reflect the current reality,” Kelsen says. Unlike, say, Dallas, TX, taxes in Philadelphia have been steadily marching north since 2008. What has changed in the City of Brotherly Love, however is that the number of appeals has increased.

Even in Texas, property taxes are frustrating and for reasons other than the obvious. It’s a given that a property tax expense line on any income statement is pretty large. But it’s difficult to pigeonhole that expense line. “It’s a moving target,” Rick Kurz says. “You can generally come up with maintenance and repair budgets for a given year and be reasonably on budget. But property taxes aren’t that simple. Any increase or decrease in property tax assessments can have a dramatic impact on the net operating income of a piece of real estate.”

The good news, however, is that reductions in taxes are possible. More than possible. “My sense is that, in many cases, reductions have been made by the taxing authorities based on the fact that market value has contracted, income has contracted and sales are few and far between,” Kelsen says. The experts in this article point to the fact that they’ve been successful in obtaining reductions for clients. But doing so requires numbers proving an unfair assessment – and the sooner those numbers can be collected, the better.

Jeff Kurz says the “must have” in any kind of assessment reduction tool kit is income and expense information from the previous year or years. The more a trend can be suggested, the better off the owner. “If they’re using a consultant, consultants are requesting that information between now and when the notices come out,” Jeff Kurz adds. The Kurz Group is walking the talk as well.

“Right now, we’re looking at cap rate studies and are doing a thorough scrub of our clients’ financials,” Rick Kurz says. “We’re looking at historical trends and trying to figure out how financials look this year relative to last year.”

In addition to having the financials ready, what is also helpful, Kelsen suggests, is finding a credible property appraiser and having that person conduct a careful assessment of the property to back up the numbers. It’s also hugely important to be aware of the deadlines for filing appeals. Though this might be a given, different jurisdictions have different filing dates – and to a commercial real estate owner with assets in multiple states, those deadlines can quickly loom. “I get dozens of calls from people who are in trouble and who want something done,” Kelsen says. “But it’s three months after the deadline for filing an appeal. I can’t do anything.”

The experts also believe that hiring a consultant or an expert in the field of commercial property can be helpful. Wolfe notes that attorneys who do a significant amount of work in that field can provide guidance as to whether an assessment is out of line; the best place to find an attorney is through an organization called the National Association of Property Tax Attorneys. The Kurzes acknowledge that individuals can certainly do as good a job of filing their own appeals, however, an experienced eye can determine whether taking the time to do so is worth it.

But is it? Certainly paying lower taxes is a good thing, but Wolfe cautions that, in some jurisdictions, “you appeal at your peril. Your assessment can be increased as a result.” Furthermore, Kelsen says, in some jurisdictions, even if the assessing authority makes reductions, the school districts and municipalities are filing challenges to those reductions. “They’re doing what they can to protect their tax base,” he adds.

But with realistic numbers and facts to back those numbers up, the chances are good that taxes can be reduced. “For the most part, assessing authorities are receptive,” Kelsen says. “But they need to be given the data that supports the request for a lower value.”

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By Howard Berends for CCIM
For commercial property owners, energy budgeting is an involved and, in some cases, difficult project. Multifamily properties in particular are difficult to budget for as there are no nationwide programs to assist owners and facility managers.

But budgeting for energy is imperative. According to the Institute of Real Estate Management 2010 Income & Expense Survey, total utility expenses account for approximately 25 percent of all multifamily operating expenses, trailing only payroll and taxes and insurance.

Energy costs may constantly fluctuate, but owners and facility managers can use these tips to keep expenses under control and forecast what will be spent in the coming months.

Common Mistakes

First, determine if the property is located in a deregulated market. These markets are ideal for controlling energy costs: Owners can shop around for utility providers and plans that best meet their usage needs for the best price.

Many organizations plan their budgets by reviewing historical expenses, identifying a trend, and projecting it forward by adding on a guessed growth factor. Others may contact utilities to ask about projected rate increases in the coming year. While utilities often claim that no increase is expected, this just usually means that their requests to their respective oversight commissions have not been approved at the time. Again, owners may just make a guess on inflation and tack it onto the general ledger.

Both of these methods are inaccurate. Utility rates are constantly changing and are affected by factors that are uncontrollable and cannot be predicted, such as natural and human disasters, extreme weather, or political unrest.

Additionally, owners need to be aware of non-recurring expenses that might have affected the previous year’s general ledger but does not need to be incorporated into a budget, such as late fees and deposits paid to utilities. Such historical transactions should be scrubbed so they are not factored into the next year’s budget.

Another common mistake is to apply budget increases to the general ledger. For example, say that a property owner is budgeting for a 2 percent increase in gas for the next year. Some owners may apply this increase across the board for all 12 months and apply the growth assumption on a same-period basis. In other words, the budget for January 2012 is based on the January 2011 actual expenses plus 2 percent.

What’s wrong with this? Utility suppliers rarely, if ever, increase their rates right on January 1. Most suppliers will increase their rates at random times throughout the year, resulting in an off-track budget. For example, say a rate increases by 5 percent in May of this year. If you assume a 2 percent increase for 2012, the January through April 2012 budgets will be based on adding 2 percent to the old rate that was in effect during those same months in 2011, not the current rate that went into effect in May. This means that an owner is under-budgeted for the first four months of the year.

The Right Way

The most effective method is to create a budget based on actual energy usage and rates. Collect all the data from the different utility accounts and base the forecasts on this data. The assumption in this method is that usage drives cost, not vice versa. Along with usage data, you will also need to have the rate data at the utility account level.

Now it’s a simple equation of usage: x rate = $ forecast. Assumptions will need to be made regarding future rates, and inquiries to the suppliers are made with the same results as those who budget based on the general ledger.

By analyzing the usage data, areas in need of attention are identified. Portfolio candidates in need of attention are easier to discover and it is easier to forecast the return on investment for these specific projects as the account level usage and rate data are all on hand. The usage data will make it possible to benchmark, giving additional insight into a property’s performance. Forecasts will be more accurate. By identifying areas of potential savings, the forecasts can be tweaked by account and by rate.

By using the actual rates in effect at the end of the current budget period, you avoid basing any assumed increases on the old rate that was in effect during the same period last year. An analysis can be made to determine if the rates and tariffs charged by the utility provider are correct. Many times they are not, resulting in refunds or credits for overpayments along with reduced future expense. This is particularly true in Texas and Florida, where the utilities are notorious for charging incorrect rates and tariffs.

Accurate budgeting is crucial for multifamily property owners. Budget too little for utility costs and other areas of the business will suffer. Budget too much and opportunities to reinvest in your properties will be missed. Be smart about utility expense analysis and forecasting to maintain steady, healthy growth throughout your portfolio.

Howard Berends, CPM, is a senior account manager for American Utility Management and has over 20 years of experience in multifamily operations and asset management. Contact him at hberends@aum-inc.com or visit www.aum-inc.com.