Financial Management

1. National Apartment Association Education Institute Certified Apartment Property Supervisor Financial Management

2. Restrooms Breaks Lunch Cellular Phones Smoking Housekeeping

3. Introductions • Name • Company • Number of Units • How Many Years In the Business • In your opinion, what is the difference between and asset manager and a property manager?

4. Participate fully. What you get out of this class is fully dependent on what you put into it. • Help us stay on track. We're going to cover a lot of ground today—at quite a fast pace—and to make sure you get the full leadership training experience, we'll need everyone to stay focused. • Have fun. The amount of learning that will take place is directly proportional to the amount of fun you have. Ground Rules

5. Apartment Investment Basics Getting to the Bottom Line Managing the Budget Process Analyzing Monthly Financial Statements Valuing Apartment Investments Maximizing Revenues Mortgages, Financing & Taxes Learning Outcomes: Financial Management

6. Apartment Investment Basics

7. The National Council of Real Estate Investment Fiduciaries reports that apartments have produced a higher total return, with less variance, than the average of all property types in the portfolios of pension funds and other large investors. During the 20-year period from 1984-2004, apartments earned an average 9.3% total annual return compared to 7.6% for all property types combined. Why invest In Apartments?

8. Investing In Apartments

9. Business Risk Financial Risk Liability Risk Inflation Risk Interest Rate Risk Property Damage Risk Obsolescence Risk Apartment Investments and Risk

10. Getting a specific rate of return Generating regular cash flow Refinancing Renovating or retrofitting the property Acquiring new properties Selling existing properties Understanding the Owners Investment Goals

11. Keep the owner well informed through detailed financial data, reports, and narratives. • Factor the owner's goals into all key financial activities. • Provide incisive and timely analysis pertaining to financial matters. • Recommend strategies and tactics. • Take decisive and effective steps . • Assess portfolio growth . • Communicate. The Financial Strategy

12. Getting to The Bottom Line

13. Accounting deals with the entire system for providing financial information—from the design of the systems through its operation to interpretation of the data. Bookkeeping is the routine, day-to-day recordkeeping that’s a necessary part of accounting. Accounting vs. Bookeeping

14. Accrual basis accounting. This method records all income and expenses in the period they are earned or incurred, regardless of when they are actually received or paid. Accrual-based accounting gives a more realistic and controlled picture of the net operating income in the period, and is the most common type of accounting used in multifamily residential management. • Cash basis accounting. This method records all income and expenses when they are actually received or paid, which causes widely fluctuating numbers. Therefore, cash basis accounting may give a distorted picture of profitability at a given point in time. Consider this: Is it more important to know when rent is incurred, or just noting the cash received when it was paid? Accrual vs. Cash Basis Accounting

15. Gross Operating Income (GOI) is all the money a property takes in, including rent and other income. Net Operating Income(NOI) is gross income less operating expenses. Operating Income

16. Fixed Expenses – Expenses that do not vary with the occupancy level. • Variable Expenses – Expenses that do vary with occupancy. Also know as controllable expenses. • Smart managers focus on variable expenses and seek ways to make fixed expenses controllable. • The two largest expense categories as a percent of Gross Potential Rent (GPR) are property taxes and salaries. Operating Expenses

17. The income statement, sometimes called the operating statement or profit and loss statement, measures performance over a certain period of time. It is the key indicator of a property’s financial position and should be used to define: progress, trends, the relationship to the competitive market place, and the continuing ownership strategy. The Income Statement

18. The balance sheet shows the financial status of a property at a moment in time. • Assets are the cash on hand, the things the property owns (such as the property itself and equipment), and the accounts receivable. • Liabilities are the debts and obligations owed, such as loans. They also include the accounts payable at the property. • Equity is the sum of Assets less Liabilities. The Balance Sheet

19. Gross potential rent, or GPR, is the total rent that would be generated from the property if all the units were occupied. GPR combines the sum of occupied units at current lease rates, plus vacant units at market rates. • All income and expenses are measured and evaluated as a percent of GPR. • Gross potential rent is different from market rent, sometimes called scheduled rent, which is the total annual income you’d receive if 100% of all units were occupied and paying market rents. Gross Potential Rent (GPR)

20. Since all units are not paying market rent because of the lease rent each resident pays at the time of move-in, there is always a variance from market rent that is called loss/gain to lease. • As market rents go up, loss to lease increases; as market rents are lowered, the loss to lease is reduced. • There will always be a gap between market rent and gross potential rent. In a strong market, it reflects the upward movement of market rents. • The formula is: (Market Rent less Gross Potential Rent) / Market Rent . Loss/Gain To Lease (LTL)

21. Vacancy, concessions, and collection loss, or VAC, includes the total value of rent loss from vacant units, cost of concessions given, collection loss as a result of writing off bad debt, and the total amount of rent loss from any non-revenue units. Vacancy, Concessions, and Collection Losses (VAC)

22. Effective gross income (EGI) is the amount of gross potential rent (GPR) less vacancy, concession, and collection loss (VAC). The formula is: GPR - VAC = EGI. Effective gross income is also called net rental income or total rental income. It represents only rental income. Effective Gross Income (EGI)

23. Other income (OI) is any money collected for items other than rent. Includes collections from laundry, vending, cable, deposit forfeitures, parking, amenity charges, late fees, pet fees, application fees, administrative fees, and lease premium fees. Other income may add up to an additional 5% to 10% of the total property income. Other Income

24. Gross operating income (GOI) is the total amount of money the property collects. Also known as total revenue or total income. GOI is the sum of the Effective Gross Income (EGI) and other income (OI). Expressed as a formula, it is: EGI + OI = GOI. Gross Operating Income (GOI)

25. Operating Expenses (OE) include all expenses, fixed and variable, that are paid to manage the property. Typical expense categories are: • Salary and personnel costs • Insurance • Taxes • Utilities • Management fees • Administrative costs • Marketing • Contract services • Repairs and maintenance Note: Capital expenses and replacement reserve payments (if required) are not typically considered operating costs. Operating Expenses (OE)

26. Net operating income (NOI) is gross operating income (GOI) less operating expenses (OE). The formula is: GOI - OE = NOI. NOI is a critical number on the operating statement as income producing properties are valued based on a derivative of NOI Net Operating Income (NOI)

27. A cash flow statement is another measure used to show financial performance. • Statements can include before tax cash flow (BTCF) or after tax cash flow. • Cash flow is similar to net operating income except that you also subtract capital expenses, (including replacement reserve payments), and debt service. • This usually represents the distributable cash of a property. CASH Flow (CF)

28. Capital expenses or capital expenditures (CE) are large property expenditures. • They include non-recurring capital expenses, such as replacing a roof, adding a swimming pool, and otherwise improving the property in ways intended to add to its life. • Capital expenses have a “useful economic life.” • They are depreciated over an "expected" life rather than in a single year. Capital Expenses (CE)

29. Some lenders may require that property owners set up a replacement reserve account (RRA) and make certain minimum payments. An RRA is money set aside in a special account for the replacement costs of items that wear out and must be replaced periodically, such as carpeting, roofing, boilers, parking lot repaving, and exterior painting. Replacement Reserve Accounts (RRA)

30. Debt service (DS) is the mortgage or loan payment (principal plus interest). Most fixed-rate loans have the same amount due monthly. Properties may have multiple loans or mortgages on the property. Debt Service (DS)

31. Along with NOI and cash flow, other financial calculations can help you understand more about a property's financial performance. These calculations are the: • Break-Even Occupancy Percentage • Break-Even Rent per Square Foot • Economic Occupancy Percentage • Rate of Return on Investment • Cash-on-Cash Return • Operating Expense Ratio Important Financial Calculations

32. Break-even occupancy represents the occupancy level needed to produce enough income to pay the operating expenses and debt service of a property—the minimum requirements to keep a property operating. The formula to determine the break-even occupancy percentage is: (OE + DS)/GOI. Break Even Occupancy Percentage

33. The break-even rent per square foot calculates the rent per square foot needed to pay the operating expenses and debt service of your property. The formula for break-even rent per square foot is: (OE + DS)/total square feet. Break Even Rent Per Square Foot

34. When it comes to overall property performance, the economic occupancy percentage is a better indicator than physical occupancy. • Economic occupancy reflects only the actual revenue being realized. • The difference between physical and economic occupancy/vacancy can be a measure of management efficiency, as well as one of overall market conditions. • The formula for the economic occupancy percentage is EGI/GPR. Economic Occupancy Percentage

35. ROI is the percentage of return—or yield—on the total amount invested for a given time period. • It is the ratio of NOI to the total investment. • It measures the financial performance of the investment. • It does not take into account the time value of money—that a dollar today is worth more than a dollar tomorrow. • It is calculated as follows: NOI/Equity Investment = ROI. Rate of Return on Investment (ROI)

36. Cash-on-cash return measures the cash flow received against the original cash invested. It’s a useful method of measuring return on investment for financial institutions and investors interested in purchasing or evaluating a property. The formula for cash-on-cash return is: Cash Flow / Total Initial Investment. Cash on Cash Return

37. The operating expense ratio (also known as expense-to-income ratio) is another tool to measure how well a property is managed. An owner may compare the operating expense ratio for your properties to those of other properties in the area—or national averages—to evaluate your success. • The operating expense ratio calculates the percentage of the gross potential rent that’s used to pay operating expenses. The ratio can be affected by many things such as age, location, etc. • The formula for calculating the operating expense ratio is: OE/GPR = operating expense ratio. Operating Expense Ratio

38. Managing The Budget Process

39. A budget is an itemized summary of estimated income and expenses for a defined period of time, most often one year. It provides the "window" on property operations and is the principal source of information relating to a property's financial performance. There are three types of budgets: • Lease-up budgets • Operating budgets • Renovation or modernization budgets What is a Budget?

40. Budgets monitor a property’s performance. By regularly comparing actual income and expenses to the budget, you’ll be able to identify income shortfalls and expenses overruns, and then take corrective measures. You may also use a budget to evaluate the performance of personnel. The Importance of A Budget

41. A budget begins with the owner's operational and financial goals. For example, does the owner want to: • Receive a specific rate of return? • Generate cash flow? • Renovate or upgrade a property? • Sell a property? Before beginning to prepare the annual operating budget, you’ll need to identify and understand the owner’s investment goals for the property. Budget Goals

42. Preparing the Operating Budget

43. Extrapolation: You’ll often need to use extrapolation to forecast figures for your budget. This is where you estimate a number based on information you already know. • Annualization: Annualizing a number is much the same as extrapolating. Be careful, though. If the electricity includes the heat—the cost of which can vary tremendously—use the historical data for the same months in the prior year instead. Two Budgeting Techniques

44. Start early. Ask property personnel to help develop realistic projections. Describe the specific supporting documentation that must accompany budgets. Supply your team with the right tools. Distribute copies of the budget. Think about holding a budget workshop. Tips for Supervising the Budget Process

45. Analyzing Monthly Financial Statements

46. The general ledger is a group of accounts that support the major financial statements. • It is the formal record for all financial transactions for the property and transfers journal data from the book or page where accounting entries are posted. • The sub-accounts (or ledgers) are assigned names or numbers and provide details of financial activities that occurred. • These sub-accounts are often called the chart of accounts. • It is much like a check register of expenses. The General Ledger

47. The chart of accounts provides the basis for budgeting, variance reporting, journal entries, and financial statements. • The chart of accounts lists account codes for each income and expense item, and defines what should be posted for each account. • A portfolio of properties may use one chart of accounts, or different ones, depending on owner entity and lender requirements. Chart of Accounts

48. A variance is the difference between a budgeted income or expense number and the actual income or expense in a particular month or year-to-date. You (or the community manager) will need to: • Keep track of budget variances. • Use them to prepare a new forecast of future results. • Analyze and explain variances to the owner. • Take action when necessary. Budget Variances

49. Analyze the variance: What is the source, what is the cause? Explain the “reason” for the variance. Explain what effect it will have on future months. Recommend Action to correct the variance. Seek to see if this variance is part of a trend. Explaining Budget Variances

50. Re-forecasting allows you to: • Assess how the property is expected to perform for the balance of the year in relation to the original budget. • Determine whether you need to make further changesin income and expensesin future forecasts. • Understand your propertyand the impact of occupancy conditions on property performance. Remember: You're not changing the budget. You're simply taking the actual year-to date results and projecting the income and expenses for the remaining months in the budget year. Budget Re-forecasting