Page 6-4 April 2004 Corrected account number and figure callout in Case Study. Page 6-5 April 2004 Corrected figure callout in Case Study

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1 Updates and Errata Budgeting and Accounting, 2003 The pages listed below contain revisions that have been made to this course book since it was last printed. The rest of this file provides the corrected, print-ready pages, along with the reverse side of each page. To update your course book, print the pages on both sides of your paper by following the directions provided. Then simply filter those pages in to your binder. Revised Pages Date Revised Description of Revision Chapter 6 Page 6-4 April 2004 Corrected account number and figure callout in Case Study Page 6-5 April 2004 Corrected figure callout in Case Study Page 6-9 April 2004 Corrected list of years in Figure 6-1 note text Chapter 12 Page 12-3 April 2004 Deleted mention of parking and storage rent in item 5 Page April 2004 Corrected figure callouts in Case Study Page April 2004 Corrected table title and tagline for Figure Page April 2004 Corrected table title and tagline for Figure Page April 2004 Corrected figures for August and September Chapter 14 Page April 2004 Corrected totals in Figure 14-3 Student Packet Chapter Review Test: Chapter 4 April 2004 Corrected question 1 Chapter 14 April 2004 Replaced numbers in answers A-D, question 5 Chapter Review Test Answer Key April 2004 Chapter 4: changed question 4 to correct letter A Chapter 12: changed question 1 to correct letter B BOMI Institute page 1

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3 Financial Statements 6-3 the current month; transfer amounts from the existing balance sheet that were deferred until the current month; and generate an accrual basis income statement, balance sheet, and statement of cash flows. Accrual Adjustments First, we must adjust the cash basis income statement to reflect economic events that did not result in a cash transaction. Income Accruals If an otherwise reliable tenant has a cash flow problem and cannot pay monthly rent of $15,000 for several months, you might make a special exception for that tenant and defer rent payments until the cash flow situation improves. Let s say the tenant is unable to pay rent in December of 2002 and January and February of 2003, but in March of 2003, the tenant receives a cash infusion and pays all the back rent of $45,000 plus March s rent of $15,000. On your cash receipts journal, you will record cash income of $60,000 in the month of March But not all of that income relates to March. It is actually income from December of 2002 and January and February of If you record the entire amount of income in March, a reader of the cash flow statement might think that the building is doing better than it actually is. The large cash receipt misleads the reader of financial statements in March. Case Study This example illustrates how to treat deferred rent payments. To eliminate this problem, you must go back and record the income in the applicable months. But now you have another problem. You have already issued the monthly financial statements for December of 2002 and January and February of Readers of these financial statements have already seen what has happened to the financial performance of the property. So, do you restate the financial performance of the property and reissue the financial statements for those months? Actually, the best alternative is to anticipate the receipt of this rent income in the applicable months as they occur, with the assumption that if it has not been received in the current month, it will eventually be paid in future months. Therefore, when preparing the financial statements for December of 2002 and January and February of 2003, you should accrue $15,000 of rent income from the cash-poor tenant. Accrual basis accounting states that revenues are assigned to the accounting period in which they are earned, regardless of whether or not they are received in cash.

4 6-4 Budgeting and Accounting Of course, if the revenue earned in the current period can be determined uncollectible, it should not be reflected as income. But rather than ignore it during the income accrual process, the revenue should be recorded and then offset by an expense reflecting the amount of income deemed uncollectible. During each reporting period, the detail of all receivable rents should be reviewed for collectibility. If specific amounts can be identified as uncollectible, they should be totally removed from the receivable listing and recorded as bad debt expense. If history indicates that some of the receivable amounts will not be collected, but specific amounts cannot be identified, a percentage of the receivable may be set up on the balance sheet as a reserve for uncollectible rents and recorded as a bad debt expense, effectively reducing the receivable balance. When the uncollectible accounts are then actually identified, they should be offset against the reserve for uncollectible rents. Case Study At the Frontier Building, receivables increased during the year by $30,000, $13,316 of which was attributable to office base rent (account ) and the remainder spread throughout other revenue sources. The increase in base rent resulted primarily from a tenant who abandoned a small office space. Legal counsel advises you that collection is unlikely, but attempts are being made to recover rents. The increase in receivables is accrued on the accrual income statement, with an offsetting increase to the reserve for uncollectible rents of $20,000 (account ) and a corresponding expense reflected on the cash flow statement (see Figure 6-4 on pages 6-15 and 6-16). Expense Accruals To provide office space for the tenancy of a building, certain expenses must be incurred. The building must be cleaned, heated, and cooled. The lights must go on and the elevators must run. These costs and many more are incurred specifically to satisfy the tenants of the building. Without tenants, there would be no revenue, perhaps no building, and therefore no need to incur the expenses. Thus, it is fair to state that the expenses of a building are incurred specifically to earn revenues. When reporting the income and expense activity of the building, you must be certain that all the expenses incurred to earn the revenue for the period are properly recorded in that period. If your cleaning contractor delivers an invoice after the end of the month and payment is made in the following month, for example, we have not properly recorded the cleaning expense for that month. The following month may then reflect a cleaning expense twice as large as it should be. Similar to the revenue example above, you do not want to restate the prior month s financial statements by correcting for the cleaning invoice. It is better to anticipate that the cleaning invoice for the month will eventually be received and paid.

5 Financial Statements 6-5 Therefore, you must accrue the cleaning invoice in the month in which the service was incurred. Accrual basis accounting indicates that expenses incurred in earning revenues for the period must be deducted from revenues, regardless of whether cash has been disbursed in their payment. This is also known as the matching principle of accrual accounting. At the Frontier Building, you have not yet received the cleaning invoice for December. The monthly cleaning contract is approximately $40,000. In addition, electricity was paid through the 24th of the month. One-fifth of a typical December utility bill is approximately $20,000. These amounts are added to the expense balances recorded in accounts and , respectively, and the accounts payable balance is increased accordingly (see Figure 6-4 on page 6-15). Matching. Recording expenses incurred in earning revenues regardless of whether cash has been disbursed in their payment. Case Study Expenditures Benefiting Future Periods Often, expenses that apply to future periods will be paid in one lump sum. These expenses must be reflected differently on the financial statements. Prepaid Expenses Expenses paid in one lump sum that apply to periods up to one year are recorded as prepaid expenses. Prepaid expenses. Expenses paid in one lump sum that apply to future periods up to one year. Insurance Insurance premiums are generally paid in advance. Typically, a premium payment will cover the insurance costs for an entire year. The month in which the insurance premium is paid would be overburdened if an entire year s insurance premium offset only one month s revenue. The premium amount should more accurately be spread over the upcoming months that the insurance will cover. But these months have not yet occurred, statements have not been issued, and, therefore, there are no statements to restate. Somehow you must establish a method to remember to apply the portion of the insurance premium to all applicable upcoming months. At the same time, you must report the amount of insurance premium that has not yet been applied against future revenues. The solution is to totally remove the insurance premium from the cash flow statement and record it as an asset on the balance sheet.

6 6-6 Budgeting and Accounting Amortization. The systematic allocation of the cost of an intangible asset from the balance sheet to an expense account on the cash basis income statement. Unamortized asset. The remaining balance of a premium payment. Case Study Then, every reporting period, the applicable portion of that insurance premium can be transferred from the balance sheet to the cash flow statement, thus reducing the balance of the prepaid insurance premium. This method of transfer is called amortization, and the remaining balance of the insurance premium is called a prepaid expense, or an unamortized asset. In the case study, you still have $20,000 of unexpired insurance premiums applicable to future months contained in the insurance expense account (number 47400). Also included in the insurance expense account is $10,000 of insurance premiums paid in 2001, which were transferred or amortized to the same expense account during 2002 (see Figure 6-3 on page 6-16). The difference between these amounts represents the net increase in unamortized insurance premiums and should be transferred from the cash flow statement to the balance sheet. The balance sheet now reflects a total of $20,000 of unamortized insurance premiums, which will be amortized in Key Concept Inventory. Recording supplies purchased in bulk for use in future periods as assets on the balance sheet. Charging out. The method used to transfer inventory from the balance sheet to the cash basis income statement. Supplies Likewise, certain supplies may be purchased in bulk to take advantage of quantity discounts. These supplies are intended for use in future periods. The payment for these supplies reflected in one single month would distort the expense of building operations in that month. The supplies should be more accurately applied to the months in which they are used. Though these months have not yet occurred, you must establish a method to remember to apply the amount of supplies used to the months in which they are used. Again, the solution is to totally remove the supplies from the cash basis income statement and record them on the balance sheet as an asset. When the supplies are used in the operation of the property, the applicable cost value is transferred from the balance sheet to the cash basis income statement, thus reducing the balance of the recorded supplies. When recorded on the balance sheet, the supplies are known as inventory, and the transfer method is known as charging out inventory. In a real estate operation, the amount of supplies on hand is typically immaterial to the total supplies purchased during the year. In these cases, supply purchases are recorded as an expense, and no inventory balance is maintained on the balance sheet. Also, because of the relatively short lead time for delivery of most supplies, purchases are often made monthly to keep supply stores low, which minimizes risk of loss and square footage needed for storage. A manager can negotiate favorable supply agreements based on annual volume and thus be free to purchase smaller quantities at the bulk price.

7 Financial Statements 6-9 appropriate MACRS depreciation schedule is used to arrive at the depreciation amount shown in Figure 6-1. The furniture depreciation calculations are also shown using MACRS for the appropriate depreciation periods. The personal property of the Frontier Building at the time of purchase was $50,000. Subsequent acquisitions of $10,000 per year were made in 2000, 2001, and These assets are being depreciated using the MACRS method. The depreciation calculations for these assets are also found in Figure 6-1. The Frontier building was purchased in June The building is depreciated over a useful life of 39 years. The depreciation calculations for the real property are as follows (Note that amounts may vary slightly due to rounding): Land 10,000,000 Structures 90,000,000 Building Improvements 10,000,000 Amount Amount Date Year Annual Cumulative Date Year Annual Cumulative ,346,154 1,346, , , ,307,692 3,653, , , ,307,692 5,961, , , ,307,692 8,269, , , ,307,692 10,576, ,410 1,175, ,307,692 12,884, ,410 1,431,624 The personal property of the Frontier Building at the time of purchase was $50,000. Subsequent acquisitions of $10,000 per year were made in 2000, 2001, and These assets are depreciated using the MACRS method. The depreciation calculations for these assets are as follows: Furniture, Fixtures, & Equipment 50,000 Furniture, Fixtures, & Equipment 10,000 Amount Amount Date Year % Annual Cumulative Date Year % Annual Cumulative % 7,145 7, % 1,429 1, % 12,245 19, % 2,449 3, % 8,745 28, % 1,749 5, % 6,245 34, % 1,249 6, % 4,465 38, % 893 7, % 4,465 43, % 893 8, % 4,465 47, % 893 9, % 2,225 50, % ,000 Furniture, Fixtures, & Equipment 10,000 Furniture, Fixtures, & Equipment 10,000 Amount Amount Date Year % Annual Cumulative Date Year % Annual Cumulative % 1,429 1, % 1,429 1, % 2,449 3, % 2,449 3, % 1,749 5, % 1,749 5, % 1,249 6, % 1,249 6, % 893 7, % 893 7, % 893 8, % 893 8, % 893 9, % 893 9, % , % ,000 Figure 6-1 Depreciation Schedules Amortization Apportionment of other assets on the balance sheet is performed via the process of amortization. Amortization is the systematic allocation of the cost of an intangible asset from the balance sheet to an expense account on the cash basis income statement. The assets, which are usually amortized, are prepaid expenses discussed earlier in the chapter and other intangible assets. Intangible assets have no physical existence but have value because of rights conferred as a result of ownership or possession. The period in which these assets are amortized is subject to the asset itself and is not as easily identified as the assets that are subject to depreciation. Examples of intangible assets would include leasing commissions paid to a broker and moving allowances paid to a tenant. Generally, these assets would be amortized over the term of the lease agreement. Key Concept

8 6-10 Budgeting and Accounting Liabilities Key Concept Case Study Mortgage. A lien securing a note payable using real assets as collateral. Deed of trust. An agreement between the loan issuer and holder covering assets. Loan amortization. Repayment of a loan structured on a monthly basis, with part of the monthly payment applied to the interest and part applied to the principal. Information There are actually many types of financing. For a detailed discussion, refer to BOMI s Real Estate Investment and Finance textbook. Often, a real estate entity will obtain credit or receive cash it must ultimately repay to a creditor. When this credit is obtained or cash is received, the amount that must be repaid is held on the balance sheet as a liability until repayment occurs. Occasionally, a tenant will pay rent in advance. Since this income is applicable to a future period, it must be held on the balance sheet until that future period occurs. Essentially, these rent receipts have not yet been earned. As such, they represent payment for a promise or liability to provide future office space for rent. The cash basis income statement will reflect all the cash transactions of the property, including those creating or repaying a liability. To properly reflect these cash transactions, they must be transferred from the cash flow statement to the balance sheet. During 2002, the Frontier Building acquired a new tenant and received a security deposit of $10,000. This security deposit is not income because it must ultimately be repaid to the tenant upon successful fulfillment of the lease obligation. Therefore, it should be reflected as a liability on the balance sheet. The $10,000 is then transferred from the cash flow statement to the balance sheet. Typically, real estate is purchased as a leveraged investment. In other words, the buyer borrows a portion of the purchase price from a lender on a long-term basis and funds the remainder of the purchase price himself. These borrowings are collateralized by the property, thus creating a mortgage (lien securing a note payable using real assets as collateral) or deed of trust (agreement between loan issuer and holder covering assets). Repayment of this loan is structured monthly, with part of the monthly payment applied to mortgage interest and part applied to mortgage principal. The mortgage is generally structured to effect a complete return of borrowed funds, plus interest, at the end of the term of the loan while keeping a constant monthly mortgage payment. This is known as loan amortization. In a typical loan amortization schedule, the portion of the monthly payment applicable to mortgage principal will increase as payments are made, and the associated portion of the payment applicable to interest will correspondingly decrease, thus keeping the monthly payment constant. The amortization schedule for the Frontier Building is shown in Figure 6-2. Principal repayment is not considered an expense for accrual accounting. It should be properly reflected on the balance sheet as a reduction of the mortgage.

9 Income Budgeting 12-3 situation. How are these suites to be marketed, and when? Do you have the market knowledge to accurately use the leasing terms that will attract the tenants to fill your vacancies? If not, consult your listing broker or other brokers in the community. Do not be afraid to call your competition to find out what terms are successful for them. You will need to develop a budget based on a certain set of assumptions concerning average length of vacancy and estimates of market rates. 3. Refine the Escalatable Cost Pool: Step two provides you with an estimate of the bulk of your income dollars, but additional rent items can also be predicted with some accuracy. Before you can budget for the additional rent provisions, you must know your projected escalatable cost pool. If you have not begun the expense budgeting process, start now. If you are substantially complete with your expense budget, then fine-tune your projections for increases or decreases in occupancy based on the leasing and renewal assumptions obtained in step two. 4. Budget Additional Rent: Based on the budgeted expense figures obtained in step three, you can now budget additional rent with reasonable accuracy. In addition, you need some idea of local inflation factors and projected sales data from your retail tenants. 5. Budget Other Income: Other income, although relatively immaterial to the total income budget, should be addressed, if known. Consider vending income, interest income, and other known miscellaneous income items. 6. Review for Reasonableness: Gather your budget together and take a big picture look at income in total. Are your predictions reasonable, given the current economic climate? Are they in line with the objectives of the owner? Are they reasonably obtainable? Compare your projections with the EER and the performance of other buildings in your portfolio and other buildings in the area. The final income budget should provide you with an achievable goal that will motivate you to provide your best effort in managing the property in the coming year.

10 12-4 Budgeting and Accounting Step One: Gather Information Before you can begin budgeting income, you must first have a firm handle on existing tenancy. Before 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. Abstracting this information according to the guidelines in Chapter 10 puts this information at your fingertips. Your tenant base is more than likely in a dynamic state. Changes always occur, and it can be very 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 and to ensure you have incorporated them into your rent roll. Case Study An updated rent roll for the Frontier Building is reproduced in Figure 12-1 to facilitate base rent budgeting.

11 Income Budgeting Leasing Costs Budgeting the cost of leasing should go hand-in-hand with budgeting the income. After projecting the timing of lease renewals and new leases, calculate, as illustrated, the cost of doing the deal, such as leasing commissions and tenant improvements. These costs are considered capital expenses and would not affect the escalatable cost pool, but they must be considered in formulating the entire expense budget. See Chapter 14 for more complete examples of capital expense budget items. Step 3: 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. Key Concept The operating expense budget will be affected by projected occupancy levels. Several expense categories, including janitorial and utilities, vary with the level of occupancy. Earlier in this chapter we projected the level of occupancy during the preparation of the base rent budget. The holes in the expense budget can now be filled with the variable expenses that depend on occupancy. See Chapter 13 for further discussions of budgeting variable costs. The escalatable cost pool for our study is summarized in Figure Case Study Frontier Building Operating Expense Detail 2002 Budget Account Amount Per Sq Ft Cleaning $ 598,411 $ 1.17 Repairs/Maintenance $ 650, Utilities $ 1,529, Roads/Grounds $ 20, Security $ 307, Administrative $ 480, Total Operating Expenses $ 3,587,268 $ 7.03 Real Estate Taxes $ 3,400,000 $ 6.67 Personal Property Taxes $ 1, Building Insurance $ 85, Total Taxes and Insurance $ 3,486,151 $ 6.84 Figure 12-9 Escalatable Cost Pool

12 12-14 Budgeting and Accounting Step 4: 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. Expense Escalations Again, 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 would result in the budgeted monthly operating escalation income. These calculations were discussed in Chapter 11, and an example for one tenant is reproduced in Figure to illustrate this aspect of the budget. Real Estate Tax Calculation Budgeted Real Estate Taxes for the Year Ending December 31, 2002 $ 3,486, Less: Base Year Amount $ 3,145, Increase over Base Year $ 340, Fast Print Mailing Service Pro Rata Share 1.76%* Annual Real Estate Tax Increase Escalation $ 5, Months in a Year 12 Monthly Real Estate Tax Escalation $ * Operating Expense Calculation Budgeted Operating Expenses for the Year ending December 31, 2002 $ 3,587, Fast Print Mailing Service Pro Rata Share 1.88%* Annual Operating Expenses Due $ 67, Months in a Year 12 Monthly Operating Expense Escalation $ 5,620.05* *Answers may vary slightly due to rounding off the numbers. Figure Budgeted Tax and Operating Expense Escalation Income Example Case Study The complete additional rent budgets for both real estate taxes and operating expenses are shown in Figures and Note that all new leases have 2000 as their base year. Be sure to check your assumptions for tenants who are projected to renew or vacate during the year. Also, the retail tenants do not share in the cost of operating the building. Their leases require most services to be provided by their own contractors.

13 Income Budgeting Property: Frontier Building Total Bldg Sq. Ft.: 510,000 Budget Year: 2002 Operating Expenses: ,486,151 Additional Rent Budget for Real Estate Taxes Expense Base % Tenant Suite Base Amount Allocable Cam JAN FEB MAR APR MAY JUNE JULY AUG SEPT OCT NOV DEC TOTAL Workers National Bank ,329,745 1,156, % 1,889 1,889 1,889 1,889 1,889 1,889 1,889 1,889 1,889 1,889 1,889 1,889 22,668 Wahoo Steak House ,874, , % ,988 Arrow Discount Drugs ,874, , % ,988 Total Retail Tax Escalation 3,886 3,887 3,887 3,887 3,887 3,887 3,887 3,887 3,887 3,887 3,887 3,887 46,643 National Insurance Co ,145, , % 4,452 4,452 4,452 4,452 4,452 4,452 4,452 4,452 4,452 4,452 4,452 4,452 53,424 Lawyers Pension Fund ,322, , % ,692 John Smith Real Estate Inc ,329,745 1,156, % ,664 Norwood & Norwood ,329,745 1,156, % 2,082 2,082 2,082 2,082 2,082 2,082 2,082 2,082 2,082 2,082 2,082 2,082 24,984 Continental Computers ,874, , % 11,988 11,988 11,988 11,988 11,988 11,988 11,988 11,988 11,988 11,988 11,988 11, ,856 New Tenant % New Tenant % Fast Print Mailing Service ,145, , % ,988 Just Temporary Help ,329,745 1,156, % 1,137 1,137 1,137 1,137 1,137 1,137 1,137 1,137 1,137 1,137 1,137 1,137 13,644 Pack Management Co., Inc ,322, , % ,488 BOMI International ,545, , % 1,842 1,842 1,842 1,842 1,842 1,842 1,842 1,842 1,842 1,842 1,842 1,842 22,104 Large Systems Specialists, Inc ,874, , % ,764 New Tenant % BOMA Central City Chapter ,145, , % ,360 Byrne & Byrne ,322, , % ,328 Consolidated Telecom ,329,745 1,156, % 22,675 22,675 22,675 22,675 22,675 22,675 22,675 22,675 22,675 22,675 22,675 22, ,100 Total Office Escalation % 49,007 49,005 49,005 49,005 49,005 49,005 48,061 48,061 48,061 48,061 48,061 48, ,398 Figure Additional Rent Budget for Real Estate Taxes

14 12-16 Budgeting and Accounting Property: Frontier Building Total Bldg Sq. Ft.: 510,000 Budget Year: 2002 Operating Expenses: ,587,268 Additional Rent Budget for Operating Expenses Account #: 320 Allocable % Tenant Suite Expenses Cam JAN FEB MAR APR MAY JUNE JULY AUG SEPT OCT NOV DEC TOTAL Workers National Bank % Wahoo Steak House % Arrow Discount Drugs % National Insurance Co ,587, % 49,833 49,833 49,833 49,833 49,833 49,833 49,833 49,833 49,833 49,833 49,833 49, ,998 Lawyers Pension Fund 400 3,587, % 14,947 14,947 14,947 14,947 14,947 14,947 14,947 14,947 14,947 14,947 14,947 14, ,363 John Smith Real Estate Inc ,587, % 3,109 3,109 3,109 3,109 3,109 3, ,654 Norwood & Norwood 403 3,587, % 6,846 6,846 6,846 6,846 6,846 6,846 6,846 6,846 6,846 6,846 6,846 6,846 82,148 Continental Computers 600 3,587, % 74,735 74,735 74,735 74,735 74,735 74,735 74,735 74,735 74,735 74,735 74,735 74, ,817 New Tenant 800 3,587, % ,620 5,620 5,620 5,620 5,620 5,620 5,620 5,620 44,960 New Tenant 801 3,587, % ,955 9,955 9,955 29,864 Fast Print Mailing Service 802 3,587, % 5,620 5,620 5,620 5,620 5,620 5,620 5,620 5,620 5,620 5,620 5,620 5,620 67,441 Just Temporary Help 803 3,587, % 3,737 3,737 3,737 3,737 3,737 3,737 3,737 3,737 3,737 3,737 3,737 3,737 44,841 Pack Management Co., Inc ,587, % 8,729 8,729 8,729 8,729 8,729 8,729 8,729 8,729 8,729 8,729 8,729 8, ,748 BOMI International 902 3,587, % 7,473 7,473 7,473 7,473 7,473 7,473 7,473 7,473 7,473 7,473 7,473 7,473 89,682 Large Systems Specialists, Inc ,587, % 5,620 5,620 5,620 5,620 5,620 5,620 5,620 5,620 5,620 5,620 5,620 5,620 67,441 New Tenant 904 3,587, % ,109 3,109 3,109 3,109 3,109 3,109 18,654 BOMA Central City Chapter ,587, % 8,729 8,729 8,729 8,729 8,729 8,729 8,729 8,729 8,729 8,729 8,729 8, ,748 Byrne & Byrne ,587, % 16,202 16,202 16,202 16,202 16,202 16,202 16,202 16,202 16,202 16,202 16,202 16, ,430 Consolidated Telecom ,587, % 74,735 74,735 74,735 74,735 74,735 74,735 74,735 74,735 74,735 74,735 74,735 74, ,817 TOTALS % 280, , , , , , , , , , , ,890 3,438,606 Figure Additional Rent Budget for Operating Expenses

15 Income Budgeting Property: Frontier Building Total Bldg Sq. Ft.: 510,000 Budget Year: Budgeted Inflation Factor: % CPI Budget Prior Base Percent Base Years Tenant Suite Rent Multiplier Index Index JAN FEB MAR APR MAY JUNE JULY AUG SEPT OCT NOV DEC TOTAL Workers National Bank , % ,150 1,150 1,150 1,150 1,150 1,559 1,559 1,559 1,559 1,559 1,559 1,559 15,845 Wahoo Steak House , % ,458 Arrow Discount Drugs , % ,248 1,248 1,248 1,248 1,248 1,248 11,584 Total Retail CPI 2,504 2,505 2,505 2,946 2,946 3,355 3,779 3,779 3,779 3,779 3,779 3,779 36,886 National Insurance Co , % ,666 Lawyers Pension Fund , % ,250 John Smith Real Estate Inc , % ,228 Norwood & Norwood , Continental Computers 600 1,600, % ,453 2,453 2,453 2,453 3,327 3,327 3,327 3,327 3,327 3,327 3,327 3,327 36,428 New Tenant New Tenant Fast Print Mailing Service , % ,760 Just Temporary Help , % ,496 Pack Management Co., Inc , % ,880 BOMI International , % ,348 Large Systems Specialists, Inc , % ,874 New Tenant BOMA Central City Chapter , % ,843 Byrne & Byrne , % ,430 1,430 1,430 1,430 1,430 1,430 1,430 1,430 11,440 Consolidated Telecom ,160, Total Office CPI 7,106,000 3,620 3,745 3,837 4,302 7,513 8,051 8,191 8,191 8,191 8,191 8,191 8,191 80,214 Figure CPI Budget Worksheet

16 12-20 Budgeting and Accounting Step 5: Budget Other Income Additional items requiring a monthly tenant-by-tenant schedule may include: parking storage antenna/satellite dish rental other These amounts can be obtained from the lease abstract or through comparisons with the prior year. Our case study includes parking income from 233 spaces at $270 per month, storage income of $2,500 per month, antenna income of $720 per month, and other miscellaneous income amounts totaling $9,000 for the year. Step 6: 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. Remember to... focus your attention on developing realistic leasing and renewal assumptions. Case Study A budget can serve as an operating plan. Variances from the plan assumptions are explained each month in the variance analysis. As previously noted, 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 very 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. Upon completion of each individual worksheet, the monthly total for each worksheet should be combined to reflect detailed income by category for each month of the year. Review monthly and annual totals for reasonableness based on your knowledge of past performance. Review square foot amounts and compare them to the current market and the owner s objectives. Finally, make sure that you feel comfortable that these projections are achievable. Review the Income Budget Summary in Figure

17 Capital Budgeting BUILDING NAME: Frontier Building SQUARE FEET: 510,000 YEAR: 2002 ACCOUNT#/NAME: Building - Common Area Finishes BUDGET JANUARY $29,000 FEBRUARY 0 MARCH 0 APRIL 0 MAY 0 JUNE 9,000 JULY 0 AUGUST 0 SEPTEMBER 0 OCTOBER 0 NOVEMBER 0 DECEMBER 0 TOTAL $38,000 COST PER SQ. FT. $ COMMENTS: Replacing lobby flooring on floors 11,12,17 & 23 in January including cove base Replacing ceiling tiles in June on floors 11 & 12 Figure 14-2 The Building Common Area Finishes Budget Worksheet Tax Benefits and Depreciation Other factors you will want to consider in capital budgeting are the tax benefits of depreciation. By the same token, investments that generate income may require you to pay capital gains or other taxes. Depreciation is a benefit because it is subtracted from net profits before arriving at taxable income. Let s take a look at an example. Suppose you are considering purchasing a new piece of equipment, but you would like to compare it to the old one to determine whether or not it is advantageous from a tax standpoint. Key Concept Remember to... factor in the tax benefits of depreciation Annual Operating Net Profits Before Revenue Costs Depreciation & Taxes Old Machine $140,000 $70,000 $70,000 New Machine $160,000 $60,000 $100,000

18 14-12 Budgeting and Accounting Suppose that the annual depreciation is $20,000 on the old machine and $40,000 on the new machine. Assume the tax rate is 28 percent. See Figure 14-3 for the solution. Annaul Revenue Less Operating Expenses Net Profit (Before Depreciation and Taxes) Tax Calculation Net Profit Less Depreciation Taxable Income Old Machine $140, (70,000.00) $70, $70, (20,000.00) $50, New Machine $160, (60,000.00) $100, $100, (40,000.00) $60, Times Tax Rate X 28.00% X 28.00% Tax Payable $14, $16, Net Profit Less Income Taxes (See Calculation Above) $70, (14,000.00) $100, (16,800.00) Cash Flow After Taxes $56, $83, Figure 14-3 Tax Benefits and Depreciation Purchasing the new machine will increase cash flow after taxes by $27,200. To ascertain the full tax benefit, the property or facility manager should review the project with the organization s chief financial officer. Tax Considerations of Timing Consideration should be given to planning capital improvements late in the current tax year rather than early in the following tax year to accelerate the timing of the tax deduction into the current year. After you have gone through the details of compiling your capital budget, it is time to step back and look at the big picture. Have you forgotten anything? Summary Preparing for and planning a capital budget is an important part of the budget process. Capital projects are those involving the purchase of property, plant, or equipment. Planning for these projects requires that property and facility managers either

19 Chapter Review Test: Chapter 3 Select the one choice that best answers the question. 1. Your existing tenant's lease expired last month. Their monthly rent is $9,234 and they have a holdover clause at 125 percent. What is their monthly holdover rent? a. $2, b. $9, c. $11, d. $13, Stepped increases may be used in which situation? a. when rental rates are expected to remain constant over the coming years b. for start-up companies with low initial cash flows that are expected to increase c. to improve up-front cash flows of the building d. when rental rates are expected to decrease in the coming years 3. Rent abatements are also known as: a. rent credits. b. rent reductions. c. rent blockage. d. free rent. 4. Tenant charges and collections are summarized in the: a. cash receipts journal. b. tenant database. c. income statement. d. general ledger. 5. To facilitate their monthly rent payment, tenants may receive a(n): a. invoice. b. statement. c. billing. d. bank check request.

20 Chapter Review Test: Chapter 4 Select the one choice that best answers the question. 1. A janitorial contract is for $3,000 per month, with employees cleaning from six until midnight five days a week. What is the janitorial contractor's productivity rate? a. $12 b. $25 c. $120 d. $ To avoid duplicate payments to a vendor, all payments should be made from the: a. original invoice. b. vendor invoice copy. c. chart of account code. d. vendor statement of account. 3. Which information may be omitted from the invoice coding process? a. amount to be paid b. vendor remittance address c. description of goods and services d. chart of accounts code 4. An engineer is paid $36.50 per hour, plus overtime at one and one-half times his normal pay rate. During the past two-week pay period, he worked seven hours of overtime and took no vacation or sick pay. What are his gross wages for the pay period? a. $ b. $1, c. $2, d. $3,303.25

21 Chapter 13 (continued) 6. Your 2000 janitorial contract is billed at $ per cleanable square foot. For the 2001 budget you expect cleanable square feet to be stable at 347,200. The janitorial contract has a fixed increase of 5 percent in September. What do you budget for janitorial services in the month of April? a. $25, b. $27, c. $311, d. $327,229.06

22 Chapter Review Test: Chapter 14 Select the one choice that best answers the question. 1. Which is the best definition of the time value of money? a. a rate of return is expected from capital invested over a period of time b. the value of money will diminish over time c. money must be spent in a timely fashion to obtain full value d. only time will increase the value of an investment 2. What is the value of a property with an annual net operating income of $100,000 if an 8 percent rate of return is expected? a. $1,250,000 b. $1,500,000 c. $1,750,000 d. $2,000, If the net operating income is $653,477 and the market capitalization rate is 9.5 percent, what is the value of the property? a. $653,477 b. $705,755 c. $6,534,770 d. $6,878, The concept of the payback period for an investment factors in only: a. the net present value. b. the internal rate of return. c. capitalization. d. the initial cost. 5. What is the after-tax cash flow from a machine that generates $125,000 in net profits and has a depreciation of $40,000 when the tax rate is.35? a. $69,750 b. $79,250 c. $89,500 d. $95,250

23 Chapter Review Test Answers Chapter 1 1. c 2. b 3. a 4. a 5. d Chapter 2 1. b 2. d 3. c 4. a 5. a Chapter 3 1. c 2. b 3. d 4. a 5. b Chapter 4 1. b 2. a 3. b 4. d Chapter 5 1. d 2. d 3. d 4. c 5. d 6. a Chapter 6 1. a 2. c 3. b 4. c 5. a 6. a 7. b Chapter 7 1. d 2. d 3. b 4. c 5. d Chapter 8 1. c 2. d 3. a 4. a 5. a Chapter 9 1. b 2. a 3. a 4. d 5. a Chapter a 2. d 3. d 4. c 5. b 6. a Chapter b 2. a 3. b 4. b 5. c 6. b 7. d 8. a

24 Chapter b 2. b 3. d 4. b 5. a Chapter c 2. c 3. d 4. b 5. a 6. a Chapter a 2. a 3. d 4. d 5. d