Forecasting

Historical Data

Forecasting future expenses usually begins with information about past expenses. Information about past expenses is helpful for budget items that change by predictable amounts from year to year. While budget items controlled by the real estate manager are usually fairly predictable, it should not be assumed that a budget item will change predictably.

When putting together an operating budget, real estate managers prepare forecasts that sometimes rely on the previous year’s figures. When forecasting future expenses, the real estate manager should use past actual expenses rather than past budgeted expenses as the basis for the forecast.

Working backward through three years of expense statements gives a good basis for a forecast. If last winter was particularly severe, last year’s heating bills may be unusually high and should be compared to the previous two years. Averaging is a common technique for arriving at realistic numbers for a forecast.

In working with budgets, interpreting averages is important. Real estate managers often use averages to forecast budget figures. Averaging past years’ figures usually gives a reasonable estimate of future years’ performance. However, no one should follow figures blindly. Averages are sensitive to unusual numbers and can easily be distorted.

Zero-Based Budgeting

Instead of using past expenses when preparing a forecast, real estate managers can use a second forecasting technique, called zero-based budgeting, that avoids using past budget figures to determine current figures. Zero-based budgeting de-emphasizes the historical role of income and expenses in creating the current budget. Past numbers may be inaccurate or may not reflect the current economic situation, and that can cause them to distort the budgeting process.

Zero-based budgeting prevents expenses from being inserted automatically (and unthinkingly) into budgets year after year. Normally, when using zero-based budgeting, a real estate manager incorporates current information from sources such as contractors, vendors, utility companies, and IREM Income/Expense Analysis Reports instead of plugging in historical expenses.

Four factors indicate that zero-based budgeting may be the best course of action:

• If historical information is not available, such as for new buildings or new accounts, the budget necessarily begins at zero.
• When projections from past expenses are likely to be unreliable, for example, when expenses are highly variable from period to period, zero-based budgeting smoothes out the variation and consequent uncertainty.
• When records are inaccurate or nonexistent, zero-based budgeting is preferable. It avoids bringing mistakes into the budget cycle.
• As a check to make sure that expenses forecast by another method are not out of line, zero-based budgeting removes financial preconceptions from the budget cycle.

Forecasting: Tips for Budget Preparation

When preparing a budget, the following guidelines can assist in forecasting income and expenses:

• Collect information on utility use. Use averages of past years’ monthly utility expenses to estimate heating and cooling costs for each month.
• Use zero-based budgeting to determine payroll expenses. This technique allows you to analyze salaries during each budget cycle.
• Know real estate tax rates in your area—and keep up with changes in tax laws, tax rates, and the cycles for assessing local property taxes. Also know real estate reappraisal schedules as observed by taxing entities.
• Determine how the expenses have changed in the past to forecast future expenses. Analyze what factors may have produced the change.
• Examine all potential risk factors that may produce expenses. Risk factors include a wide array of events, from bad weather to nonpaying tenants to insurance settlements.
• Factor in inflation, even in low-inflation times. Over time, inflation has an enormous effect on costs and expenses.
• Get copies of the property’s insurance policies to forecast insurance expenses. Analyze the coverage limits to determine whether the limits are realistic, coverage is adequate, and premiums are reasonable.