Key Components of Real Estate Development Accounting

 

Real estate developers need to track their numbers closely to understand the profitability of their projects, attract investors, obtain financing, and comply with income tax reporting requirements. They also need to ensure that real estate accounting is handled in a way that improves their ability to successfully run their business.

 

Real estate accounting has a lot of moving parts. If developers want to run their business as efficiently as possible, they need to pay close attention to the following six factors, and understanding how to use accounting software is a key part of this process.

 

1. Focus on the Right Reports

The reports that real estate investors should focus on vary depending on their goals and the progress of their projects. Investors who plan to develop and resell properties typically focus on the balance sheet, which outlines the profitability of the development project based on the developer's assets and liabilities.

In contrast, those who use real estate to generate rental income should pay closer attention to the profit and loss (P&L) report, which helps you see your expenses versus your income over any time period.

Further, if you are developing a property for rental use, you should pay more attention to the balance sheet during the development phase and pay more attention to the P&L statement when you are renting out the units. Good accounting software will generate both of these reports, as well as many others, but your real estate activities dictate which reports you should study most closely.

 

2. Set up the best accounts

When you set up your real estate accounting software, make sure you choose accounts that provide the most insight into your development operations. For example, a land or building developer may need to set up accounts such as accounts payable, cash, construction in progress (CIP), work in progress (WIP), deposits receivable, equity, long-term debt, short-term debt, retention, etc.

Landlords, of course, don’t need to track WIP or CIP, but they may need to add other accounts in order to track specific expenses associated with their rental business.

 

3. Track Cost of Goods Sold

When you develop real estate, you’ll need to track cost of goods sold (COGS), which is the sum of several different expense accounts in your real estate accounting records. COGS refers to all of the direct expenses involved in developing your property, including paying an electrician, hiring an architect, obtaining permits, and purchasing building materials. Indirect expenses are not included, such as paying administrative professionals to run the offices for your real estate development company.

You may want to break down COGS per square foot or use this number to create profitability ratios. This enables you to compare the profitability of different development projects, and the better you understand your costs, the more effectively you can generate forecasts and estimates for future projects.

 

4. Understand Hard vs. Soft Costs

A real estate developer's COGS includes both hard and soft costs, and you need to track these expenses separately so you can understand how different factors affect the overall budget of the project. Hard costs are related to the physical construction of the project and include labor, materials, hazardous materials abatement, and equipment such as garbage systems or elevators.

In contrast, soft costs are related to the development of the property but not the physical construction. They include consultants and architects, permits, inspection fees, and financing costs. Every project is different, but in general, hard costs make up 70% to 80% of the project budget, while soft costs make up 20% to 30%.

 

5. Create Financial Forecasts

Real estate accounting begins before a project breaks ground. You need to be able to make accurate financial forecasts for future property acquisitions based on market data, construction costs, and your proposed timeline. You also need to make assumptions about the sources and uses of funds from the initial cash needs to the end of the project.

As the project progresses, you need to simultaneously track actual costs while continuing to make estimates and forecasts for the future. In particular, you’ll want to keep a close eye on your burn rate and create rolling cash flow forecasts so you can identify potential shortfalls early and develop plans to avoid them.