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Budgeting out of disasters

Operational budgeting is a critical yet often tedious and overlooked aspect of asset management. With the end of financial year soon upon us, it is timely to discuss a number of elements that Landlords should be considering.

To begin with, if your property runs on a standard 1 July through 30 June financial year, you should already have prepared outgoings budgets for your properties and issued statements to the tenants prior to 30 May. If you have a retail tenant, this becomes even more critical.

These budgets will typically cover recoverable expenditure items including: local authority rates, fire levy, insurances, management, cleaning, landscaping, repairs and maintenance, common area air-conditioning, lifts and escalators, and audit fees.

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In preparation of the budget, consideration is given to charges already incurred and balance charges likely to be incurred - with forethought for reasonable guestimated increases in Statutory charges and insurance.

Often insurers will not give an indication of where they expect premiums to sit until they are written. Given the global economy and the desire by insurers to cross insure, the past year gives us an idea of what’s to come.  With hurricanes in New Orleans, floods and earthquakes, and cyclones in North Queensland, we can be assured of a moderate increase.

But what’s considered reasonable to tenants, when estimating insurance increases? Striking a balance is important. When determining the amount, remember that tenants won’t want to be hit with a substantial one-off adjustment payment at the end of the financial year, when the reconciliation is completed.  Conversely, too high a budget estimate makes the property seem more expensive for prospective tenants. Hence the reason why tenants to new complexes often find that their outgoings markedly increase after the developer has leased and on-sold the complex and the true charges become evident.

From experience, we often see poor lease documentation drafted by some sectors of the legal fraternity. The leases are too vague to the point of being useless about whether items can be recovered. The other fault is where they delete clauses and the headings making it less clear to all parties years later what was intentionally removed.

We find the best leases are the ones written in plain English and with clear sectional headings. The Queensland Law Council drafted a preferred format lease that reduces the incidence of confusion and legal wrangling.  Unfortunately, many choose to ignore this.

When negotiating a lease as a Landlord, you should seriously consider other options before permitting recovery items to be deleted from leases. It has many effects into the future. This was particularly evident at our recent successful auction of a Capalaba Shopping Centre. Prior to auction, the vendor needed certain tenants to agree amendments to clarify outgoings recovery. We also found some outgoings were assumed to be recovered when in fact they were never included in specific leases. The shortfalls were significant enough that some prospective purchasers expressed the opinion they would impact the purchase price.

Another area for consideration is financial reporting. It is a given that the budget should be based on charges applicable to the relevant financial year/period after allowances for prepayments and accruals. Remember, cash flow accounting is not permissible in this instance.

Finally, the legal ramifications of not auditing and reporting to tenants in a timely manner can be significant. Retail properties in particular are much more regulated than other commercial types and they have specific requirements. There must be an audit by an external qualified accountant and this must be reported in a prescribed format to the tenants within three months of the completion of the relevant financial period.

Daryl Gallagher-Collins
Manager, Asset Management Services

If you are experiencing problems with operational budgeting or would like assistance working through any of the above aspects, please contact Daryl Gallagher-Collins, who will be happy to assist.  As well as being Raine & Horne Commercial’s manager of Asset Management services, he is a qualified Property Valuer, Justice of the Peace and has over 18 years experience in the industry.

More information on Asset Management can also be found on the Asset Management page of the Raine & Horne Commercial website, at www.RnHcommercial.com.au.