The importance of accurate financial reporting in real estate
Real estate investing, for all practical purposes, is just like a business. Indeed, the owning of any real estate, whether for personal use or investment or for commercial use is very similar to operating a business. Just like a business, it is vital to successfully own and manage a piece of real estate to have accurate financial reports. Whether the real estate is a building that has rental income or undeveloped real estate, the financial reports are mainly the same as those for business. However, for real estate that does not have a regular income stream, say from rental income, then the financial reports will likely be things like a balance sheet or a cash flow analysis.
General Financial Reports
Real estate can use the same reports as a business- Income Statement, P&L, Cash Flow, and Balance Sheet. However, unlike a business, not all reports are used or need to be used. If the real estate is undeveloped land, there is likely not going to be an income statement. Even a P&L statement might not be of use to a real estate investor, as they may only have expenses related to things such as property taxes. This is an example of one concern with real estate reporting. The expenses related to real estate are not always deductible like a business expense. Ordinarily, the expenses related to real estate are accrued. Thus, the expense of owning the property may not be realized until the property is sold, or it may not be deductible at all. The expenses in these situations usually increase the basis of the property but it may have to meet certain criteria to be claimed. In fact, it is because of these technicalities that real estate accounting can be a very complex operation.
While expenses may not be used in the year they occur in real estate, it is usually necessary to track the numbers for future use. A balance sheet might be useful to help real estate owners track expenses against the property over the long term. Aside from when it would be required by tax needs to track expenses, it is smart to keep a running tab on all expenses for when the real estate is finally sold. Thus, at a minimum, a real estate owner should have a yearly accounting of their real estate. Through these reports, the owner can see and analyze how values have changed over time.
Importance and Benefit of Accurate Reporting
As mentioned, it is important to have at least a yearly report on the value changes of real estate for an owner, even if the property is undeveloped. Then the issue facing an owner becomes one of ensuring that the reporting is accurate. However, accurate reporting in real estate is not as simple as it might seem. If you bought some real estate for $50,000 10 years ago and now the value of the property might range from $75,000 to $100,000. But, unless the property is sold, the actual value of the property is not known, this is because it is based on the current market conditions. Fortunately, the expenses of owning the real estate are ordinarily a known figure. Property taxes paid on the real estate and added expenses for improving the property are easy to figure out. However, since the actual worth of the property may be more of a range, then total return on the property cited above could vary significantly depending on the range of the value. It is easy to see how accurate reporting of real estate can influence decisions regarding ownership.
The previous example of how a piece of property could have a range of values and how expenses impact the final profit or loss on the property shows why it is important to have accurate reports. The reporting demonstrates a major challenge people may face regarding real estate reporting. Real estate is a classic example of a non-liquid asset. The value of a piece of property is always based on current market conditions. Whether the property is a house or an office building, the actual value of the property is based on what the market is willing to pay. Thus, it is possible that a $100 million piece of property might sell for $1 if the market conditions warrant such a price. Even very liquid assets such as stocks are subject to this rule. If a stock is bought on a Monday, by the time it is sold on a Tuesday, the market conditions could be vastly different. This change would result in a price that could change dramatically overnight. For real estate, the change in value is not usually overnight, but it could change dramatically in a short period of time. This is a good example of the challenges facing accurate reporting in real estate. Value numbers are not written in stone and given market conditions they could change radically in quick order.
Additionally, even using the best technology available for financial reporting is still subject to these limitations and challenges. However, one advantage that most of the technology has today is that it can analyze several dynamics in accounting and offer multiple reports on the value of property based on different dynamics. This can be of great use as the owner can then see not only a range of values but also how those calculations are made based on market conditions. Tech cannot only be of value in making these determinations, but it can also be instrumental in helping in decision-making regarding the property.
Summing it all up
Real estate financial reporting is an important issue for all real estate owners. Property ownership, in and of itself, is not the same as business accounting. Accounting for real estate requires more “unknowns” to be considered and taken into account. Values in real estate are subject to current market conditions, meaning they could vary wildly when compared to business accounting. To best counter these variables, a real estate owner should use the most accurate accounting possible regarding their property. Using technology that can analyze multiple factors regarding real estate can assist in getting the most accurate value of a property. In the end though, for a real estate investor or owner, the most important thing is to use accurate financial documents to improve the decision-making process. For more information on accurate reporting in real estate look at the links below. Also, Powell Finance Group manages all forms of accounting and investment services, we are always happy to discuss with you real estate accounting issues.
