In my last article on cooperative benchmarking, I made the case that boards would be better informed in their budgeting decisions if they used more and different benchmarking techniques.
Certainly, most boards have used historical data to benchmark future costs. If boards know what the water bill was the past three years, they should be able to reasonably forecast water for the coming year.
Using historical cost assumes the cost is appropriate. It does not provide a competitive comparison but rather looks solely at the property’s history.
Boards can learn quite a lot from comparing similar properties and their operating costs to the cooperative’s own. Comparing water as I did in the last article is a fairly simple process. However, when boards start to think of the totality of all the expenses, the task can be daunting.
Some techniques that lenders and appraisers use to simplify the numbers are helpful. First, these professionals must sort the data and then provide a basis for comparison.
Often, they are provided with statements of revenues and expenses that have significant detail. I recently reviewed a financial statement that tracked the cost of painting under six different line items. The document had a line for cost of painting the exterior, the hallways, the units, the materials, etc. The property provided extensive detail.
To benchmark, lenders and appraisers need to find some commonality, and they do this by reducing all expenses to seven simple cost centers:
- Management Fee
- Capital Reserves/Capital Expenditures.
Reducing the numerous line items on the operating statement makes the financial information easier to digest and to compare with other properties.
If cooperatives have audited financial statements, you can assume that their CPA has gone through similar steps. Within the audited financial statements, there is a very brief financial statement with few expense categories that were created from the more detailed operating statement the board might review monthly.
It is important to group expenses similarly to the way the industry groups expenses to get the most value and accuracy from the benchmarking. As the categories are broad, it is usually easy to determine where to place each line of detail, but not always.
Health insurance is a good example. A board member could argue to place this expense in either the subgroup payroll or insurance. The industry would tell the board member to put the cost in payroll as the lender or appraiser is trying to understand the total cost of labor, and benefits are a part of that cost. Insurance would be for building, liability and similar insurance.
After reducing the numerous line items into our seven simple cost centers, the lender or appraiser must then find a method to compare the properties to others.
In my last article, I discussed the difficulty of finding good properties with which to compare your cooperative. It is important to find properties of a similar construction design. Limiting yourself to buildings of the same age would make the task very difficult. In many respects, older buildings and newer buildings have similar operating costs. The difference in age is usually seen in capital expenses. Here, the focus is on benchmarking the operating expense.
The method that lenders and appraisers use is to project expenses and then divide the cost by the number of units at the property. By doing so those professionals can measure the operating cost to another property.
If the board were to examine the financial statements and combine the cost of payroll for staff and maintenance people and then divide the sum by the unit count, that would reduce the cost of payroll per unit. If this number works out to $1,500 per unit per year, the board could now gather information on other buildings, obtain their payroll and benefit cost, divide by their number of units and hence have a competitive number by which to view the operating cost.
Boards may wonder how to obtain information like payroll and other data but may be surprised to know they already have the data in hand.
Third-party management companies can also provide the data. They may be unable to give you the actual financials but should be able to speak in terms of per unit per year cost. Regional associations may gather financial statements from their members and publish the data without identifying the actual buildings while still providing enough descriptive information to make comparisons doable.
Benchmarking your cooperative may provide you with better insight into the operations of your property. First, reduce your detailed financial down to seven cost centers. Then divide to learn your per unit per year results. If the property has been recently appraised, the appraisal will contain a section called the “Income Approach” where “comps,” competitive properties to yours, as well as their operating numbers are located, which will help you to find competitive properties for comparison.
This article was featured in CHQ fall 2020 issue. Click here to read the PDF newsletter.
David Wilkins is the managing director of the Walker and Dunlop Detroit offices. He has over 30 years in commercial finance and education.