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One of the most important management duties when owning a CRE asset is to prepare annual operating budgets for the property and portfolio. With the depressed volume of transactions in the industry since the Fed began raising interest rates, many CRE owners are focused on their existing properties, with strategies and procedures to increase the cash flow and net operating income (NOI). Most CRE owners and developers begin the budgeting process in September or October of the current year for the next year. There are typically three budgeting methodologies used by most CRE firms. These are baseline budgeting, zero-based budgeting, and NOI budgeting. The most common budgeting technique used in the CRE industry and corporate finance is baseline budgeting.

Baseline budgeting is an accounting method that begins with last year’s actual operating statement amounts and makes adjustments to revenue and expenses to arrive at next year’s budgeted amounts. This is the most common and easiest-to-use budgeting technique in the CRE industry but is flawed as it assumes that future operations are entirely based on last year’s numbers and increase at an inflation rate for the new year. Many CRE firms that own apartment properties just apply an inflation factor to increase revenues and expenses, subject to specific fixed or contractual lease income and expense adjustments, to determine next year’s budget amounts. For commercial properties, the tenant leases must be extended and projected with CRE software like Argus and expenses are increased by an inflation factor. Although baseline budgeting is the easiest and the most preferred methodology, it can also be the most inaccurate. It often leads to unrealistic budget numbers and large variances with actual operations.

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