Believe it or not, knowing how to handle real estate accounting is likely an important part of your job as a real estate professional. With that in mind, we've brought you a guide on this tricky subject. Read on below to learn what real estate accounting is, how it works, and some tips that you should follow in order to better manage your money.
What is real estate accounting?
As the name suggests, real estate accounting is simply an accounting practice with a focus on real estate entities. Put simply, when you work in certain aspects of the real estate industry, you're often charged with managing multiple transactions at once, and each transaction has the potential to be worth hundreds of thousands of dollars, if not more.
With that said, when you're a real estate professional, it's important that you know -- and have accurate records of -- where all that money is going. A huge part of accounting is bookkeeping, or keeping those records up to date. However, beyond that, you also need to be able to summarize, analyze, and report on your financial transactions to the appropriate regulatory agencies.
While bookkeeping and accounting may not be the main focus of your real estate business, if you're a real estate developer, investor, or property manager with real estate clients, you'll need to have a firm grasp on the basics of real estate accounting in order to be successful in your field.
How does real estate accounting differ from other types of business accounting?
On the surface, especially if you're looking at taking a buy-and-hold strategy as an investor, certain aspects of accounting for your business can look different than, say, for a shop owner whose main goal is to get their product out the door. In this case, your expenses are often much higher, and there are long-term carrying costs and vacancy rates to consider.
However, at its core, all business accounting is really very similar. At the end of the day, you really want to focus on doing the same three things: Evaluating your expenses and spending, maximizing your business revenue, and minimizing your business debts.
Here's a snapshot of what those three things could look like for a real estate business.
Evaluating expenses and spending
Whether you're in the business of building new construction properties, selling real estate, or handling the property management on investment pieces, your goal should be to keep your expenses as low as possible.
Every so often, it's important to take a day to go through all of your bills and expense records -- which are crucial to keep for tax planning purposes -- and to find out where you can cut down on spending.
For example, maybe you can switch to a different dumpster provider for your demo work or you can renegotiate your desk fees with your broker. The key here is to zero in on any excess money that you don't need to be spending and to find ways to save.
Maximizing your business revenue
The other side of the coin from minimizing your expenses is increasing your revenue. Many real estate professionals neglect to look for ways to do this because they mistakenly believe that since buying and selling real estate relies on accepting offers, they don't have much control over the amount of money that they bring in.
We're here to tell you that's not true. Whether it's looking for opportunities to institute a rent increase or simply setting a higher goal for the number of flips you successfully complete this year, there are steps you can take to increase your income.
Minimizing your business debts
Finally, along the same lines as evaluating your expenses, you'll also want to take the time to work toward minimizing your debts. In addition to making timely payments to pay down any debts you currently owe, this could also mean refinancing high-interest loans or consolidating other debts into a single, low-interest loan.
Best practices in real estate accounting
Now that you know what real estate accounting is, it's important to take a look at some best practices to keep in mind going forward.
Keep your business and personal accounts separate
If you don't have separate business and personal accounts already, you should work to separate them as soon as possible. Put simply, mixing your business and personal transactions can lead to a whole host of problems, including disorganized bookkeeping, inaccurate tax returns, and poorly-managed cash flow.
On the other hand, when you do have separate accounts, all the transactions for your business stay in one place. You'll easily be able to see where each transaction is in its process and you'll be able to see where your money is going.
Select an accounting method
There are two accounting methods that you can choose from for your business: cash basis or accrual.
Cash basis is a slightly simpler accounting method than accrual. Here, you use one entry for each of your income and expenses. Put simply, you record income when you receive it and expenses when you pay them.
Accrual accounting is slightly more difficult. In this case, you record two equal-but-opposite entries for each transaction. Using this method helps ensure that your books stay balanced.
Keep in mind that the IRS will know which accounting method you use by looking at your first business tax return. After that point, if you would like to change methods, you'll need to request a change with the IRS.
Set up a chart of accounts
A chart of accounts lists every real estate transaction you make. You can use it to create reports, measure your business growth, and keep a history of historical transactions.
Every time you make a transaction, you should enter it into your chart of accounts, along with information about what the charge was for. Update your chart of accounts often to ensure you maintain complete financial records.
Reconcile your bank account and financial documents every month
In addition to keeping your chart of accounts up to date, you should also be sure to check it against the transactions recorded in your bank account and to organize your financial documents at least once a month.
In terms of what documents you need to keep, you'll need a system for storing:
- Invoices and receipts.
- Bank and credit card statements.
- Tax returns.
- Insurance information.
- Contracts and leases.
Consider an accounting service or CPA firm
If you don't feel like dealing with the ins and outs of accounting on a regular basis, consider hiring a real estate accountant to do the job. While you'll still have to do your best to maintain good records, having someone else who can help manage your finances can take a lot of weight off your shoulders.
The bottom line
Real estate bookkeeping and accounting is often not the most exciting part of having a real estate business, but it is an essential one. Every real estate professional should at least have some grasp on accounting basics. With that in mind, use the tips above to help you get a handle on your accounting today.