Most real estate developers and investors don’t care much about Generally Accepted Accounting Principles aka GAAP. It’s not that people in the industry don’t respect accounting standards and the creation of accurate and timely financial reports, it’s just that cash is king.
GAAP requires the preparation of a balance sheet, income statement, and statement of cash flows on a regular basis. All real estate developers want to review and use as a decision-making tool is a cash flow forecast. In my many years of accounting and audits I’ve taken pride in preparing accurate financial reports, even with use of some key estimates as discussed in the last blog. But cash is all that matters.
Every project is evaluated from the beginning with a model, almost always in Excel, based on how much cash will be spent to acquire, plan, build, and sell a project. On the back end the model will forecast sales. The timing and the price of sales will be the great unknown, based on best estimates after understanding the market, the local economy, and demand for housing.
Real estate development is different than other businesses in that we’re not going to make the same thing(s) or provide the same service(s) over and over again. Every project has an end point, when the last house or lot is sold. If you’re making Coca-Cola, you’re going to keep doing that for as long you can, occasionally rolling out new products based on what you’ve been doing in an effort to grow revenue, while always analyzing the costs to make sure you’re efficient. Likewise, if you’re an attorney, you may practice in different fields and cases come to end, but you can anticipate what your future work will be.
Real estate developers will build houses repeatedly, but every time it will be different, and every time there will be a finite end. That’s why real estate developers are always looking for the next project. There is a certain expertise that can be developed about the process, but building 500 homes in Fresno is different than building an apartment in Miami and is different than building a golf course community in St. Louis.
The basics of looking for available land in a desirable location, understanding local law which governs how the land may be used, estimating the costs of design and construction, and then figuring out how to communicate to a target audience will be similar. But the details for each project will be very different. Every locale will have different laws, different labor markets, different attitudes towards development, different local engineers and contractors, and different costs for materials.
To be successful in real estate development you must be able to take all those factors into account. You’ll need to build a financial model that quantifies all the many estimates and assumptions about dollars and timing, then convince someone to fund your project based on bringing in more than you’ll spend, and ultimately manage the many elements in a way that successfully achieves your paper plans. Who can worry about GAAP financials with all this at stake?