In this Article…
- Understand the basics of real estate accounting and cash flow management for real estate developers.
- Learn six strategies for managing cash flow in real estate development.
- Finally, find ways to leverage technology to optimize cash flow management and real estate financials.
Disclaimer: The information provided in this article is for educational purposes only and should not be considered legal or financial advice. For any legal/tax concerns or questions regarding construction, please consult a qualified legal or accounting professional.
The skills of navigating cash flow and real estate accounting as a real estate developer have never been more essential than they are today.
According to J.P. Morgan, the U.S. housing market will experience growth in 2025, “but at a very subdued pace of 3% or less.” The company goes on to say that demand for homes “remains exceptionally low” and that, while housing inventory is improving, “it still remains below the historical averages.”
These insights mean that real estate developers must walk a fine line between building more to expand their businesses, but not overextending themselves and falling into financial trouble.
The best practices and insights to accounting for real estate developers explored in this article can assist your business in making informed decisions and navigating cash flow, even in this cautious market.
Understanding Cash Flow Management in New Home Development
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Let’s start with the basics of real estate accounting.
It is imperative for real estate developers to know the key financial metrics and property metrics in order to assess the viability of projects and make informed decisions.
The three key financial metrics to know for your real estate development business are:
1. Gross Operating Income (GOI)
Gross Operating Income, or GOI, represents the total income your company anticipates from a home resale—before deducting expenses.
For example, your company plans to build a housing development with five single-family homes. You will price each house at $350,000. When every home sells, that’s $1,750,000 in GOI.
2. Net Operating Income (NOI)
Next, once you’ve determined your company’s GOI, Net Operating Income, or NOI, factors in operating expenses, such as construction materials, wages, permits, and utility installations.
The equation is basic:
- NOI = GOI − Operating Expenses
For the housing development that your company is planning, estimate that the costs will be $750,000 for construction and $225,000 for the purchase of 5 acres of land.
$1,750,000 - $975,000 = $775,000
The resulting NOI of $775,000 provides an indication of the profit potential for this project.
3. Cash-on-Cash Return
Cash-on-Cash Return calculates the real estate investment return on the actual cash your company has invested in land acquisition, construction, and related costs.
This equation is also basic:
- Cash-on-Cash Return = (Annual Cash Flow / Total Cash Invested) x 100
($775,000 / $975,000) x 100 = ~79%
The greater the Cash-on-Cash return, the greater your investment returns.
Considering the Factors That Can Influence Your Company’s Cash Flow
Timing is everything.
Keeping an eye on the regional and national trends in housing will help your company time home sales for optimal returns.
Read the “Leveraging Technology” section below to learn more about the tools that can provide valuable data into the housing market.
There are always conditions out of your control that will impact your business’ cash flow stability. Such factors include:
Economic Trends
The economy and housing market conditions have a direct impact on buyer demand and your homes’ sale prices, as cited in the J.P. Morgan report earlier.
Construction Material Costs
Unexpected increases in the price of lumber, steel, or other building materials due to demand, inflation, and supply chain issues can strain your project budget.
Regulatory Changes
Compliance standards and other mandates can have a significant effect on your project costs, especially when they have been updated. These include:
- Zoning laws
- Building codes
- Safety regulations
- Environmental regulations
- Labor laws
Buyer Demand and Financing
Also cited in the J.P. Morgan report is the effect of interest rates on lending practices and buyer credit availability. These factors can disrupt new home sales, and therefore, your company’s cash flow.
Six Proactive Strategies for Managing Cash Flow
Be adaptable.
When the housing market cools, offer flexible financing options to homebuyers and adapt your marketing strategies to improve sales.
Real estate development isn’t for the faint of heart. The industry is unpredictable and developers constantly encounter challenges that complicate their cash flow management.
However, addressing these challenges with strategic planning and proactive measures can help your business mitigate the risks. These measures include:
1. Establish a Detailed Budget and Timeline
Create a realistic budget, accounting for potential cost overruns that may occur during construction. Also establish a realistic timeline, aligning it with market conditions.
This provides your team with a strong plan that's also adaptable to external factors, ensuring that you get from ground-breaking to sale as quickly and efficiently as possible.
2. Build a Reserve Fund
Contingency funds can help when your project encounters sudden spikes in material costs, delayed permits, or other unforeseen expenses.
A healthy reserve can give your company breathing room during lean times and is crucial for effective real estate accounting.
3. Negotiate Favorable Contracts
In addition to having a reserve fund for sudden spikes in material costs, plan ahead to control cost variability. Do this by negotiating fixed-price contracts with subcontractors and securing bulk discounts from suppliers.
4. Monitor Market Trends Regularly
Use the data from housing market forecasts and buyer preferences to adjust your project scope and to pace developments to meet demand (or lack thereof). This is an essential part of real estate financial analysis and investment analysis.
5. Leverage Technology for Real-Time Insights
Leverage platforms that integrate real estate accounting solutions with payment management systems, such as Truss Payments. This enables real-time tracking of your company’s payables and cash flow for more-accurate financial forecasting and cash flow planning.
6. Diversify Your Sales Strategy
When the market is competitive, or experiencing a downturn, unique sales strategies and marketing techniques can boost your company’s cash flow. This includes:
- Traditional listing agents.
- Digital marketing.
- Social media marketing.
- Incentives for early closings.
Leveraging Technology to Optimize Cash Flow Management Processes
While the construction industry has been slower than other industries in embracing technology, the time has come for tech’s full impact on construction companies.
Get with the times and find even more tech to help your business construct homes, “From Blueprint to Build.”
From efficient expense management to robust data analytics, the technology exists to revolutionize the way your company manages its cash flow and real estate financials.
Below, we outline several approaches and tools that enable your business to leverage technology for the greatest impact on your real estate accounting and financial reporting.
Expense Tracking and Bill-Pay Tools
Platforms built for the construction industry enable automated expense tracking and real-time financial monitoring.
With Truss, keep an eye on your expenses easily and send payments quickly. Invite your team members, such as your bookkeeper or project manager to assist with company expenses. Then, review and approve draft payments and keep your bills paid on time.
And even better, with no transfer fees and no monthly costs, Truss provides your business with substantial savings. Take Truss fan Richard Miller, president of Richard Miller Custom Homes, who says before using Truss, “We used to pay thousands every year on payment processing.” However, thanks to Truss, the money that would normally go to processing fees can be added to a business’ reserve fund or used for growth.
Learn more about the positive impact Truss Payments has had on Richard Miller Custom Homes in their featured story here.
Automated Payment and Collection Systems
You know that processing payments from your homebuyers is an involved process. Make things easier with a digital payment portal for large real estate transactions, like Dwolla. Systems like these minimize delays, automate tasks, and reduce your company’s administrative overhead.
Data Analytics for Strategic Sales Decisions
Use data analytics and market forecasting tools, like Zonda, to assess market demand and trends. The valuable information your company can acquire from these tools will allow for optimal pricing, agility in strategies, and greater cash flow margins.
Key Takeaways
In the high-stakes market of real estate development, precise cash flow management and accounting can mean the difference between profitability and financial strain for your company.
This article has outlined several essential insights, including:
- The basics of accounting and cash flow management for real estate developers.
- Six strategies for managing cash flow in real estate development.
- The technology for real estate developers to optimize cash flow management and real estate accounting.
With these insights, your business can overcome industry challenges and build a strong foundation for sustainable success.
Book a demo with the Truss Payments team to harness all of the features of Truss for your company’s expense tracking, bill pay, and cash flow management, enhancing your overall real estate accounting practices.
