This Budget Is Broken
Today’s show is inspired by a conversation that I had with an investor about a project that they were undertaking.
The situation should never have happened and that is the purpose of today’s episode. The construction budget was based on a quote from a contractor, but unfortunately it was riddled with problems and the investor didn’t see it. As soon as I looked at the numbers, it was obvious that the budget would never work in the real world. I was able to see it instantly and the investor didn’t. I don’t have any special super powers. A few simple calculations immediately showed the problems. The goal of these calculations is to quickly answer a simple question: “Do these numbers make sense?”
The first thing I look at is the allowance for interest reserves in the project. I start with the loan amount and calculate the interest for the construction period, and then make a guess at how long it might take to lease the property followed by how long it might take to complete the refinance into permanent financing. I then compare the interest that would be due over that entire time period and compare to what is in the budget. In this particular instance, it looked to me like the budget took the time for construction into account, but not the period for leasing or refinance. I would even add a buffer to that of 50%. So the interest reserve in the budget needed to triple compared with the amount in the budget.
Next I look at the allowance for appliances. You can easily drive down to your nearest Best Buy and price our an appliance package for a single apartment. Choose items on sale and you will get s pretty good estimate. We are usually talking about 6-7 appliances. A good estimate is somewhere between $3500-$4000 for a class A apartment. In this particular instance, the budget was a little over $2000 per apartment. It was easy to see that the estimate was not close to where it should be.
Hardwood flooring costs about $3 per square foot to purchase the material and about $2.50 to install in large quantities. You are looking at about $$5.50 per square foot for hardwood. Ceramic tile starts at $1.00 per square foot and cost about $3.50 per square foot for installation. The cheapest tile will cost $4.50 per square foot installed. I usually budget $2.00 for square foot for the material which brings me total cost to $5.50 per square foot. It means that the price for ceramic versus hardwood is virtually the same and in this instance I didn’t have the breakdown of the different flooring types. Vinyl plank flooring is less expensive and can be done for about $2.50 installed on the best day ever.
My friend had received a budget allowance of slightly above &1.00 per square foot installed. If doesn’t require a huge skill to see that there is no flooring on the planet that would fit within that budget number. The estimate was off by anywhere from 250%-550%.
These are simple rules of thumb. But they can quickly show when a budget has problems.
Being in this business requires a high degree of diligence every step along the way.