The Super Bowl crowd was on their feet. It was the moment everyone had been waiting for. You could feel the excitement in the air.
Peyton Manning of the Denver Broncos was leading his team down the field. He dropped back to pass, heaved the ball into the air, and a diving receiver caught the ball in the back of the end zone with one hand!
It was an incredible play. The crowd went wild!
But then — nothing.
Everyone looked to the scoreboard, but it was blank. There were no points added. Were the Broncos winning? Or were the Carolina Panthers? Did anyone really know?
Everyone watching on TV waited to see the statistics for the game. It seemed like the Broncos were playing better, but who had more yards? Who hard more turnovers? Who had more first downs? Who would eventually be crowned the Super Bowl Champion? Who was the MVP?
No one was tracking the key statistics of the game. The Broncos could brag about all of the great plays they made, but could they really PROVE that they won the game?
OK. I know this sounds ridiculous. But it reminds me of a lot of real estate investors I know.
Too many investors play the game of real estate with sloppy or bad bookkeeping. Bookkeeping is the system you use to organize and analyze all of your financial transactions. It’s how you track your key financial statistics. It’s how you know if you’re winning or not.
You can do an excellent job of finding deals, acquiring money, and generating cash flow. But if you forget or delay the detailed work of excellent bookkeeping, what’s the point? It’s like scoring a touchdown with no scoreboard.
This article is written to to help you improve or start keeping excellent books and records for your real estate business. The good news is that it’s not that complicated. Like cleaning your kitchen after a meal, it just requires a little hard work and a simple system of organization.
Let’s get started.
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Why You Need Excellent Books in Real Estate Investing
Bookkeeping is not the game of real estate itself. It’s the scoreboard, the game film, and the organization of information related to the game of real estate.
But an organized, timely, and easy to use system of bookkeeping serves many practical purposes within your business. For example, it helps you to:
- Keep track of key performance measurements like cash flow, profit/loss, and net worth
- Compare your growth (or lack of growth) from year to year
- Manage your cash so that you don’t run out
- Know whether certain business strategies actually worked well or not
- Analyze which rental properties perform better than others (so you can sell some and keep others)
- Prepare for yearly tax returns without extra stress
- Save money on tax preparation because your CPA or other professional doesn’t bill you for time spent getting your information organized correctly
- Avoid extra time and stress digging up information in case of an IRS audit
- Avoid potential IRS tax penalties or backed taxes because you can’t defend deductions you claimed
- Pay all of your bills and financial obligations on time as agreed
- Raise capital with lenders and partners using real data from past performance
I could go on and on with more practical uses of bookkeeping. In essence, good books allow you to meet your obligations to outside parties, and they allow you to make better decisions inside your business. The best business people I know see their business in numbers, and bookkeeping allows them to do that.
But if it’s so important, why don’t we do it better?
When my business partner and I first began investing, we found that bookkeeping was not as urgent or as exciting as other issues in our business. Putting together deals, finding money partners, managing a rehab, and selling or renting our properties were obviously very important. We always intended to do our bookkeeping right, but life and the weekly schedule got in the way.
It wasn’t until a year or two after starting that we really got serious about having an excellent system of bookkeeping. By then, the things we had done incorrectly or had ignored for too long became monster-like problems that required painful, late-night bookkeeping marathons to correct.
So, the best practice is to learn and begin bookkeeping early before you get too big. Your future self will thank you!
The Basics of an Excellent Bookkeeping System
We basically divide our own bookkeeping system into two separate buckets:
- The books: A paper or digital record of all financial transactions.
- The supporting documents: The paperwork that proves or supports all of the financial transactions.
Today, most investors use some sort of software like Excel or Quickbooks to handle the books. Our businesses currently use a combination of Quickbooks and a property management software called Buildium. I’ll share how we use them in a later section.
Most investors also keep their supporting documents in a physical file cabinet and/or a digital filing system. We have used a physical filing system for a long time, but we’re moving more and more towards paperless, cloud-based records using an online filing system called Evernote.
These two systems — books and supporting documents — are mirror images and work together with one another.
If you just have books without the paperwork, an IRS auditor may never believe the expenses you claimed to have. But if you just have paperwork without the records, you’ll never have a clear, easy to understand summary of what’s happening financially.
When you first start investing, it’s easy to get overwhelmed with all of the fancy bookkeeping options.
In reality, simple or fancy options basically do the same thing. Early on, you should keep your bookkeeping system as simple as possible so that you can spend most of your time learning about the other important tasks like finding deals and finding money.
If I were to start over again and had zero or just a couple of properties, I’d quickly set up a system with two parts, like this:
Part 1: Books
- Excel/Google Docs spreadsheet
- Business bank account with online banking
- Debit card
All money coming into or out of the business would use this bank account. Because everything is in one place, I could easily track every transaction by periodically downloading my bank transactions into the spreadsheet and organizing them. My spreadsheet might look something like this:
In an “Account” column I’d categorize each transaction with labels like repairs, insurance, legal and professional fees, management fees, advertising, etc. To make your tax preparation easy, you can model your categories after the IRS Schedule E categories. Just create a separate tab on your spreadsheet with the list of all of these expense categories for reference.
I’d include a “Memo” column in order to describe in more detail what the transaction is. This is handy when you have to look back over transactions months or years later.
I’d also include a “Property” column so that I could separate transactions by property when needed.
This spreadsheet transaction list is very simple. You might argue it doesn’t do everything you need from a bookkeeping system. You’re right. At some point, you’ll probably want to switch to something a little more advanced (or at least add more spreadsheets).
But when you first start, the most important habit is to track and categorize everything. If you effectively do this simple spreadsheet or something like it, you will have a firm foundation to build upon when you choose to get more advanced.
Part 2: Supporting Documents
- Box of simple manilla folders (or free Google Drive account)
- Small, portable file box or other filing cabinet (if using paper)
- One folder per year for all proof of expenses (invoices, receipts, etc.)
- One folder per year for all bank statements (and another for credit cards)
- One folder per year for tax return documents
- One folder per property for insurance docs, contracts, HUD-1 statements, leases, and any other non-financial property documents
The key habit here is to keep your supporting document system handy. It should take three seconds to open your file box and put a receipt in the proper folder (or scan and upload it). It should also take three seconds to find the folder if you need to pull a receipt out. I like having a portable system because you can file or access the paperwork anytime.
Most bookkeeping systems break down because you have to go home and wait for quiet time to “do bookkeeping.” Instead, carry it with you (or on your smartphone) and do it all the time.
If you are beginning with a paperless system, you can use your smartphone to take pictures with scanning apps like Evernote, Google Drive, or other stand-alone apps. If you’re doing more volume of paper, I suggest getting a good scanner that can quickly process your documents. We went all out and got this expensive, super-charged scanner, but you can also do just fine with a less expensive portable scanner, like this.
And as you can see, it doesn’t take a lot of effort to create a support document system that is useful and scalable.
Take Your Bookkeeping to the Next Level
Don’t discount the value of a simple bookkeeping system like I just described. Some real estate investors go years using a spreadsheet and a small file cabinet to accurately track their entire real estate business.
But there are many benefits to getting a little more advanced with your system. Especially as your business gets more complicated with multiple properties, separate companies, and hundreds of transactions, bookkeeping software can make your life easier, either as a stand-alone version on your desktop or a portable, cloud based version.
Software can automate many of the functions you have to do manually, like downloading transactions from your bank. It can also take the raw data you give it and quickly produce very helpful reports on a variety of metrics within your business. Software can also integrate with other necessary business functions, like doing payroll, sending invoices, and issuing required 1099 forms to contractors each year.
Real estate investing also has a variety of more complicated bookkeeping entries that are just easier using software. For example, correctly entering a HUD-1 so that your balance sheet and basis in a real estate property is correct would be tedious for me in a spreadsheet. But with good software, the entry can be done fairly easily.
Software can help you with both of the major divisions of a rental property business:
- Managing properties
- Owning properties
If you hire third party property management, your management company will do all of the bookkeeping for property management. The management company will invoice tenants, collect unpaid rent, hold security deposits, and pay most of the contractors who do repairs to the property.
Then when you get your monthly owner’s check and a report, you take the data from the report and enter it into the books for your rental holding company. You can begin by making these entries yourself, but when you get enough volume, a bookkeeper is a great resource to do the tedious data entry.
If you self-manage, you’ll need to keep track of books for both property management and property ownership. Software can be a HUGE help in keeping both systems straight.
For years my business partner and I used Quickbooks to keep both the property management books and also the rental owner books. Because these functions were done in separate companies, we just had a separate set of books for each one.
Recently we switched the property management side of our bookkeeping to a cloud-based management software called Buildium. We made this move because it also helped us to handle many other functions outside of bookkeeping, like leasing, tenant qualification, work order tracking for maintenance, and more. We also have enough properties to justify the extra cost.
We still love Quickbooks for bookkeeping within our rental holding companies. We find it more versatile, and it can handle more complex entries, like installment sales, 1031 exchanges, and more.
Software solutions are constantly changing, and which one you choose will depend upon your personal business criteria. When you reach this stage, do your homework, ask around here on BiggerPockets.com, and choose one that works for you.
Confidence, Calm, and Power From Excellent Bookkeeping
We real estate investors don’t have crowds cheering for us like the stars of a Super Bowl. Our great plays don’t get replayed on scoreboards in front of 80,000 people or shown on ESPN Sportscenter.
But having an excellent set of books can give you the same confidence, calm, and power as a sports champion. When you know the key statistics of your business at all times, you also set up yourself up for growth and many years of all-star real estate performances in the future.
I still enjoy the popular parts of real estate, like negotiations or rehabbing an ugly house, but I also have found that keeping good books is equally satisfying.
When I print out a balance sheet for a property and see everything in its place, I get a deep sense of satisfaction. When I send my books to my CPA each year, I enjoy knowing that we can have substantive conversations about strategy and tax savings because the information is clear and well organized. When I share some of my books with a partner or a private lender, I take pride that they are confident in my future performance because I accurately tracked my past.
There are no perfect, one-size-fits all bookkeeping systems. But I hope this article inspires you to begin your own system or to improve the one you already have.
Even if you don’t enjoy it like I do, you’ll find your business getting better and better and your life getting easier and easier with an excellent set of books.
Now it’s your turn. What kind of bookkeeping system do you use? Spreadsheets, software, or old-fashioned paper ledgers? How do you organize and track all of your paper supporting documents? Are there other benefits to keeping excellent books that I missed here?
I’d love to hear from you in the comments below.