A few weeks ago I reached out to the broker for a multifamily listing I was interested in. While I was typing up my message to the broker I realized, I had no idea what to ask! Most who find themselves trying to break into real estate investing will probably find themselves in this position.
In this article, I'll show you the three most important documents you need when considering a property's financial position.
I’ll start by giving the list of information to request. The reasons why you’re asking for these items is more important than the questions themselves.
If you can get these three documents, you’re in excellent shape to analyse a property’s financial position through it’s Net Operating Income (NOI).
- Rent rolls for the property
- Real past expenses for the last two years
- Historical income records
The rent rolls are by far the best measurement tool to assess a property’s current income position. The rent roll lists the current lease holders and their lease expiry dates, the amount that they’re paying, and notes about the tenant. For a property, the rent roll lists the bulk of the income.
When calculating NOI, the rent roll is your best friend.
If the seller provides this document to you at first contact, you’re off to a great start in understanding your property. Expenses can be difficult to estimate depending on your property and surrounding area, and are required to estimate NOI for the property. If a property is located in a cold or snowy area, you may have higher heating bills than you were expecting due to poor insulation, or a high snow removal budget due to large parking lots or many sidewalks.
Properties in hot areas might have electric bills due to air conditioning usage, or high water bills because of elaborate gardens.
These unpredictable expenses will become clear quickly through the actual historical expense reports.
Seasonal expenses such as snow removal or A/C bills may make computing annual expenses difficult with partial-year expense reports. These bills may be high in summer and low in winter, causing you to over or underestimate the actual expenses and either pass up a good opportunity or miss a red flag. Just be careful when prorating expenses – partial year reports aren’t always an accurate reflection of the real situation.
Historical income records
Beyond the rent roll, there are several other ways that a property can earn income. The actual historical income records will give you the full picture of how much money a property is taking in. When estimating income, you may have left out things like CAM (common area maintenance), late fees, application fees, utility reimbursements, and so on. Some oddball fees that you might not impose on tenants in your existing rentals may be considered “normal” to the tenants in this rental, and will increase your income.
This is the seller’s chance to paint a pretty picture in front of your eyes and provide you with a heavy dose of optimistic speculation. Don’t put too much weight on the seller’s pro-forma – they don’t represent the real situation.
If the seller is telling you that all units will be filled and that expenses will go down without substantial investment, they’re selling you snakeoil.
If units are so easy to fill, why aren’t the vacant ones filled right now? If the expenses over the last year are high under your management, why should they be lower under mine? Remember the asymmetrical information present – the seller knows why expenses are high, and it’s in their best interest to minimize the scope of the underlying cause.
Now that you have all of the documents you need to assess the property’s financials, the real fun can begin.
Buyer’s Pro Forma
Based on the real-life expenses and income for the property, set up realistic projections for the property’s future earnings.
- Remember to increase or decrease property taxes appropriately. Get the tax rate from the county and compute your property tax based on the likely purchase price
- If there are vacant units, don’t assume you can fill them unless you have a great strategy to do so
- Don’t assume you can get the same deal on property management as the seller. Assuming a 10% property management fee is a safe bet, unless you have a property manager already lined up with quotes in hand.
- Don’t forget to compute deferred maintenance. If a property has had little or no maintenance expenses in the last years, it’s likely that those bills will be passed on to you. Include estimates of repairs in your pro-forma.
- Remember that rent increases are gradual. Suddenly increasing the rents on your existing tenants may create animosity.
- Be as objective as you can. Don’t get emotional about a property, on the positive or negative side. Any idiot can use bad science to pluck data that supports their point of view – don’t be one of them. Weigh the data that supports and detracts from your inner voice.
- Don’t pay for what isn’t there yet!