The Books and Records of a multifamily can be not only hard to understand but incomplete as well!
When I am asked to review books and records, it is always important to understand two items.
First, knowing what to look for as real expenses. Most owners and property managers simply lump both operating and capital expenses together. Here is the good news-this is an easy way to evaluate the “major” work done to the building. Here is the bad news-this makes it harder to ascertain the real operating numbers on a building. Remember that capital expenses are considered nonrecurring expenses.
A good rule of thumb is to see if these expenses are completed on a routine basis. Pest control may not be done every month, maybe every three months but a termite treatment would be considered a capital expense. Carpet may or may not be considered a capital expense as this may need to be replaced whenever a tenant moves out but tile flooring is a capital expense. Maintaining the landscape is an operating expense but installing new landscape is a capital expense. When I look at books and records and I see a plumbing expense over $500 I will question what it was for. Often I can find new hot water heaters in the books and records.
Once we have removed the capital expenses from the operating numbers, this makes it easier to do an honest evaluation on the property. WAIT I said that there are two factors that I look for on Books and Records.
Secondly, it is important to make sure that all expenses are accounted for. One of the biggest issues that I see with books and records on the MLS is that uneducated agents (again why you need use an experienced commercial Broker) is that they will not add a vacancy rate or management fees on the MLS. This will give you a higher cap rate but not accurate figures. When I question them, here is what I often hear, “Oh, the owners manage the building themselves!”, or “The building is full.” When I respond, I will ask, “Does this mean that the owner will manage for my clients forever for nothing?”‘ or “Does this mean that the owner will guarantee 100% occupancy forever?”. The answer is of course not. Then my answer to the agent is get your numbers right. Even a self managed building should show these numbers.
Often the taxes and insurance are not shown on the books and records. This may be due to the fact that the owner has the building self managed and pay these expenses out of the their account vs. the property manager’s account.
What about additional income? Laundry, storage and pet fees etc? Some property managers keep the late fees as part of their income. So this as additional income may not be used.
Once you have the actual numbers and they have been verified, it becomes pretty easy to figure out if the property makes sense.
In the Phoenix market, where rents are easily increased, I usually run two spreadsheets. One with the VERIFIED actuals and one with the projected income based on the actual expenses.
I had a client this past week not understand that without this being done completely, I would not provide the analysis on the building. This type of analysis usually takes me 3-4 hours to completely do depending on the information that has been provided. Often it is a back and forth between myself and the other agent in order to get the correct answers. The above mentioned client was frustrated with me instead of welcoming the information being done correctly.
Often times we can obtain a building that other investors overlook due to the inability or lack of knowledge to understand the books and records. This is a great benefit for my clients.
Next week we are going to discuss inspections and I will give an overall view of what kinds and when they are needed.
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Have a great day!