Since apartments are how I make a living, I pretty much look at numbers all day and every day. They’re either my financial or someone else’s. When I’m sitting down with property managers or clients, the focus is on numbers always – income collected, delinquent income, income we’re never going to collect, vacancy percentages, and cash left in the operating account at the end of the month, just to name a few. But after all these years, I am still not a “numbers guy”. That’s not my passion, but to look them over carefully and understand them is a necessary requirement in running a business profitably and responsibly.
I want to share with you 2 very important things when reviewing numbers on your apartment deal BEFORE you buy. Then later, I’ll share with you 2 very important things to watch after you buy.
So, BEFORE you buy any apartments or just when you’re evaluating a deal, take a close look at these 2 things:
Number 1 FINANCIAL thing to look at: the actual income, what I mean by actual income is not the agent’s “proforma” income from his brochure. Proforma income is best-case, perfect world income, this is not realistic income, don’t use it. In fact, completely ignore it. Whenever you receive financial information from the agent or seller, ask where it came from. Did it come from a bookkeeper? Did it come from the property manager’s software?
Those two are typical and mostly good places to start. But if it comes to you in a colorful brochure or handwritten, or gives the appearance it was made up, stop right there and ask this one question – does the income shown here match what’s reported on the property’s tax returns? This is a great question! Which one would you tend to believe: an agent’s or seller’s “made-up” income statement or a tax-return showing the income? You know the answer to that one!
Number 2 FINANCIAL thing to look at: the operating expenses over the last 3 years. If you were doing a deal today, obtain expenses for 2008, 2009, and 2010 year-to-date. Compare each year’s expenses and look for the following: consistency in the annual overall expenses, large fluctuations of any one expense (such as plumbing or any utility), and any other expense that you don’t understand.
What I have found to be true about 90% of the time (that’s 9 out of 10!) is that the expenses supplied to you are what I consider to be too low for normal operations. They do this to make the property look like it’s performing better than it is actually. So, instead I want to give you a couple rule of thumbs I use to estimate expenses in EVERY deal I look at BEFORE I buy. For 5 units to 20 units, I run my expenses at 35% of the effective gross income. And for 20 units to 50 units, I run my expenses to be 40% of the effective gross income. And finally, from 50 units to 100 units, I run my expenses to be 45-50% of the effective gross income. Over the years, I have found two truths about those two thumb-rules: one, agents always present expenses that are lower than the rules and two, the biggest mistake new investors make is underestimating the expenses.
See? You don’t have to be a genius to evaluate the financial's of an apartment deal…you just need common sense…and help.