Study The Rent Roll(s) Closely Before You Purchase An Apartment Building
Before I purchase an apartment building I want to see the current rent roll and past rent rolls. I suggest you do the same.
Well, first of all it never hurts to have too much information when you are completing your due diligence on a potential commercial real estate investment. It is your absolute right to ask for anything that pertains to the income property.
In theory you could
ask for ten years worth of rent rolls and income statements if you wanted to. It's your right, although the seller might balk at this. And the reality is that you seldom need information going back that far when you are looking to purchase an apartment building. But three to five years of information is not out of line. So ask for at least three years worth of rent rolls.
Not unlike how a balance sheet gives you a snapshot of a company's financial position at one point in time, the current rent roll of an apartment complex only gives you a snapshot of the building's rental revenues. However, in order to make a full assessment of the current, as well as historical rental situation, you are going to need rent rolls going back a few years. These "old" rent rolls can tell you a lot.
For one thing, you can compare the actual vacancies on the rent rolls with what is portrayed on the pro forma statements. If you receive an "optimistic" pro forma statement from a seller of commercial real estate, you won't be the first. Sellers (and their commercial realtors) are notorious for putting forward less than accurate financials to potential buyers. It is up to you to ask for all of the supporting documents to verify the numbers. Hold the seller's feet to the fire on this one, and never settle for less information than you need.
Sidebar: In fact, would you like to know what I do when I receive a pro forma income statement from a commercial real estate agent or a seller? I pretty much toss it in the garbage. O.K. I do take out the pertinent information, but then I recreate the income statement from scratch using my numbers and commercial real estate analysis software. Then I verify, verify, verify as they say. And I...make sure everything is in writing.
A final thought on using proformas when looking to purchase an apartment building. Look for the word "normalized" at the top of any income statement that is provided to you. What this typically means is that the numbers have been estimated based on "normal" operations. This can be legitimate if an extraordinary amount of repairs and maintenance took place in a particular year for example. However, beware of sellers who try and use it to reduce the expense figures below what they should be.
|Before we move forward I'd like to stress that the best way to "get a handle" on this information (and everything else you need to know to successfully purchase an apartment building) is to get yourself some good courses/books on the subject. Here are a few e-course that I recommend...|
1. Creating A Financial Fortress Investing In Apartments (written by the author of "Commercial Real Estate For Dummies")
2. Buy Your First Apartment Building E-Course (even if you choose not to purchase this course, at the very least you should sign up for the free 10 day mini course offered)
3. Apartment Building Cash Flow System (a good resource when looking to purchase an apartment building)
Have a look at all three and see which one appeals to you.
Alright, another thing that I look for in the rent rolls is tenant turnover. Again, a current rent roll should tell you when the current tenants moved in, but it won't give you an indication of how often tenants have turned over in the past. You need historical rent rolls for this. The more tenants turnover, the more it will cost you. Every time you have to re-rent a unit in your apartment complex it costs you time and money.
When were the last rent increases? Historical rent rolls will tell you this. Many sellers will jack up the rents just before marketing an income property to make the NOI look better. There is nothing wrong with this per se, except that it leaves little room for you to increase the value of the multi family building by raising the rents yourself. Essentially you would be giving away that value to the seller, when what you should be doing is looking to purchase an apartment building where you can add that value after you make the purchase.
Another reason (although not the main reason) to ask for historical rent rolls would be to test the seller's motivation. If they refuse to provide you with what you want then either they aren't motivated enough or they may be trying to hide something. In either scenario you may be wise to move on and look for another opportunity to purchase an apartment building.
Finally, when it comes to the current rent roll, make sure that you verify this as well. Are the tenants paying what it says on the rent roll? Are there any hidden incentives or verbal agreements with the current owner? The time to find these things out is now, not after you purchase an apartment building.
It's the so-called "little things" like study rent rolls properly before you follow through on a investment property purchase that will ultimately determine your success or failure. And to make sure that you know what to look for and ask for, you need to get yourself educated now. As I mentioned above, I recommend a course by a colleague of mine that focuses on purchasing your first apartment property. It is priced fairly (well under $100), and will give you a solid foundation from which you can build upon until you actually take the plunge and invest in an apartment building.
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