It is not uncommon for owners to under-report income and over-report expenses. This is especially true when it comes to filing taxes. The net operating income number is the key number in multifamily investments. This number is used to determine value, profitability, and overall strength of the multifamily unit.
Net operating income is the gross income less the operating expenses.
It is typical of the industry to consider the following expenses as "operating expenses."
Real Estate Taxes
Property Insurance
Utilities
Repairs and Maintenance
Janitorial
Interior/Exterior Decorating (Usually applies to Apartments)
Management
Too many times I am looking at deals where the borrower has fallen in love with a particular property. The realtor has provided them with a pro forma displaying excellent cash flow with no down side. The buyer is all set with their down payment money and is just waiting for me to flip the magic funding button so they can reap the endless benefits of their investment property.
The first thing I explain to these borrowers is the fact that the numbers they were provided were not real. They often show what income the park could generate at full occupancy with increased rents. This may be helpful to some investors looking for upside potential, but a lender sees it as completely useless. A lenders best clue to how a property will perform in the future is to look at how it has performed in the past. Lenders have special filtering goggles that only allow them to see a number representing risk. They dont look at hopes, dreams, or speculation. For the most part a lender wants to see that a property has cash flow to support normal expenses including loan payments with a little cash left over. Cash flow is key to any conventional finance program.
So we throw out the pro forma information and collect about 3 years of income/expense statements. After we have what we would think to be real numbers, we start to sort information further. Park owners will, more so than not, include expenses such as car insurance, health insurance, gas, bank charges, etc. These are usually considered to be outside the definition of operating expenses. Lenders are looking for normal operating expenses. Expenses that are required for the park to run, normally, are looked at. Some is left to interpretation, but these numbers become easier to filter out as you become experienced in the buying process.
The expense ratio for a mobile home park will usually be about 25%-40% of the gross income. Park-owned mobiles, master-metered utilities, miscellaneous amenities, etc. are factors that will send the ratio to the higher end of the spectrum. Individually metered utilities, tenant-owned mobiles, etc. tend to mitigate expenses.
The area of the country will also be a big clue as to what can be expected. In FL taxes can be extremely high. This is also true in CA. Many times a tax expense in CA or FL will change dramatically from before it was purchased. The reason for this is that CA and FL adjusts property taxes based on the date of sale. Once title is transferred, the new tax adjustment is set in place.
The job of the realtor: to show the property in its best light. It is the job of the buyer to sort through the nonsense to find the real value of the property.
The thing to remember is, benefit. People will be motivated by what benefits them the most. Start to think like a property owner, instead of a buyer, and you may find yourself one step ahead of the game. Once you have analyzed many deals, it will become easier to spot numbers that are probably an incorrect reflection of operation. I suggest getting out to shop, shop, shop. See what's out there.
About the Author: Colby Callahan - Commercial Loan Officer - Business Loan Store
