What do "expenses" actually entail on property listings?

Question

Hello, I am beginning to look at property listings online for multi-unit properties and am seeing the "expenses" vary from property to property.  Sometimes it's not even listed at all.  What exactly do the expenses entail?

I understand it is "pro forma" but am having a tough time with the following...

• Are the expenses for a specific time period?
• Did the agent that listed this get this from the seller?
• How do I calculate expenses on a property I've never seen (aside from the usual built in expenses like property management)?
• Is there any way to truly know the expenses? I'm guessing the only way is to access the sellers books?

Below is an example of what I'm referring to...

http://www.realtor.com/realestateandhomes-detail/3...

Colleen F. · Answer

There is no standard in how it is listed.  The agent did get it from the seller so it could and probably is some version of fiction.  You can ask to see books but for the start just estimate your own numbers.   Ask what utilities the landlord pays, estimate what they would cost, estimate insurance, taxes ,  etc. , add property management.   Don't forget to include all the things for  a multi like lawn, snow, any regular fees that you would not have in a SF rental.

Frank Gallinelli · Answer

Mark,

You have a asked a very important question -- actually two questions: What, really, are operating expenses, and how to you find them out?

Let's start with the first part. As the name implies, operating expenses are the costs that are necessary to operate the property on an ongoing basis.  These will include items like insurance, property taxes, repairs, maintenance, and management. They will not include the costs of mortgage financing or capital improvements, neither of which is necessary for the operation of the property.

When you have the sum of those operating expenses, you will subtract them and an allowance for vacancy and credit loss to get what is called the Net Operating Income (NOI). NOI is a critical metric for real estate investors, because it is used by appraisers to estimate the current value of the property, and by lenders as part of their mortgage underwriting. That's why it's important to know what you should and what you should not include as an operating expense. Debt service and improvements will affect your cash flow, but they do not affect your NOI.

Now for the second part. Where do you get the data? You'll start with the expense data provided by the seller or the broker, but you will not assume that this information is necessarily accurate or complete.  After you collect that data you will do what is called "reconstructing the owner's statement," which is a polite way of saying that you will start with what you've been given, then try to get closer to  the truth by verifying everything you can and rebuilding that statement if necessary.

First you need to fill in what the seller or broker has simply failed to include. I've seen many listings which were obviously incomplete in terms of the costs that an owner would encounter in real life. One of my favorite examples: Let's say you're looking at a building in Boston, and the broker doesn't mention snow removal as an expense. Perhaps he or she was hoping you wouldn't notice that six-foot mound of slush.

You can confirm some costs independently, such as property taxes, insurance, and, in some locations, utility costs. Many investment properties are held in LLCs; try asking for a copy of  the tax return (tax ID redacted). Certainly ask to see current leases to verify the revenue.

Obviously, this is an abbreviated answer to your question, but perhaps the most important point is this: Due diligence is critical to successful real estate investing. Don't give it a quick pass, and don't be reluctant to push for documentation and answers.

Frank