Strategies for dealing w/ MFR brokers (who fudge numbers)

34 Replies

Hey folks

I've been looking to buy a couple small (6 to 10 units) MFR. I'n looking to get 7%-8% CAP c-o-c. Have been scouting usual sources like MLS, Loopnet, Marcus... Plenty of fish in metros I'm interested, advertised caps look good on surface, but...

Went through about 60 of these, requesting ttm income / expense report only to consistently discover fudging of numbers to arrive at a higher 'advertised' cap, basically dressing of numbers, including

* not including management expenses (oh, we don't include maintenance fees because they are specific to buyer)

* not including repairs / maintenance expenses (oh, seller just refurbished couple units 2 years ago)

* not including vacancy (oh, the complex is 100% occupied over the last 12mo)

* not including property taxes (oh, buyer can request tax abatement) 

you get the drift. and the conversations stop at the broker level after pointing out to all the gaps, most just stop responding - there are obviously reasonable / experienced folks who smirk and continue chatting but for every one of those, there are 50 who seem to just seem to either be completely incompetent or useless. and it seems to be getting worse vs ~5 years ago when i picked up my last MFR

any thoughts / advice how to deal with these types? is this a common situation for you as well? 

To me, you're doing the right thing. Giving the brokers honest responses.  You could take a page from grant cardone and become 'super interested' in the deal at the beginning, to give them a warm fuzzy feeling...and begin early on asking about other properties.  They see you mean business even more so when you send them these points you've stated here, but since you've established the relationship already with positivity/forward thinking/flattery, they may be more willing to respond?  Just a thought. But yes, overall, you should stick with your numbers and point them out. They show you're professional and doing this for a living, not 'on a wing and a prayer.'  Brokers who don't respond probably aren't the ones you want to be working with at your level anyways.  You want pros who respect pros. Go get em!

@Avtandil G. That’s just the business, make some basic assumptions and if you like the property send an loi and request the information during your due diligence period. I have a question for you. You live in California where are you finding decent properties with 7-8 caps. I have a 16 and 18 unit complex in Delaware which need built out. With a joint venture I would let them go at a 6.5 cap. 2 brand new building in a military base area, no deferred maintenance for 5-7 years. Just some thoughts.

Management may or may not be included in cap rate. Not including is not fudging numbers.

You almost never need any of the information you are mentioning. You know the cost of the building, and you should know the rents.  Condition of the property can be seen by looking at it.   Basically by pointing out all the gaps as you say, you are showing yourself as a non serious buyer, because the serious ones dont need any of that info.

@David Miller - thanks, but I do not do JVs at this point

@Russell Brazil - I do not follow your position about not needing these details. Example - some small unit MFRs are not individually metered for water, if I don't ask whether seller eats that cost or not, I'd end up with a fairly significant difference in actual expenses, particularly in states with high cost of water... In Fresno, for example, water expenses alone can be 15% of gross... Could you perhaps elaborate at how you arrive at the NOI from cost of building?

To me the numbers are fudged.  And griping about investment sales brokers is a popular topic between investors.  They advertise the cap rate, yet it is not real.  

Correct, if you're experienced, you should know what to add back into your proforma / financial analysis.  I've laughed at some of the turnover costs that were included by brokers.  

I find deals listed by the major brokerages usually to be overpriced - for me.  

@Avtandil G. Sounds like you are doing all the right things. Point out in a professional manner how your arrived at your numbers and your conclusions. Ask him to provide further justification on his end if he disagrees. Ask if there is any flexibility on price based on these realalities, if not, no problem we’ll move on and look to work together on the next one. Do that long enough and they’ll see your serious.

@Avtandil G. unfortunately, this is just part of the process with bigger commercial brokerages and this is why it's critical that you do your due diligence on every property.

Since cap rates are based on the projected estimates of the future income, they are subject to high variance. In today's strong MFR environment a broker can manipulate the numbers as there will be another buyer right behind you.

@Avtandil G.

Yes per @Russell Brazil

- all you may need is the three years of rental-income verification - if possible, 

otherwise just

current tenant rental history, lease details etc.

Rest is your own research work,

 town records, understanding city and neighborhood,

due diligence, detailed building inspection reports, appraiser input 

and counter offers!

You should try to get copies from seller broker of all the invoices of utilities and contracted services like garbage, maintenance etc. and also search city fire, police, building and the health inspection records, (they are public records), of their siting any concerns for the building.

@Avtandil G. most every listing I have ever seen has either missing/low expenses or over inflated income. It is a marketing document with disclaimer. The numbers are provided by the owner, not the broker. The owner is going to try to make it look as good as possible.

As @Russell Brazil said, it really doesn't matter. You shouldn't be using their numbers as anything beyond reference. You can independently calculate everything. The reason they stop responding is because there is nothing they can do to help you. Experienced buyers know how the game is played and run their own numbers. 

Larger multifamily may have an operating statement with exact expenses. Smaller multifamily you can request their tax statement for the property (seller may refuse to provide). 

All expenses and income estimate can be independently calculated, which is your job. Also keep in mind that some expenses depend on the owner, such as vacancy. Maybe they have been 100% occupied, but once you jack up rents 20%, your vacancy will be 10%. Most of my houses have had 100% occupancy over many years, even with tenant turn over because of back to back tenancy. 

@Joe Splitrock - the issue is not in the ability to calculate the property value at a specific cap rate - that's straightforward with current rent roll. the issue is that brokers calculate the price and corresponding cap off fudged income / expense reports - it does not really matter who fudges the numbers

just yesterday I was negotiating on a 6 unit in Fresno - the seller's broker is adverting it as 6.6% cap @ 460k on revenue of 41k. At 6.6% cap, this should be priced in the ~310k-330k range. so i request detailed income / expense - got it and discover that reported expense is only 25% of gross. there's no market in the world, where rental property expense is only 25% of gross (and if there's, nobody will ever sell such property), but the broker took the number 30.5k and arrived at the asking price using that reported NOI. After digging into the expense, I find out that there's no management fee, no property taxes and no vacancy allowance included. i make an offer at 325k and explain the rationale and the numbers, instead get back a 'we will not even talk about your offer' type of an answer.... And by the way, 325k turns out to be only 5.7% cap because owner eats cost of utilities.

Originally posted by @Avtandil G. :

@Joe Splitrock - the issue is not in the ability to calculate the property value at a specific cap rate - that's straightforward with current rent roll. the issue is that brokers calculate the price and corresponding cap off fudged income / expense reports - it does not really matter who fudges the numbers

just yesterday I was negotiating on a 6 unit in Fresno - the seller's broker is adverting it as 6.6% cap @ 460k on revenue of 41k. At 6.6% cap, this should be priced in the ~310k-330k range. so i request detailed income / expense - got it and discover that reported expense is only 25% of gross. there's no market in the world, where rental property expense is only 25% of gross (and if there's, nobody will ever sell such property), but the broker took the number 30.5k and arrived at the asking price using that reported NOI. After digging into the expense, I find out that there's no management fee, no property taxes and no vacancy allowance included. i make an offer at 325k and explain the rationale and the numbers, instead get back a 'we will not even talk about your offer' type of an answer.... And by the way, 325k turns out to be only 5.7% cap because owner eats cost of utilities.

I rarely see vacancy and management included in CAP rate. Why are you getting so hung up on the CAP rate they are calculating? Like I said, they ALWAYS misrepresenting information, unless it is a bigger property that is professionally run. You are doing the right thing. Calculate your own and share the numbers/logic with them when you counter offer. They will either accept the offer or look for someone who is willing to accept lower CAP rate. Or someone who doesn't know better and blindly trusts the numbers they provide. Sadly that is getting more common with the current frenzy to get into real estate.

I am not arguing that it is frustrating. I am just saying that is the way it is, so you need to deal with it. Every listing has BS in it. There could be a toxic waste pond in the back yard and the realtor would call it lake side property.

@Avtandil G.

That's just the way some of them operate unfortunately. You make your own assumptions and then in due diligence get all the correct info as best you can. Unfortunately it's just the way it is, doesn't make it right, just is what it is, but it's there and probably not changing. You have to adjust your methods to it or just pass on every deal.

I consider all information provided by a seller or broker to be geewhiz.  It gives me a general idea of what they want you to believe.  

They are “selling” something.  Just like if it says “cozy” that’s code for SMALL or “needs some TLC” normally means, needs to be stripped down to the studs because it’s a dump. 

They can sell all day and you can either buy into their snake oil salesmenship or you can look at the property yourself run your numbers and then make a offer based on your DD.  Don’t concern yourself with their magical number they listed it for.  

Eventually you will get a seller to sell based on what you offer.  It isn’t your job to overpay.  

I ALWAYS include management and vacancy when calculating CAP rates which is why realistically you are not going to find anything of quality over on the MLS with over 6% in Fresno - typical buildings here are getting closer to 4.5% to 5.25% - that's also the reason why I never pay attention to the numbers provided by the broker or the seller - I mean sure , I will look at them and run some numbers - have a good laff when I realize they have not included any major expenses and run their property for 4K a year ..lol. but then I look at what the actual expenses are likely to be based on experience and look at the REAL potential for rent and run my numbers based off of that - of course not a lot of properties will show a good cap rate when you do this - but I feel that it is more realistic and I don't have BS anyone when it comes to what a property can generate - I don't have to go back and adjust numbers for things that weren't taken into account initially - keep in mind that most real estate agent don't even own any property much less investment property - try to work with someone who has their own investments and understands the intricacies of income property. As someone posted - the actual priced based on a 6% cap rate will be much less that what is currently on the market - these sellers are seeing SFR prices going through the roof and somehow thinking that it applies to Multifamiles - but a MFR is only going to be worth what you can get out of it and investors are too savvy to pay what they are asking which is why so many of them are just sitting on the market right now and agents are blowing smoke up about their cap rates

Originally posted by @Avtandil G. :

@Joe Splitrock - the issue is not in the ability to calculate the property value at a specific cap rate - that's straightforward with current rent roll. the issue is that brokers calculate the price and corresponding cap off fudged income / expense reports - it does not really matter who fudges the numbers

just yesterday I was negotiating on a 6 unit in Fresno - the seller's broker is adverting it as 6.6% cap @ 460k on revenue of 41k. At 6.6% cap, this should be priced in the ~310k-330k range. so i request detailed income / expense - got it and discover that reported expense is only 25% of gross. there's no market in the world, where rental property expense is only 25% of gross (and if there's, nobody will ever sell such property), but the broker took the number 30.5k and arrived at the asking price using that reported NOI. After digging into the expense, I find out that there's no management fee, no property taxes and no vacancy allowance included. i make an offer at 325k and explain the rationale and the numbers, instead get back a 'we will not even talk about your offer' type of an answer.... And by the way, 325k turns out to be only 5.7% cap because owner eats cost of utilities.

"...we will not even talk about your offer..."

Uhm...aren't brokers obligated to present all offers to the seller?

Originally posted by @Merritt S. :
Originally posted by @Avtandil G.:

@Joe Splitrock - the issue is not in the ability to calculate the property value at a specific cap rate - that's straightforward with current rent roll. the issue is that brokers calculate the price and corresponding cap off fudged income / expense reports - it does not really matter who fudges the numbers

just yesterday I was negotiating on a 6 unit in Fresno - the seller's broker is adverting it as 6.6% cap @ 460k on revenue of 41k. At 6.6% cap, this should be priced in the ~310k-330k range. so i request detailed income / expense - got it and discover that reported expense is only 25% of gross. there's no market in the world, where rental property expense is only 25% of gross (and if there's, nobody will ever sell such property), but the broker took the number 30.5k and arrived at the asking price using that reported NOI. After digging into the expense, I find out that there's no management fee, no property taxes and no vacancy allowance included. i make an offer at 325k and explain the rationale and the numbers, instead get back a 'we will not even talk about your offer' type of an answer.... And by the way, 325k turns out to be only 5.7% cap because owner eats cost of utilities.

"...we will not even talk about your offer..."

Uhm...aren't brokers obligated to present all offers to the seller?

That statement doesn't mean the offer wasn't presented. It means they are not interested in negotiating with you. That is not uncommon when an offer is just way too low. I have had people not counter back and not reject the offer. The agent just says it is too low.

Personally, I would never even respond to an offer 30% below what I was asking. Partly because I would never list a property for 30% more than what I thought it was worth. I am sure they believe the comps support the value.

Interest rates are low and the real estate market in CA is hot. Looking at it logically, don't you think they will be able to get well over $400K for that property? Maybe not from you. I am just saying there are plenty of CA investors that are looking for affordable options closer to home. 

@Joe Splitrock - financial definition of CAP rate and NOI is sort of well understood. it's just brokers have been dressing these numbers for so long, that not including management fees or vacancy has become an urban legend - i rationalize it this way - if we were talking about 500 unit complex rather than 6 unit, management fee will be a line item on the expense report and if it's not, ppl would just laugh. similarly, if owner is out of state, management will be a line item in the expenses - no way someone can self-manage a property out of state. Same goes for vacancy - it does not matter whether the property is 100% rented today - sooner or later you will have a turnover, and then it will take 30+ days to put a new tenant. On average, that happens every 24mo, so unit will not generate any income for you on average 15 days out of the year, or 5% vacancy. In some markets that's gonna be even higher

Of course I understand that the sellers will try to dress up the property, but what is the value that the brokers brings to the table if they do not try to bring their clients down to earth when a reasonable offer comes along? In particular, I've been seeing more and more MFRs going off market because they just didn't sell. And the number of properties overpriced by 30%+ is increasing

@Grant Rothenburger - not sure what you mean by 'adjust your methods'? do you mean accept lower cap? if so, i'd say it makes no sense for me personally (although it may for someone else) - if i were a pension fund, i'd be willing to accept a lower cap for A grade property since i'm just trying to preserve capital, but for me, lower cap means lower return and i'm in growth mode not preservation mode. 

@Avtandil G. No, I mean they will almost NEVER be accurate, accept it. Make assumptions, underwrite, make an offer. When you're under contract, get the real financials and do your due diligence. If you're waiting for an honest and realistic OM or listing, you'll never submit an offer. Maybe I'm misunderstanding your issue/question.

Also, partly yes to your question, if something has a low cap rate but your business plan is to add value and increase rents, does it really matter what current cap rates are?? I think you are waaayyy too hung up on cap rates, just my opinion. We have some videos and blogs on why we don't care about cap rates (much), I can share with you via DM if you want to message me, can't share here. Basically, the MORE important part than the cap rate is your business plan. That's not really what you asked for, you asked how to deal with these brokers fudging numbers, my answer is the first paragraph in this response. You'll always have to do your own underwriting, they will almost never be correct or honest, simple as that. Just have to keep searching or adjust your business plan to something that can work with lower cap rates to your advantage. Or find off market deals more to your liking, or don't buy real estate anymore. That's about all the options.

@Avtandil G. Oh, those numbers are definitely always fudged. What I find frustrating isn't so much when it's actually based off a seller's numbers and took some work to reveal. It's when it's so dang blatant that there's absolutely no integrity on the part of the agent. I've had a local agent call me with "deals." One he owned himself and kept saying it was a 10 CAP... basing it off gross income and no expenses. Then, every time we talked, which was frequent because he kept calling, new expenses would come up. He also tried to sell us an industrial property with some of the most made up financials I've ever seen. Rent rolls changed significantly every time they sent us information.

List prices and cap rates are almost irrelevant. Run numbers, make offers that make sense, take the wins when you get them.

General rule is to always assume the broker information is fudged, but ask for it anyways 

Then ask the right questions. They will know they are dealing with a pro and should provide the info, since they ultimately want to sell the place. Otherwise they wont deal and will hold out for a sucker, and eventually will come back around. Don't be that sucker! And you're not, which is why you are here! 

Ask for the T12's, rent rolls, get legible easy to understand records from the broker. If they can't provide clear and factual records, you could provide your own given the market and the area - use that to come to a fair price and make an offer

@Avtandil G.

It is MARKETING by broker while he tried to get the listing, just helped the seller to eliminate some numbers as NOT relevant to new owner etc etc to show that he can MARKET it at higher price!

We can ask for all information, in writing and will get some; but will miss out on others. They want you to decide from what they gave you and what you may find out of your own!

Well, each one of us have to develop our own BUYING due diligence and evaluation. Rent estimates, occupancy estimate, ALL the expenses estimate, Building condition, neighborhood, past history and future mix, almost EVERYTHING is BUYER beware! 

Even then, we buy and make more money than the seller - depending upon our skill set developed.