The seller for a 12 unit complex I’m looking at has been refusing to provide detailed financials. They sent a flier with high level figures but the numbers don’t look right. This is student housing and sell says the monthly rent is low because three rooms are rented to family. OK, 3/12 units are non producing so occupancy rate is 75% best case, right? When I back calculate from actual gross rent I get 90% occupancy. Doesn’t add up.
I’ve requested three year actual financials but the seller is refusing. I’ve never run into this before, Is this a red flag?
@Pete Harper is ask why they don’t want to share financials. Maybe they just didn’t keep track of it well if that’s the case just request a copy of their tax returns and you should be able to piece it together. When they provide “estimates” it’s either bad accounting or someone is fluffing the numbers.
If financials The they provide don’t look right then don’t use them in your analysis. Build your analysis based on conservative market data. I do this for vacant properties or properties that are clearly underperforming to see what it “should” look like once up and running. Then build in some headroom before making an offer.
@Pete Harper yes it is a red flag-very likely it is the tip of the iceberg too. There may be much worse hiding in the leases too and he may not be forthcoming with them either. Definitely you will need to have the building inspected unit by unit by an inspector and yourself. I'd be willing to live without financials provided I got everything else including Estoppel certs from the tenants. Check for liens and unpaid taxes etc. You can likely check water and sewer, and electricity with the county and utility co. Whatever you do make sure you do not overpay for this property. All the best!
The numbers they are providing could be pro-forma numbers, which are useless most of the time. Used to see this all the time looking at buying retail properties, where the seller would give out pro forma numbers and be cagey about actuals. Offer to sign an NDA agreement (very standard) to get a look at the real numbers, so you can evaluate what a fair offer looks like.
You can request for a Schedule E of their tax returns with all of their pertinents crossed out to protect their privacy. Either you request it in your due diligence or your lender will for financing so he should cooperate now. Have your agent speak to him and iterate this and make sure you have the financials, after all, what is investing without the numbers?
Your are making a reasonable request. All income/expense information is contained on Schedule E with taxes, so they have the information. No logical reason not to share it.
They are probably covering up vacancy, high utilities, excessive repairs, tax fraud or some other financial problem.
Regardless of what they provide, you should calculate your own conservative numbers and use that for your offer. Seller data is rarely completely reliable.
@Pete Harper often times sellers won't provide actual financials until an LOI (letter of intent) is submitted and accepted. If you are not yet under contract, you may be able to ask the seller specific financial questions about the property's operation without seeing the actual financial documents. For example, you can ask for the average gross rent per unit per month, the average operating expenses per unit per month, and from that you can get an approximate NOI (net operating income) and therefore the value of the property (NOI / Cap Rate = Value). You can also ask for the costs of specific expenses and that will help round out your initial analysis. Then, once you are under contract, the seller can provide the detailed financials.
@Pete Harper I very frequently encounter sellers who just don't keep good records. When you ask for their schedule E's, they may have reported inaccurate income and expenses to the IRS as well, so that they pay a lower tax bill. More important than reported financials is local expertise on the area and tenant behavior combined with an understanding of the building's characteristics and condition. At 12 units, this deal is small enough that confidence in what units can rent for and how easily they can be filled and kept full would be at the top of my due diligence list.. above seller reported operating statements.
If it were me, at this point it would be buyer is refusing to buy property. I'd move on and find easier fruit to pick.
@Erik Mehus . There is a second page with pro-forma numbers that is even more suspect. I like the suggestion to receive a copy of tax schedule E. This is what was reported to the IRS.
Of course I’m running my own analysis based on my own estimates for rents and expenses.
Thanks for the advice
Could very well be a red flag. Revealing a rent roll and other docs are standard procedure for MF property. As for market rents, you could just view what other units of "like kind" rent for in the area. Or use sites like Rentometer
@Pete Harper definitely a red flag in my eyes. No financials? How can you determine a fair offer. I'd move on (or give a ridiculously low ball offer - protect your downside) I wouldn't spend to much time on this deal. Onto the next.
In addition to the items discussed above, I’d also recommend requesting Tenant Estoppel Certificates to help validate lease terms etc.
We were looking at several tenant occupied SFR as part of a larger portfolio. When reviewing the actual rent rolls, we discovered that not a single property's tenants had paid the rent consistently. No wonder the landlord wanted to unload these. We wound up not purchasing any of them.
I expect this property is not performing well so your offer would have to be based on what "could be" vs "what is".
If it’s a “tired landlord”, off course the rents would be under market, property with lots of deferred maintenance and maybe serious capital expenditures to do.
Financials might be not available - it’s possible that some Tenants paid not registered cash, sch.E was filed with actual expenses but huge “vacancies” which created “losses”.
The real question here is: can this property perform better and what's the cost of CapEx/maintenance ?
That might be a great opportunity to buy under market and turn it around. Problem will be with financing though: if you can’t buy for cash and refinance it later after repairs and better tenants, it won’t work
@Pete Harper Do you have the property under contract? If so, then I would say the seller is being unreasonable because what you are asking for is a reasonable request. If you do not have the property under contract then I actually see both sides of it.
There are a lot of tire kickers who want all of this information without ever planning to do anything no matter how good or bad the numbers are. Those pretenders drain a lot of sellers and prevent them from giving to much info until they know they have a serious buyer and instead they give very general numbers like it sounds like you have been provided.
This strategy can only hurt the seller. If they provide wrong or incomplete information and you base your offer on that information, then you'll have grounds to re-trade the purchase price during the contract period. It's worth finding out if the seller is a mom-and-pop, in which case they may not understand that not providing financials could hurt their interests. It's also worth offering to sign an NDA, which often fleshes out whether or not they're serious about providing information.
@Pete Harper I bought a 10-unit a couple years ago with poor/bogus/insufficient numbers. It all worked to my advantage.
- I didn’t care what his rents were, I knew what they should be (just call sec-8 office to see what they will pay for your units).
- I didn’t care what he listed as his insurance cost, my agent gave me a quote ($1k cheaper than He was paying! BUT I used HIS cost to justify my offer!)
- I didn’t care what his water bill was - he had leaky faucets and toilets throughout the complex! I used his number, knowing I’d cut significant cost by simply repairing the leaks!
- My contractors did my inspections and gave me bids for the work so I knew what my cap ex was going to be.
- I looked up the property tax on the county assessors web site and updated his number to the current year.
It’s all part of due diligence. What I want to know from the seller is when do the leases come due - or are they month-to-month. You can pretty much figure out the rest on a deal this size.
Write an LOI with language that requires the seller to provide Schedule E's and annual P&L's for the past 3 years, along with the rent roll, and all other standard DD items. A lot of sellers don't want to give financial numbers until it's under contract. Many sellers are also just sloppy with their books.
Look at the current performance of the property, but also understand its potential.
I thought I would post an update. We were finally able to get a copy of three year financials. No surprise, the books are a total mess. Four partners went in on the deal while their kids went to college. They are down to only one kid still living on the property. I assume that is the reason for selling. Self managed, no leases on any of the units, missing deposits, pets with no pet deposit, and friends staying in unit for below market rent. The units that are rented had recent increase that were used for all units in analysis. The complex ran in the red two of the last three years. When I re-run the numbers it is not even close to supporting asking price. I found a better property two blocks way. See ya later.
Very common in residential or commercial building sales. Reasons are many, often involved unreported income etc. I had one inquiry wanting prime storage sales. I asked about preapproval as a realtor. The ans is not prepared yet. Can you provide the financials? To demand financials like tax returns with tax id the sellers would expect an offer or accepting offer.
These days many rentals do not come with financials anymore meaning you research and generate your own.
Originally posted by @Pete Harper :
The complex ran in the red two of the last three years. When I re-run the numbers it is not even close to supporting asking price. I found a better property two blocks way. See ya later.
Did you try going back at a lower price?
I do not get a good feeling from Broker/Seller. I just scratched the surface and found a number of red flags. Besides, I found a better opportunity two blocks away. If I can’t get that one under contract I will think about it. This property is not going to sale at current price.
I’ve had my 15 seconds of fame. This post was selected for the “fire round” on BP episode 347.
I was listening to podcast this morning in the truck on my way to start renovations on our new 4-plex. Imagine my surprise when my name was mentioned.
This was way cool!