Case Study: A 7-Unit Multifamily Financial Statement Analysis [Real-Life Example!]

by | BiggerPockets.com

Brokers can be excellent deal sources for investors, but it’s important to analyze their offering memorandums (OM) and do your own projections.

I recently reviewed the OM of a 7-unit building I was considering purchasing. After reviewing the financials, I decided the deal didn’t fit my criteria. Hopefully there are some lessons in the analysis.

The cap rate looked good, so I analyzed the financials to validate it (there’s an excellent explanation of cap rate here).

Offering Detail

  • 7-units, a mix of 1 and 2-bed apartments
  • Building approximately 100 years old
  • Large lot in the Northeast (Hint: landscaping and snow plowing costs)
  • Coin-operated laundry in place
  • Building fully-occupied with no vacancies reported the past two years
  • Current owner self-manages and owner provided 2 years of historical financials
  • Broker assembled a pro forma

Actual numbers are adjusted slightly so as to not call out the deal and this broker specifically.

Here’s what I saw in my analysis. Have a look for yourself and let me know your thoughts by leaving a comment under this article. I’ll do my best to reply to all your comments.

2015 Actual 2016 Actual Broker’s Pro-forma
INCOME
  Rent

$85,000

  (Less Vacancy 5%)

($4,250)

  Net Rent

$80,750

  Other Income
  Laundry

$700

  Pet Fees

$350

  Other Income

$700

  Total Other Income

$1,750

  TOTAL INCOME

$75,000

$74,100

$82,500

EXPENSES
  Utilities

$11,700

$8,660

$10,532

  Landscaping & Snow Plowing

$4,400

$3,100

$700

  Property Management

$4,125

  General & Administrative

$2,900

$5,000

$700

  Insurance

$4,000

$4,100

$3,350

  Property Tax

$12,000

$12,400

$12,400

  Repairs & Maintenance

$18,000

$13,000

$3,000

  Advertising & Marketing

$275

$250

$700

  TOTAL EXPENSES

$53,275

$46,510

$35,507

NET OPERATING INCOME

$21,725

$27,590

$46,993

Income

It appears the current owner is only reporting a single number for income, inclusive of rent, laundry income (unless laundry income isn’t stated), and any other fees. The slight Year Over Year (YoY) decrease in income could just be a decrease in laundry usage or other fees (if other fees are being charged). It could also be tenants behind in rent.

Rent

Monthly rent can be increased $75-100 per unit, with some cosmetic updates to units. That’s $6,300-8,400 per year total for the building.

The broker used the high estimate for the increase in rent. Based on the local market, the projected rents are reasonable. However, increasing the monthly per unit rate by $100 when the existing rent is well under $1,000 per month may not be realistic all at once.

To get that increase, you would need to:

  • Make the cosmetic enhancements one unit at a time as vacancies occur and charge the next tenant $100 more.
    • The risk here is it could take years for this to happen. Remember, the current owner reports no vacancies for the past two years.
  • Evict the tenants, make cosmetic updates, and charge higher rents to the new tenants.
    • This is the simplest way to do it in my opinion, but it also eliminates some or all income for a while. If the existing tenants are good tenants, this may not be a good idea.
  • Without cosmetic enhancements, increase the monthly rent by a full $100 per unit all at once (in this area, there is no legal maximum increase).
    • The risk here is the existing tenants can’t afford a large increase and/or feel some kind of injustice at paying so much higher for the same unit and leave.

Laundry

Does the historical total income reported by the owner include laundry? The broker or current owner might be able to answer that. The 2015 and 2016 numbers don’t break down rent from other income.

The pro forma includes the existing total income, plus the rent increase, plus laundry income.

There could be some double-counting of laundry income in the pro forma.

Pet Fee, Other Income

This one is interesting. With the current owner self-managing and not breaking down any tenant fees in the financials, it’s doubtful (s)he was charging pet fees, but it’s possible. The pet fee could be double-counted in the pro forma. (Ask about this.)

What is “other income”? The pro forma states it’s estimated at $100 per unit per year. It could be late fees, but if current tenants have been there for at least two years continuously, that number may not be realistic.

Expenses

The expenses here hint at a story. Two years of stabilized tenants, yet 2015 expenses were quite a bit higher than 2016. Why?

Utilities, Landscaping & Snow Plowing

Utilities decreased 25.9% YoY, and repairs and maintenance decreased 27.7%. Snow plowing costs also went down. The differences here could be attributed to the milder 2016 winter relative to 2015. It’s an older building likely without insulation, and the better weather also could have resulted in fewer repairs. There are some assumptions in there, so I would ask the broker and owner to explain.

Landscaping and snow plowing? Unless you’ll be shoveling snow yourself or we somehow know mother nature isn’t planning a northeast snowfall this year, the big decrease in the pro forma snow plowing cost isn’t at all realistic. Call a contractor and get an estimate to plug-in.

Property Management, General & Administrative

The current owner self-manages. Presumably, some related management costs are accounted for in “general and administrative” in 2015 and 2016.

The pro forma general and administrative expense is a reasonable estimate and should go down, since the new owner may not self-manage.

The pro-forma includes 5% of rent for property management services. In this region, the standard is 10%, with a bunch of fees piled on (see a breakdown of property management fees here). I would plug in a more realistic property management cost in the analysis.

Insurance & Property Taxes

Insurance costs are also projected to go down. Based on my experience, the current owner more often than not is getting a decent rate. A good analysis should include a slight increase in insurance costs unless the current cost is clearly too high (that would be another thing to ask about) or unless you know a really good insurance broker.

The pro forma predicts stable property taxes. To be safe, a slight increase the same amount as seen as in 2016 would be prudent. This isn’t a large amount and definitely not a deal breaker.

Advertising & Marketing

It’s a safe assumption these costs will increase if you’ll be vacating the units to make repairs, increasing turnover. Personally, I would place the marketing burden on the shoulders of the property manager and negotiate those costs as covered under the 10% fee.

My Analysis

After looking at the expenses, there isn’t a projection for the needed cosmetic repairs to get the higher rent. If I want the higher rent, I’ll probably need to make the cosmetic repairs. If I get as far as a property visit, I’ll try to eyeball this or bring along a contractor.

Below is a sample that I put together to analyze this deal myself.

analyze-multifamily

Related: 5 Ways to Jump Up to Large-Scale Multifamily Investing

My assumptions:

Income

  • Rent will go up by $100 per unit per month
  • Laundry income of $700 will be removed from rent income and added to laundry income
  • The pet fees will be included (I would visit the property and see if tenants actually have pets and if I can get them on new leases)
  • No “other income” will be added since it may already be included in rent


Related: Swap ‘Til You Drop: Multifamily Tax Avoidance Tips from Closing Table to Inheritance

Expenses

  • Utilities, Repairs & Maintenance, Landscaping & Snow Plowing: used the mid-point of the 2015 & 2016 numbers
  • Property Tax: $400 increase, consistent with 2016
  • Insurance: $100 increase, consistent with 2016
  • Property Management: 10% of net rent, inclusive of all fees
  • Advertising & Marketing: $0, covered under property management
  • General & Administrative: I would have some administrative costs, but property management should cover most of them; $100/unit/year is reasonable

2015 Actual

2016 Actual

Investor Pro-forma

INCOME
Rent

$84,300

(Less Vacancy 5%)

($4,215)

Net Rent

$80,085

Other Income
Laundry

$700

Pet Fees

$350

Other Income

$0

Total Other Income

$1,050

TOTAL INCOME

$75,000

$74,100

$81,135

EXPENSES
Utilities

$11,700

$8,660

$10,180

Landscaping & Snow Plowing

$4,400

$3,100

$3,750

Property Management

$8,008.5

General & Administrative

$2,900

$5,000

$700

Insurance

$4,000

$4,100

$4,200

Property Tax

$12,000

$12,400

$12,800

Repairs & Maintenance

$18,000

$13,000

$15,500

Advertising & Marketing

$275

$250

$0

TOTAL EXPENSES

$53,275

$46,510

$55,139

NET OPERATING INCOME

$21,725

$27,590

$25,997

The financials can tell a story, but also generate a lot of questions. You’ll need to piece together a solid analysis of the building by asking good questions, validating answers, getting contractor estimates, and, of course, looking at the property yourself.

In this case, I wasn’t interested in learning more. I would still need to factor in the cost of upgrading the units but didn’t get that far. The broker may have a wonderful and honest explanation for why costs are projected to go down so much and revenue to increase, but I saved him the phone call. The potential net operating income (NOI) just isn’t high enough to fit my strategy right now, and I’m sure a 100-year old building will continue with ongoing maintenance costs.

There is more than one way to analyze a deal. What do you see that I didn’t?

Leave a comment!

About Author

Jamie Turner

Jamie Turner is an entrepreneur, real estate investor, and holds an International MBA. He’s also a licensed salesperson based in Philadelphia & NYC. He blogs at: jturner.ca

38 Comments

    • Erik Whiting

      My guess is the author didn’t want to reveal the asking price for the same reason he stated he tweaked the numbers to avoid calling out the deal specifically. But I agree that a low enough prices makes almost anything a deal.

      The thing I would do is work the deal backwards…assuming the investor’s proforma is correct then the deal is throwing off about $310 per unit per month before debt service. (NOI $26,000 / 7 units / 12 months = $309 and change.)

      So how much would I spend to get $26,000 per year? Applying the metrics I typically look for (12 CAP)…I’d be at $217,000…far less than what I guess they are asking.

      $216,666 = $26,000 / 0.12.

  1. Curt Smith

    Self managed commercial props are impossible to buy. The seller is always shocked when the prospective buyers proforma includes 10% managment expense, 5% payment to capex reserves and other expenses. Expenses the long time self manager doesn’t have to budget.

    Then the broker, working hard for his commission, says the property will trade at 7% cap rate, yet a buyer needs to get 9% or higher to compensate the buyer for the added risk vs dollar alternatives like a 7% foreign bond fund where there’s no tenants or toilets.

    I feel investors get tunnel vision re best and highest use of funds. The choice is not MF vs SFR vs self storage,,, it also includes Stock market / bonds with optional leverage. IMHO buying below 8% cap rate doesn’t make sense vs other non real estate choices that (may) have less risk and certainly much less work.

    • Chester Lee

      Hi Curt. Well said. Why would I want to work so hard as to deal with prop managers, pay prop taxes, and scout deals for a 5 or even 7% CAP, when I can get the same with zero liability by investing in a REIT on the stock market, assuming I invest in the real estate category. I can access 9 to 12% note investments for much less time duration (6 months to 1 year), backed by a first mortgage and the property insurance is issued in my name. Zero work in the REIT or notes investments. At year end, i get a 1099 for dividend or interest, and turn that into my tax guy.

        • Chester Lee

          Hi Tim,

          For stocks, especially REITs, find the on https://seekingalpha.com/dividends

          For Notes, you got to know people. It is a lot about networking. Often, flippers will need to borrow money to partially fund their purchase. The loans are always short term 6 months, with extensions if needed. typical rates are 9% to 12% or more. Just depends on the deal, and the risk. Plus, a lot depends on your assessment of the borrower. Does he select high quality properties to rehab? Does he have a reputation to finish on time Do his finished projects look like class A properties in class A or B neighborhoods? Do they sell fast? he has to sell, before he can return your investment. Go to Real Estate investment meeting in your area. there are always people looking to lend. There are always people looking to borrow. Get to know them.

          For turn key rental properties that return 9 to 10% net, cash on cash, message me if you are interested. I know a company who doesnt advertise. his company rehabs 150 properties a year. They all sell, either to locals looking for a place to live, or to investors.

  2. Justin Koehn

    Jamie, – Great article – I really appreciate you sharing your thoughts and analysis on this deal. One question that came up in my mind was about the 5% vacancy. If it had been fully rented for the last 2 years, why did the broker put in 5%? I would want to question him on if this was physical vacancy or financial. Maybe that would let you know more about those unexplained “fees”.

    Thanks again!

    • Chester Lee

      5% vacancy is almost an industry standard plug number. For a multifamily, that is a reasonable number. For a single family home, I’ve always felt a more accurate number is 10%. Consider this scenario. The house is initially leased out on a 18 month least (not 12 month, which is more typical). after 18 months, tenant moves. There is a month’s rent lost due to cleaning and showings to the next tenant. Unless self managed, there is another month rent lost due if using a property manager for leasing . So, 18 months of rent collected in a 20 month period (18 + 2). Note, we assumed the owner got all 18 months rent, and not 17 months, with 1 month going to the prop manager at the start of the least.

    • Jamie Turner

      Chester is right – for multi-family, in most areas, I would plug-in a 5% vacancy rate, even if the current owner reports no vacancies for a while. Circumstances change, management changes, tenant’s move. It should be planned for. I agree with the broker’s 5% vacancy in the pro-forma.

  3. This was very helpful to someone like me (own one 8-unit looking to expand). To be perfectly honest, I would probably consider the deal because to me the cash flow is hugely beneficial. I think an opportunity such as this comes down to the investor’s strategy.

    Depending on the investor’s relationship with the property manager and what they’re able to get covered/included may tip the scale.

  4. Calvin Bessonet

    So if you were to put down 20% of $560,000 which is $112,000 the cash on cash per yr would be 23% (26,000/112,000). What am I missing as to why this isn’t a good deal and better than the market? You also are building equity by having the tenants pay the note on top of the depreciation and other tax benefits. Thanks in advance.

        • Chad Drewson

          i’m new to financing. would you plug in 30 amortization numbers on a commercial property instead of shorter terms with a balloon where you’d need to refi every 5 years or so?

        • Megan Greathouse

          Chad, you’re right that this type of property would be on a commercial loan. I haven’t used a commercial loan personally, but my understanding is they generally include a balloon payment/refinance every 3 – 7 years, depending on the lender, and I believe the amortization period is usually 15 – 20 years, rather than 30. So yes, the financing example I gave is actually too optimistic for what the principal + interest payments would be.

  5. Mike Buckley

    Great article to get to the real picture. I love reading RE listings and seeing the expenses. $700 for snow removal! i got a good laugh. Nowadays you can’t even get someone to show up to a property without paying at least $70. So take that by the amount of times it snows, and how about some of those 24 inch snow days, forget it.. So true though people commenting about the price. It all comes down to the price, but for what you’re showing, I wouldn’t blame you to pass this one up. You won’t see that down payment back for close to 10 years.

  6. Jonathan Child on

    Thank you, Jamie! I actually just ran numbers on an 8 unit in similar condition of that you described. Your analysis was quite timely! I too passed on the deal, I love the scale of MF properties but on older buildings the energy and maintenance isn’t there compared to what seller’s want.

    Additionally, the lack of management fee is always a point of contention I find.

    Question: Why are broker’s numbers always so off? In your scenario, the broker’s pro forma is clearly pretty botched, but why? To fool an unknowing potential investor?

    Jon

    • Jamie Turner

      Brokers are salespeople and want to present the property in the best light possible; a higher published cap rate will draw more attention to the property, and that increases the likelihood of a sale. I’m sure they have some way to justify their assumptions, but it’s important to do numbers based on how each investor would manage the property.

  7. Philippe Johnson

    Thanks for article! My question is about the use of CAP rates in analyzing this or any deal. It’s confusing to me when I hear someone say “the CAP rate looked good on this deal”. CAP rate based on what? The seller’s asking price? It’s my understanding that properties of a certain type in a particular area should have a “given” CAP rate, and then that is used along with the NOI to get the value or asking price (there are websites that calculate the CAP rate when you provide the address and financials, etc.). Based on the notional asking price of $550K for this property, my spreadsheet gives a 5% cap rate. But should this property really be using a 5% to determine it’s value? Depends on the area, but with perhaps a more realistic 7% for a building this old, the asking price changes dramatically based on the NOI. Any other insights on methods to determine CAP rates for a property in order to determine asking price would be appreciated.

    • Jamie Turner

      Good thoughts. For a building this old, especially with the high maintenance costs, realistically I’d want a 10%+ cap rate.

      There are generally accepted cap rates for areas, but if the building is old and likely in need of repair like this, relative to other properties in the area, the cap rate should be higher.

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