by Theresa Bradley-Banta
Looking to buy a multifamily property? How do you know what to offer? How do you know if you’ve found a great deal?
The key is in practicing thorough analysis. On every deal you look at. The only way you’ll get good at multifamily property deal analysis is to practice. The more deals you analyze the better because you will:
- Become proficient with the use of deal analysis spreadsheets
- Develop a baseline for analysis using properties in your submarket
- Gain an understanding of what local renter’s want—and what the competition offers
- Become practiced in the art of pro forma assumptions
Here are some tips on multifamily property deal analysis. When you carry out these tips you will start making offers on properties from a knowledgeable standpoint.
Grab a Pen
Before you open your multifamily property deal analysis spreadsheets grab a pen and paper (or open a new text document on your computer) and get ready to start taking notes as you review the deal. I do this every time I look at a new investment opportunity. Sometimes my list is two or three pages long.
Any question that comes to mind, no matter how small or seemingly insignificant, should make your list. For example your property analysis might raise questions like:
- Why does the property have such a high vacancy rate?
- Does the potential to raise rents really exist?
- The property appears to need some upgrades. How much of the repairs and maintenance will be immediate? What are the immediate and long-range costs?
- Are major building mechanicals like the roof and HVAC system in good condition?
- Why is the owner selling?
Whatever your question or observation, write it down.
Read the Offering Memorandum
What are your first reactions? What strikes you as odd?
Marketing comments like, “A new major neighborhood development is underway!” or, “Great opportunity to increase rents!” should raise red flags. Neighborhood developments don’t always materialize and when they do they may have no positive affect on the property. If the current owner can raise rents why hasn’t he/she already done it?
Hype is hype. Always question extraordinary remarks.
Keep adding to your list of questions. You can use your questions as you negotiate the deal or challenge the offering price if you think it’s too high. And the answers to the questions will help you plan for what you’ll do with the property if you actually acquire it.
Ready to Run the Numbers?
Open your property spreadsheets. By the way, you’ll find some free multifamily analysis spreadsheets at garytharp.com. I generally do three sets of analysis when I analyze a multifamily property.
1.) Analyze the Property Using the Broker or Seller’s Numbers
I like to run a property analysis based on the numbers provided in the Offering Memorandum (OM) because I want to see how the broker/seller has arrived at an asking price for the property.
The OM will give broadly categorized data for income and expenses.
Income usually includes “Gross Potential Rents.” This refers to the property’s potential rental income at 100% occupancy. The broker/seller will also include “Other Income” such as laundry income, fee income and utility income (tenant reimbursement for utility expenses).
On the expense side you’ll see:
- Real Estate Taxes
- Property Insurance
- Utilities (Electric, Gas, Water, Sewer and sometimes Trash)
- Repairs & Maintenance
- Marketing & Promotion
- Management & Leasing Fees
Again, the data is broadly categorized. You’ll see what I mean by taking a look at my article What Are Typical Apartment Building Operating Expenses?
In most cases you’ll see two sets of numbers: the current property income and expenses; and the pro forma income and expenses.
I’ve seen hundreds of offering memorandums where the current numbers are grossly exaggerated. It’s not a good place to start when you’re attempting to arrive at an offer price.
Pro forma numbers, which are based on assumptions, are often nothing more than calculated guesswork.
For example, potential rental income is often based on “market rents”—the rent local competition charges for their units. However the potential to realize “market rents” may not be realistic for the property you’re analyzing.
Until you complete significant upgrades and repairs, you won’t be able to command market rents. Or you’ll discover that the property is in a small pocket of a neighborhood that will never realize market rents. Or the property has a poor reputation that only proficient management, time and great marketing will fix.
It’s your job to investigate and challenge the pro forma numbers.
As my favorite mentor says, “If the grass is green, someone’s been fertilizing.”
A great place to start is by taking a look at where the property is today. And where it’s been over the past two or three years.
2.) Analyze the Property Using the Historical Operating Data
A property’s Historical Operating Data are the Year to Date (YTD) property financials.
You get them by asking for them.
I like to run a property analysis based on the seller’s current and historical operating financials because I want to see how the property actually performs today. Without assumptions and glorified pro forma numbers.
Also known as Annual Property Operating Data (APOD) these financials will include:
- Annual YTD Profit & Loss Statement
- Property Rent Roll
These two documents are rarely included up front. You must ask for them.
On the income side:
You can use Gross Potential Rent when running this analysis. But do not base the rental amount on “market rents.” Use the current rents listed in the property Rent Roll. For more information on Rent Rolls read my article Multifamily Rent Roll Analysis.
Be sure to base your Gross Potential Rent at 100% occupancy. If some of the units are vacant find out what they would rent for or use your best guess based on the unit type. Also, don’t forget to apply the market vacancy rate to your analysis. You might think twice about using the current, record-setting low vacancies of today—I use a 7% vacancy in my local market analysis.
Include any other income the seller lists in their YTD statements.
On the expense side:
Use the P&L statement provided by the seller. Rather than base your analysis on the broadly categorized income and expenses a seller/broker generally provides, use all the line item property expenses.
You want to arrive at a picture of where the property is today.
Does it cash flow? Is the owner self-managing or using a third-party management company? Can the rents be raised? Don’t change your analysis based on what you will do with the property. Use the seller’s numbers to get a good picture of the property under its current ownership.
You’ll learn a lot from this analysis. For example, you’ll know:
- How motivated the seller is
- Whether the asking price is realistic
Don’t forget to keep taking notes from your analysis of the property.
The Art of Multifamily Property Deal Analysis
Obviously a seller/broker will paint the best picture of a property in support of their asking price. After you take a look at how the property actually performs today you may not want to offer the full asking price.
Should you make a lower offer based on what you see in your analysis of the APOD? Many sellers are struggling with their property. They are not currently realizing the returns a property should get when managed and operated well.
Your job is to decide what the property is worth to you in the long run. What is an acceptable return for you and your partners?
Important: Don’t forget to include the necessary capital expenditures that will come out of your pocket to upgrade a property to it’s fullest potential. Money you may have to spend from the first day of ownership. Also, consider the time and cost (including lost revenue) to get the property fully operational.
3.) Analyze the Property from a Pro Forma Perspective
Now it’s time to look at the property as if you actually own it. How will this property do financially under your good management and new operations policies?
For this analysis you’ll need to create or get a spreadsheet that includes categories for all projected income, expenses, debt service and capital expenditures over a 12-month period.* Click this link to see a sample multifamily pro forma spreadsheet.
On the income side:
Begin month one with the current occupancy and expenses. If the property is at 25% vacancy, start there. Make income projections based on your ability to begin to rent out the vacant units and increase rents over the next six to twelve months. However long it will take to reach market occupancy and market rents if possible.
Do the same with other income. For example if the current residents are not paying for their utilities but you will be implementing a utility reimbursement program for all new leases and renewing leases, project that future income in your analysis. Do the same for new fees or other ancillary income you will introduce to the property.
Ancillary income would include fees such as: common area usage, trash, vending, parking, storage, guest suites for visitors, clubroom rentals, bulk telecom programs (bundle TV, internet and phone), renter’s insurance, and pet deposits.
On the expense side:
This is where having a good baseline from similar properties comes in handy. Or having a good mentor in your corner. A multifamily real estate investing mentor can help you with pro forma assumptions. Start with the current expenses as provided by the seller. Now replace the expenses that will change under new ownership.
For example, if you plan to hire a third-party management company at a 6% management fee, use that cost in your analysis. Other property expenses that will change under new management are:
- Debt service (mortgage payments)
- Leasing fees
- Maintenance fees
- Trash removal
- Legal and accounting
You get the idea. When you own the property you will not be paying the same expenses or debt service as the previous owner.
You can get a good idea of expenses by shopping around. For example, check with your local tax assessor to find out what the new property taxes will be. Call your insurance agent and verify the cost of new insurance. Call local vendors such as trash removal companies and ask about their service fees. Talk with your property manager about their associated costs and fees.
This analysis will help you arrive at a fair offer price.
Is the current reality so dismal it will take years and large infusions of cash for the property to reach it’s full potential? Or is the property worth the current asking price because it is well-managed and operated? Is there a happy medium?
When you thoroughly analyze a real estate deal you remove the guesswork. Another benefit of multifamily property deal analysis is that you’ll have a great strategy in place for what needs to be done the day you close on the deal.
Practice, Practice, Practice
The best way to become great at multifamily property deal analysis is to practice. A lot. Thorough multifamily property deal analysis is the best way to avoid making costly mistakes.
Real estate is a game of negotiation. It’s expected. Guesswork is not.
*If you want me to e-mail you the pro forma spreadsheet or you have questions on multifamily property deal analysis, get in touch. I’m easy to reach over at my contact page!
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