Investment real estate: detailed records required
Buyers and lenders are looking for good information when performing due diligence
The first step we take in working with real estate investors thinking of selling their property is to understand the financial aspects of the investment so we can arrive at a suggested valuation.
And one of the very first obstacles we run into in this process is either a lack of information kept by the owner, or a lack of understanding of the importance of the information.
We typically ask the property owner for a rent roll, income and expense statements for the past three years, and any leases.
Before we get to income and expense information, we need to get a current rent roll, showing all rentable spaces, names of tenants, lease length, square feet occupied, base rent, reimbursable items like taxes and operating expenses and renewal options.
This document helps us to understand the potential revenue that can be generated by the property, and a sense of the types of tenants, how long they have been/will be there, and what they are paying.
We next look at income and expense statements, or “P and L’s,” that show us how the property has been performing over some period of time. We generally like to look at statements for the previous three years to get some historical perspective.
The starting point is gross rental income, which can take the form of base rent, reimbursements for the tenants’ share of taxes and operating expenses and other potential income sources like parking, laundry room revenue, etc.
One adjustment that we make to the income is a vacancy factor. We do this even with properties that are 100 percent occupied, because there are usually vacancies at some point, and this factor also takes into account unpaid rent, bad checks and other financial issues with tenants.
This is an item that many property owners don’t take into account, but it’s critical to buyers and lenders and must be factored in.
Expense items include insurance, property taxes, repairs and maintenance, utilities, advertising, landscaping/snow removal, etc.
One item generally overlooked in this area is a management fee. Many investors “self-manage,” and don’t hire third-party management companies, so they aren’t incurring an out of pocket expense for this item. However, many buyers outsource management and will impute a management fee in their analysis.
Lenders also impute a management fee because if they need to take over the property due to a default of the borrower, they will outsource management and incur a fee for it.
Other overlooked items include leasing commissions, fit-up costs for new tenants, and especially reserves for future capital expenses like roofs, painting, boilers, etc.
I would point out here that tax returns will eventually be requested by buyers and lenders as part of their due diligence, so it is very important that the internal bookkeeping documents bear a reasonable correlation to the tax returns.
The last group of documents we like to look at is leases. Rent rolls and income and expense entries don’t always tell the whole story about tenant obligations and rights, so a review of the leases is important.
And as with tax returns, leases will surely be required by buyers and lenders as part of due diligence.
The two takeaways should be: make sure you keep detailed records regarding your investment property, and make sure your tax returns accurately reflect the financial records you keep. Not only will this keep you out of trouble with the tax authorities, but in the end it will support the best value for your property when you go to sell it.
Dan Scanlon, a senior associate with Colliers International in Manchester, focuses on business tenant representation and investment sales. He can be reached at 603-206-9605 or firstname.lastname@example.org.