Bad Accounting

[Craig Willard]

I found a stash of duplexes that I have become interested in potentially purchasing. The numbers look solid at 13% Cap Rate. The 2% rule is at 1.5 and COC return is close to 30% (20% down). After feeling good about that, I request financials from one of the duplexes. The accounting work is crazy, for example, the units rents for $765 however the year to month end is $9900. I have a statement for each side. the other side shows year to month end at 6000. One would think that if you are really interested in selling your rental property, at least make sure the accounting adds up. Have any of you all experienced bad accounting when investigating rental property purchase? What did you do if you did experience accounting numbers that mathematically did not make sense? Is this a sign?

[Mike T.]

Yes, all the time and the reasons for it vary as much as the quality of tenants that you will be inheriting, which by the way, from my experience is directly proportional to how good/bad the previous owners accounting was. Best thing to do in those situations is to do your homework and generate your own numbers. Use the line items (not their quoted costs) as a starting point to determine what expenses go into you cash flow analysis. Get the actual costs of each line item from either your own personal experience or research and go from there. Common line items that are too high or are not necessary to have, are typically related to services that the current ownership is paying for (e.g. gardeners, coin laundry leases, pest control services, etc.) Obviously some of these expenses won't disappear entirely, but could be run differently (coin laundry for example - you could opt to not renew when the lease is up and instead buy your own machines) but perhaps could be performed for much cheaper price (i.e. gardeners). Part of the most important part of getting the line items is to see what contract/liabilities that you're going to inherit (i.e. are there service contracts that you will be inheriting and responsible for paying? like "Bud's Pest Control Service" that charges $150/month on a 2 year contract?).