How do you verify income on a property (rent rolls, leases?)

Question

Hey guys,

I'm reading a REI book and it is talking about verifying the income on a property before making a purchase. This seems obvious but how this is done more specifically and what prevents a seller from inflating numbers, and how can you independently verify current rent rates and occupancy? Is this a buyer beware type of situation, or are sellers contractually bound not to inflate their numbers?

Thanks,

Julius

Jeff Copeland · Answer

It is commonplace to have each tenant sign an estoppel letter that basically states "I hereby certify that my lease is $X per month and expires on XX/XX/2017".

The seller should provide this upon request and it should be part of your due diligence. At least that way you've double-checked with each tenant and confirmed that they acknowledge their lease terms.

This also prevents a tenant from coming to you after closing during your first rent collection and saying "Hey, my rent is not $660, it's only $600" - This actually happened to me recently, and I was able to show them the estoppel letter they signed just a couple of weeks previously and say "Well, you just signed this last month acknowledging that your rent was $660, so $660 it is"...

The seller also can't provide an estoppel letter from a vacant unit (there's no tenant to sign it), so it should eliminate any confusion over occupancy rates.

Dustin Beam · Answer

On my deal, I asked for his previous year's tax statements. If he/she lies to the IRS, you'll never get the truth anyway. But frankly it will probably work to your benefit of they did. As far as I know, people don't typically over report their income haha.

Dustin Beam · Answer

@Amit Kal you're probably right on most accounts, but I want expand a little on what I said earlier. What I like about the tax statement is that it should have expenses and income in there. And you're right that people lie to the IRS, but if they do, it probably helps the buyer.

Think about it, what are the two most likely things they would lie about? Probably under reporting the income or exaggerating the expenses. In either scenario, it makes the property look less valuable and gives the buyer negotiation power. But, I can't disagree that a buyer should always go through the financials as thoroughly as possible, so additional verification may be needed.

Amit Kal · Answer

My personal opinion is that the tax return method is not reliable for a number of reasons including rent rolls that could have changed drastically since the last filed return or the seller may be underreporting income, etc.

What a seller reports to the IRS is none of my business, if they want to cheat the government, that is their own issue to deal with. My only concern as a buyer is the rents the seller is advertising are verifiable. I do like the estoppel letter idea that @Jeff Copeland points out. Although as a seller I would not provide that until after the property was under contract; conversely as a buyer I would make furnishing of an estoppel letter a contingency for the sale.

Matt Smith · Answer

My take away from this post, be it 3 years ago, is that you are not convinced that the offer is a great deal as it stands. A great deal is a great deal regardless of what the stated, or actual rents are on the property. If you're needing to see rent rolls on anything SFH then you're telling me you're not familiar with the area, and/or not convinced of the deal. Commercial Rent Rolls are a different story, but I argue the same. You've got to know a great deal when you see one as it is presented.

Dustin Beam · Answer

The amount of positive cashflow doesn't matter to you. It does to me. I'm saying that if a seller says he collects x amount each month but his taxes say he collects half that, then you can bet your life I'm going back to the negotiation table with a lower price. Or it will confirm what the seller claims in the first place. Either way, it is super unlikely a seller is paying taxes on money they aren't earning. Ymmv

Amit Kal · Answer

That might work if it's a SFH or duplex. But to try and do that at any larger scale would be madness when trying to coordinate with X amount of tenants.

One thing I recently did was have one months rent put in escrow by the seller which would be released as I received the rents from the tenants.

Amit Kal · Answer

@Dustin Beam as a buyer, why is it of any concern to you if the income or expenses reported to the IRS are true or false?

Take for example where I am a seller and all my tenants are paying me in CASH and I report only 25% of it to the IRS - that I have chosen to underport my income does not affect the value of the property one bit. Likewise if the reported expenses are being inflated; it has nothing to do with reality.

I don't think you will get anywhere with saying to a seller "well because you lied to the IRS, I think I should get a discount on the property."

Ibrahim Hughes · Answer

I like the estoppel letter also. However, I would look to either have it signed by the tenant in my presence OR have it notarized (I have experience in this and having the tenant sign it in my presence saved my butt on one occasion). Sellers do some crooked ish in some markets. Just to get a property sold.

How do you verify income on a property (rent rolls, leases?)

How do you verify income on a property (rent rolls, leases?)

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