Due Diligence: Verify and Validate Operating Expenses

[Charles D. Smith]

1. In today’s environment where prices are high and achieving targeted returns has become increasingly more difficult, every dollar saved is important. Investors should put a heavy emphasis on understanding all operating and capital expenses. This can best be done by requesting historical income and expense statements along with itemized (general ledger) detail showing every line-item expense the property has incurred for the time period requested. This type of examination may bring to light certain issues that an investor may not have been aware of. For example, the historical expenses may show lots of roof repair expenses, while it was thought that the roofs were in great shape. Or maybe you are buying an apartment building and see no charges for pest control only to find out it has not been done and needs to be budgeted going forward. Always ask for details on any capitalized expenses. Often there can be expensive repairs that aren’t easily detected in the income and expenses statements because they are being capitalized. This can make property operating expenses appear to be less than they really are.