Deal Analysis

[Jeff Jenkins]

Hello all,

Can anyone recommend a method to practice analyzing multi-family deals without having a broker waste time retrieving rent rolls, P&Ls, etc?

Would anyone also be kind enough to provide a spreadsheet, or software recommendation for this process?

Thanks!

Jeff Jenkins

[Frank Gallinelli]

@Thierry Van Roy The "pupil" gets an A+ for hitting the nail on the head ;)

I may not be old enough to have discovered fire, but having done this kind of analysis for more than 40 years might qualify me as the ur numbers guy. And so I'm especially glad to see you encourage others to do the kind of financial work-up that I think is essential to making informed investment decisions.

Sadly, I find too many investors dismiss the importance of doing a Discounted Cash Flow Analysis and opt instead for very simplified (and dare I say sometimes too simple?) approaches. Those techniques may suffice for smaller properties, but when one gets involved with larger residential or just about any size commercial investment, I don't see how you can commit a serious amount of cash without performing such an analysis as part of your decision-making process.

I know I'm repeating myself from former posts, but I believe the process should go something like this:

a) Careful due diligence to determine current and likely future revenue stream, operating expenses, capital costs, and financing for the particular property; as well as investigation of market data regarding prevailing rents, vacancy levels, cap rates, and general economic trends.

b) Next, using that data to project current performance along with best-case, worst-case, and in-between future performance. This is where you start to take the investment's vital signs: Is the cash flow adequate, is the debt coverage ratio strong enough to secure financing, etc?

c) Using the projections not only to make a decision about an appropriate price to pay or to sell for, but also using the DCF to demonstrate (i.e. "sell") your reasoning to other parties involved in the transaction -- to the seller if you're the buyer, the buyer if you're the seller; the lender; or your potential equity partners.

Let me take this a step further, and bring up a point that is a big part of the grad-school course I teach. It is essential to run the numbers and to do so as reasonably and realistically as possible, but then you have to look for the story that may lurk behind those numbers. Why are the operating expenses or the current vacancy level higher or lower than you might have expected? The revenue figures may be accurate, but how strong are the tenants? -- in other words, is the revenue stream sustainable? Or perhaps, could you re-lease the property to stronger tenants in the future, creating a greater income stream and a higher value?

Running the numbers in a DCF is essential, but it's not just about what the numbers are; it's about what they can tell you.

In short, I don't believe in shortcuts, such as taking the rent roll and knocking off 50%. Buying and operating an investment property involves commitment, and that should start with a thorough financial analysis.