Capital expenses and NOI

[Gretchen Roberts]

I've read that capital expenses shouldn't be included in an NOI calculation, but is it ok to include a per-door reserve? (By OK, I mean if I include it and use the resulting figure as reasoning for making a specific offer, will the seller think it's normal or that I'm trying to pull one over on him?)

[Joel Owens]

How many units are you talking??

The sophistication of the seller is usually based on the number of units they have.

Example 5,50,100 unit building etc. will have different sets of books and accounting procedures. Generally I find the smaller the property the sloppier the books.

This is because larger properties tend to be ran by larger commercial firms that keep and track mostly accurate and various reports lenders will require.

For reserves you will need to see the type of property and size you are going after and if you get a loan what the lender requires.

You will get push back on reserves and capex from the seller as they will say it's subjective and they are selling based on the NOI. You have stand your ground if they do not include customary items. So as an example when my clients buy a larger building the lender will make certain assumptions of (UCF) underwrite able cash flow. If the seller says they manage themselves and no fee is calculated the lender will use a safe percentage for that area ( say 6% for example) if market shows that is the standard rate on the appraisal. If the seller is claiming 100% occupancy but vacancy in the area averages 5% then the lender will take that off as well. They do this to protect their position in case of take back or foreclosure etc. If they lent based on all the sellers inflated assumptions they would take a much higher loss if things went bad. This is why it is absolutely critical to know for an area the vacancy rate and average management fee and calculate it upfront along with lender reserves. If the numbers are not adding up from what the seller is stating it's better to know upfront and explain to them WHY you won't be able to pay that price for XX reasons. If they will not comply and are looking for a sucker it's best you found that out now before spending thousands to tens of thousands only to find out they are not motivated to sell. Another gotcha is they base NOI off of unrealistic numbers and claim higher occupancy but when you go in the books you find higher vacancy ( they said 3 year average was 94% but it really was 87%) and claimed rents were 600 a door but after finding out waiving of first months rent the effective rent really was 550.

All of these little things start adding up to where you have to come back to the seller for a 700,000 reduction and they say no way etc. You learn after doing this all the time to do most of the work upfront on key metrics to save time. Hope it helps.