Case Study: A 7-Unit Multifamily Financial Statement Analysis [Real-Life Example!]

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Brokers can be excellent deal sources for investors, but it’s important to analyze their offering memorandums (OM) and do your own projections.

I recently reviewed the OM of a 7-unit building I was considering purchasing. After reviewing the financials, I decided the deal didn’t fit my criteria. Hopefully there are some lessons in the analysis.

The cap rate looked good, so I analyzed the financials to validate it (there’s an excellent explanation of cap rate here).

Offering Detail

• 7-units, a mix of 1 and 2-bed apartments
• Building approximately 100 years old
• Large lot in the Northeast (Hint: landscaping and snow plowing costs)
• Coin-operated laundry in place
• Building fully-occupied with no vacancies reported the past two years
• Current owner self-manages and owner provided 2 years of historical financials
• Broker assembled a pro forma

Actual numbers are adjusted slightly so as to not call out the deal and this broker specifically.

Here’s what I saw in my analysis. Have a look for yourself and let me know your thoughts by leaving a comment under this article. I’ll do my best to reply to all your comments.

	2015 Actual	2016 Actual	Broker’s Pro-forma
INCOME
Rent			$85,000
(Less Vacancy 5%)			($4,250)
Net Rent			$80,750
Other Income
Laundry			$700
Pet Fees			$350
Other Income			$700
Total Other Income			$1,750
TOTAL INCOME	$75,000	$74,100	$82,500
EXPENSES
Utilities	$11,700	$8,660	$10,532
Landscaping & Snow Plowing	$4,400	$3,100	$700
Property Management	–	–	$4,125
General & Administrative	$2,900	$5,000	$700
Insurance	$4,000	$4,100	$3,350
Property Tax	$12,000	$12,400	$12,400
Repairs & Maintenance	$18,000	$13,000	$3,000
Advertising & Marketing	$275	$250	$700
TOTAL EXPENSES	$53,275	$46,510	$35,507
NET OPERATING INCOME	$21,725	$27,590	$46,993

Income

It appears the current owner is only reporting a single number for income, inclusive of rent, laundry income (unless laundry income isn’t stated), and any other fees. The slight Year Over Year (YoY) decrease in income could just be a decrease in laundry usage or other fees (if other fees are being charged). It could also be tenants behind in rent.

Rent

Monthly rent can be increased $75-100 per unit, with some cosmetic updates to units. That’s $6,300-8,400 per year total for the building.

The broker used the high estimate for the increase in rent. Based on the local market, the projected rents are reasonable. However, increasing the monthly per unit rate by $100 when the existing rent is well under $1,000 per month may not be realistic all at once.

To get that increase, you would need to:

• Make the cosmetic enhancements one unit at a time as vacancies occur and charge the next tenant $100 more.
  • The risk here is it could take years for this to happen. Remember, the current owner reports no vacancies for the past two years.
• Evict the tenants, make cosmetic updates, and charge higher rents to the new tenants.
  • This is the simplest way to do it in my opinion, but it also eliminates some or all income for a while. If the existing tenants are good tenants, this may not be a good idea.
• Without cosmetic enhancements, increase the monthly rent by a full $100 per unit all at once (in this area, there is no legal maximum increase).
  • The risk here is the existing tenants can’t afford a large increase and/or feel some kind of injustice at paying so much higher for the same unit and leave.

Laundry

Does the historical total income reported by the owner include laundry? The broker or current owner might be able to answer that. The 2015 and 2016 numbers don’t break down rent from other income.

The pro forma includes the existing total income, plus the rent increase, plus laundry income.

There could be some double-counting of laundry income in the pro forma.

Pet Fee, Other Income

This one is interesting. With the current owner self-managing and not breaking down any tenant fees in the financials, it’s doubtful (s)he was charging pet fees, but it’s possible. The pet fee could be double-counted in the pro forma. (Ask about this.)

What is “other income”? The pro forma states it’s estimated at $100 per unit per year. It could be late fees, but if current tenants have been there for at least two years continuously, that number may not be realistic.

Expenses

The expenses here hint at a story. Two years of stabilized tenants, yet 2015 expenses were quite a bit higher than 2016. Why?

Utilities, Landscaping & Snow Plowing

Utilities decreased 25.9% YoY, and repairs and maintenance decreased 27.7%. Snow plowing costs also went down. The differences here could be attributed to the milder 2016 winter relative to 2015. It’s an older building likely without insulation, and the better weather also could have resulted in fewer repairs. There are some assumptions in there, so I would ask the broker and owner to explain.

Landscaping and snow plowing? Unless you’ll be shoveling snow yourself or we somehow know mother nature isn’t planning a northeast snowfall this year, the big decrease in the pro forma snow plowing cost isn’t at all realistic. Call a contractor and get an estimate to plug-in.

Property Management, General & Administrative

The current owner self-manages. Presumably, some related management costs are accounted for in “general and administrative” in 2015 and 2016.

The pro forma general and administrative expense is a reasonable estimate and should go down, since the new owner may not self-manage.

The pro-forma includes 5% of rent for property management services. In this region, the standard is 10%, with a bunch of fees piled on (see a breakdown of property management fees here). I would plug in a more realistic property management cost in the analysis.

Insurance & Property Taxes

Insurance costs are also projected to go down. Based on my experience, the current owner more often than not is getting a decent rate. A good analysis should include a slight increase in insurance costs unless the current cost is clearly too high (that would be another thing to ask about) or unless you know a really good insurance broker.

The pro forma predicts stable property taxes. To be safe, a slight increase the same amount as seen as in 2016 would be prudent. This isn’t a large amount and definitely not a deal breaker.

Advertising & Marketing

It’s a safe assumption these costs will increase if you’ll be vacating the units to make repairs, increasing turnover. Personally, I would place the marketing burden on the shoulders of the property manager and negotiate those costs as covered under the 10% fee.

My Analysis

After looking at the expenses, there isn’t a projection for the needed cosmetic repairs to get the higher rent. If I want the higher rent, I’ll probably need to make the cosmetic repairs. If I get as far as a property visit, I’ll try to eyeball this or bring along a contractor.

Below is a sample that I put together to analyze this deal myself.

Related: 5 Ways to Jump Up to Large-Scale Multifamily Investing

My assumptions:

Income

• Rent will go up by $100 per unit per month
• Laundry income of $700 will be removed from rent income and added to laundry income
• The pet fees will be included (I would visit the property and see if tenants actually have pets and if I can get them on new leases)
• No “other income” will be added since it may already be included in rent

Related: Swap ‘Til You Drop: Multifamily Tax Avoidance Tips from Closing Table to Inheritance

Expenses

• Utilities, Repairs & Maintenance, Landscaping & Snow Plowing: used the mid-point of the 2015 & 2016 numbers
• Property Tax: $400 increase, consistent with 2016
• Insurance: $100 increase, consistent with 2016
• Property Management: 10% of net rent, inclusive of all fees
• Advertising & Marketing: $0, covered under property management
• General & Administrative: I would have some administrative costs, but property management should cover most of them; $100/unit/year is reasonable

	2015 Actual	2016 Actual	Investor Pro-forma
INCOME
Rent			$84,300
(Less Vacancy 5%)			($4,215)
Net Rent			$80,085
Other Income
Laundry			$700
Pet Fees			$350
Other Income			$0
Total Other Income			$1,050
TOTAL INCOME	$75,000	$74,100	$81,135
EXPENSES
Utilities	$11,700	$8,660	$10,180
Landscaping & Snow Plowing	$4,400	$3,100	$3,750
Property Management	–	–	$8,008.5
General & Administrative	$2,900	$5,000	$700
Insurance	$4,000	$4,100	$4,200
Property Tax	$12,000	$12,400	$12,800
Repairs & Maintenance	$18,000	$13,000	$15,500
Advertising & Marketing	$275	$250	$0
TOTAL EXPENSES	$53,275	$46,510	$55,139
NET OPERATING INCOME	$21,725	$27,590	$25,997

The financials can tell a story, but also generate a lot of questions. You’ll need to piece together a solid analysis of the building by asking good questions, validating answers, getting contractor estimates, and, of course, looking at the property yourself.

In this case, I wasn’t interested in learning more. I would still need to factor in the cost of upgrading the units but didn’t get that far. The broker may have a wonderful and honest explanation for why costs are projected to go down so much and revenue to increase, but I saved him the phone call. The potential net operating income (NOI) just isn’t high enough to fit my strategy right now, and I’m sure a 100-year old building will continue with ongoing maintenance costs.

We’re republishing this article to help out our newer readers.

There is more than one way to analyze a deal. What do you see that I didn’t?

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.