What are the best sources and methods for verifying operating expenses of multifamily properties?

1 Seller's documents

The first source of information for operating expenses is the seller's documents, such as income and expense statements, rent rolls, tax returns, utility bills, and invoices. These documents should provide a detailed breakdown of the actual expenses incurred by the seller over a period of time, usually 12 months. You should request these documents from the seller as part of your initial offer or letter of intent, and review them carefully for completeness, consistency, and accuracy. You should also compare them with the seller's pro forma, which is a projection of future income and expenses, and identify any discrepancies or assumptions.

3 Market data

The third source of information for operating expenses is the market data, which is the average or typical expenses for similar properties in the same location and submarket. Market data can help you benchmark and validate the operating expenses of the property you are evaluating, and identify any outliers or anomalies. For example, you may find that the property has unusually high or low taxes, insurance, or management fees compared to other properties in the area, and investigate the reasons behind them. You can obtain market data from various sources, such as industry reports, publications, databases, brokers, appraisers, and other investors.

4 Tenant interviews

The fourth source of information for operating expenses is the tenant interviews, which are conversations with the current or prospective tenants of the property. Tenant interviews can give you insights into the quality of service, maintenance, and management of the property, and how they affect the tenant satisfaction and retention. For example, you may learn that the tenants are happy with the responsiveness and professionalism of the property manager, or that they are dissatisfied with the frequent breakdowns and delays in repairs. You may also learn about any tenant concessions, incentives, or reimbursements that may impact the net operating income of the property. You should conduct tenant interviews in a respectful and courteous manner, and ask open-ended and relevant questions.

5 Third-party verification

The fifth source of information for operating expenses is the third-party verification, which is the confirmation of the accuracy and validity of the information provided by the seller or other sources by an independent and reliable party. Third-party verification can help you avoid fraud, errors, or misrepresentation of the operating expenses of the property, and protect your interests and rights as a buyer. For example, you may hire an auditor to review the seller's financial records and statements, a tax consultant to verify the tax assessments and liabilities, or an insurance agent to check the coverage and premiums of the property.

6 Sensitivity analysis

The sixth source of information for operating expenses is the sensitivity analysis, which is the estimation of how the operating expenses of the property may change under different scenarios or assumptions. Sensitivity analysis can help you prepare for contingencies, risks, and opportunities that may affect the performance and value of the property in the future. For example, you may project how the operating expenses may increase or decrease due to inflation, market conditions, tenant turnover, capital improvements, or operational efficiencies. You should use realistic and conservative assumptions, and test various scenarios to determine the best and worst case outcomes.