Evaluating Multifamily Operating Statements

By Brent Horvay, Portfolio Risk Solutions, LLC

April? 2024

Multifamily is one of the more widely held sectors within commercial real estate. While it is a traditional (and familiar) asset class, methods used to report operating performance vary. For example, a self-managing owner may report performance without fully allocating costs associated with the management function. To the contrary, a passive owner will allocate the market rate cost of a third party manager. ?It is important, especially to a creditor, to understand how the underlying property would perform using market-rate costs. This point is illustrated through the following Class C multifamily case study.

Let us start with analyzing an operating statement provided by a self-managing owner. In this case, the property is a 28-unit apartment building (consisting of Class C studios).The property owner, separately, owns a general contracting firm which he utilizes to manage accounting (both payables and receivables) and handle maintenance calls for the property.

·??????? Income

o?? Rental Income

§? $188,404

·??????? Expenses

o?? Insurance

§? $5,989

o?? Property Taxes

§? $28,219

o?? City License

§? $1,250

o?? Fire Alarm Monitoring

§? $1,755

o?? Utilities (gas, electric, sewer, water, garbage)

§? $16,794

·??????? Net Operating Income

o?? $134,397

The expenses reported by the property owner are accurate, however, that cost structure is only available to the current owner. It does not reflect the anticipated costs for a new, passive owner.

In order for a new owner, or a creditor, to evaluate the fully loaded costs of operating this property going forward, the following analysis must occur:

Expenses

o?? Insurance

§? $6,288 (5% projected inflationary increase)

o?? Property Taxes

§? $31,041 (10% standard anticipates tax increase)

o?? City License

§? $1,250 (to remain the same)

o?? Fire Alarm Monitoring

§? $1,808 (to remain the same)

o?? Utilities

§? $17,298 (3% projected inflationary increase)

o?? Property Management Fees

§? $14,130 (third party market rate of 7.5% of rental income)

o?? Leasing Commissions

§? $2,240 (market rate of 50% of one month’s rent for 30% of units)

o?? Unit Turns

§? $3,200 ($400 for 30% of units, based on historic turns)

o?? Common Area Cleaning

§? $2,400 (market rates for third party service)

o?? Repairs & Maintenance

§? $9,400 (market rate of 5% of revenue)

o?? Snow Removal

§? $1,000 (estimate)

o?? Pest Control

§? $500 (estimate)

·??????? NOI at Market Rates

o?? $97,849

These adjustments provide a more realistic NOI and a better indication of value, debt service capacity, and return on equity.

In addition to financial analysis, it is important to conduct a site inspection when taking control of a property. Site inspections often reveal important factors that financial statements do not such as:

deferred maintenance - capital expense issues that need to be budgeted can be found during a site inspection and it is essential to understand the useful life term of the building’s systems and mechanicals (HVAC, water heater, electrical system, roof, basement/foundation issues, etc).

occupancy verification - comparing the rent roll to actual occupancy will assure that units reported as rented are, in fact, rented; and units reported as vacant are, in fact, vacant and not occupied by parties not paying rent to the property owner.

Furthermore, finding the right property manager is critical to the success of a property. A good property manager will prioritize the property owner’s best interest, and will be able to operate the property effectively and efficiently.

Some areas to consider when searching for a property manager include:

1.??????? Does the manager have experience with property similar to the subject property;

2.??????? Does the manager hold a real estate license (important when dealing with tenants);

3.??????? Does the manager have a dedicated staff and/or a reliable group of vendors to handle property matters;

4.??????? What systems does the manager use to report and what measures are taken to protect data;

5.??????? What are the conditions of other properties under the manager’s control;

6.??????? Will the manager provide references.