Data Collection and Income & Expense Analysis of Apartment Buildings

Data Collection and Income & Expense Analysis of Apartment Buildings

Here is the first post in many to come on analyzing residential income properties. This is directly from my course on property valuation and analysis.

Learning Objectives of this Post on Analyzing Apartment Buildings and Residential Income Properties: Data Collection and Income & Expense Analysis

  1. Identify sources of data
  2. Describe the components of an income & expense sheet
  3. Understand how to arrive at Net Operating Income (NOI) from Gross Scheduled Income (GSI)

The first step to accurately determine the market value of a real estate investment is a solid program of data collection and analysis. Each property will have its own unique considerations

All should at least begin with:

  • Property type
  • Overall condition of the improvements
  • Type of construction
  • Neighborhood analysis
  • Overall market conditions
  • Income and expense analysis
  • Legal requirements, zoning etc
  • Comparable property data

This list is broad in scope, but it’s a good foundation for the data collection plan. The data collected from the market on comparable type property will be used to determine the appropriate capitalization (CAP)  rate and make market comparisons in a later step. Unsure of what a Cap Rate is? Check out my blog post that explains everything you need to know about this powerful valuation metric.  The next step is the actual collection of the data.

Data Sources

The data required for the analysis is obtained from many of the same sources as the information used in residential sales.

  • Owners records
  • Multiple Listing Service (MLS), Costar, Loopnet, Commercial Agents & Property Owners, Public records
  • Census data
  • Chamber of Commerce
  • Local Housing Authority
  • Appraisers
  • Trade associations
  • Local Council of Governments
  • Tax assessment records

This should give you an idea of a few of the possible sources of data and the steps to begin the data collection process. Once the data has been collected the next step is the analysis of the data.

The Operating Report (Profit and Loss Statement)

When analyzing a real estate investment, we begin with an existing operating statement, also known as a profit and loss statement. The operating report will consist of both income and expense items attributable to the property. In the first step of the analysis, we will only be concerned with the cash income and expense of the property. We will consider depreciation and other non-cash benefits in a subsequent calculation.

Gross Scheduled Income

The gross scheduled income is the amount of money that the property would produce on an annual basis if it were fully occupied. Included in gross scheduled income would be any income attributable to the property from non-rent sources.

What types of sources can be included for determining gross scheduled income?

These sources could include income from laundry and vending machines, parking and storage fees, as well as other owner operated concessions.

When analyzing the gross income, consideration is given not only to the existing rents being charged, called contract or current rent, but also economic or market rent, which is the rent the property would command if it were available for rent in the current market. An adjustment can be made to the gross income if the market indicates that market rent differs from the actual rent. If such an adjustment is made, that should be plainly noted on the operating statement (see loss to lease).

 

Vacancy & Collection Losses and Effective Gross Income

The chief component in the calculation of effective gross income is the vacancy and collection loss rate. Most properties are not expected to remain fully rented for the entire period of ownership. When a tenant vacates, often there is at least some rental income lost during the turn over period due to repair or remodeling time. In addition to this consideration, one must face the reality that there may be a situation where a tenant becomes unable or unwilling to pay rent as agreed. In this circumstance there will be some rental income lost.

The vacancy and collection loss is usually expressed as a percentage of the gross annual rental income. There are several generally accepted methods for determining the amount of the vacancy and collection loss

  •  Historical data on the subject property
  • Published figures for the community
  • Market analysis

Other places to get historical operating data is

None of these things by themselves will probably give you a 100% complete picture but combining different resources the picture will become much clearer.

Historical data and market analysis are perhaps the most accurate, because typically published figures for the community are an average, and may not be representative of the property you are analyzing. Once the appropriate rate has been developed, the loss is subtracted from Gross Scheduled Income to derive at Effective Gross Income.

Example:
Gross Scheduled Income $12,000
Vacancy and Collection Loss (5%)  (600)
Effective Gross Income   $11,400

Gross Operating Income

To figure the gross operating income you go through the following steps:

Gross Scheduled Income
– Vacancy & Credit Loss
= Effective Gross Income
+ All Other Income (garage rent, laundry income, vending, etc)
= Gross Operating Income

The figure derived from this process is what we will call rental income. This is the actual income received after taking into account vacancy and credit loss against potential income.

Other income can come from a variety of sources. In apartments, it is quite often laundry, but it could be rental on furniture for furnished apartments, garages, etc.

The resulting figure of gross operating income is all the income left over after subtracting out the above mentioned items. It is your actual income in hand before expenses. Therefore it is a very important number.

Operating Expenses

The next step in the analysis process is to determine the total operating expenses for the property. Like income, expenses will be analyzed on an annual basis. The investor will do a detailed analysis of the expenses of a given property, so it benefits the practitioner to have done a thorough analysis in the beginning.

It is important to carefully analyze all categories of expenses to accurately portray the financial condition of the property. There are different categories of expenses, depending upon the type of property you will be analyzing, however all expenses are segregated into two basic categories, fixed expenses and variable expenses.

What are three fixed expenses and 10 variable expenses?

Fixed Expenses

A list of typical fixed expense categories will include

  •  Property taxes
  • Insurance
  • Landscaping and service contracts
  • Any expense that does not change from month to month

What determines a fixed expense is the fact that the expense will not vary in response to changing levels of occupancy.

Do not include mortgages as part of operating expenses!Mortgages are not part of operating expenses and are categorized elsewhere.

This group of expenses is not difficult to document for your analysis, but be careful to consider the fact that these expenses may not be the same for a new owner; i.e., the building insurance may go up and most likely the real estate property tax may be reassessed upon transfer.

Real Estate taxes can be one of the largest expenses so make sure to calculate any new tax increase or decrease in your analysis.

Variable Expenses

This category of expenses is much longer, and categories to consider will vary depending on the type and size of the property under analysis. This category will include all of the expenses necessary to maintain the income stream of the property and to provide agreed upon services to the tenant. To attempt a comprehensive list of all expense categories for all types of properties might be impossible and, certainly, is beyond the scope of our study. We will discuss the more common types of expenses in some detail, remembering that each property has unique characteristics and may include its own unique expense categories.

Off-Site Management

Many properties will be managed completely by off-site personnel. The cost of off-site management is determined and subtracted as an expense of operation. It should be noted that a management expense is a valid deduction from income even if the owner is managing the property. There are many firms specializing in this field; they usually charge between 4% and 10% of the rental amount.

 Payroll On-Site Personnel

Resident management is used when the day to day activities of the property require constant supervision. A resident manager is sometimes given free or reduced rent. If that is the case, you must include the managers unit rent in gross scheduled income, then enter the amount of free rent as an expense. In California, if a property has 16 or more units it is the law to have a resident manager on site.

 Expenses/Benefits

This would be for other management costs. For instance, office and administrative expense, performance bonuses paid to an on-site manager, and any health insurance or retirement plan contributions would be listed here.

Taxes – Workers’ Compensation

Whenever there is an employee, there are various taxes the employer is responsible for. Among these are: Social security tax, unemployment tax, as well as local, state and federal income taxes. These taxes are payable by the employer, and in addition, the employer is required to withhold some amount from the employee’s pay and forward it to the IRS.

Repairs and Maintenance

This is the total amount of repairs and maintenance necessary for the year. This would not include any money spent on capital improvements. A capital improvement is any improvement which substantially increases the useful life of the property. If you find a property which has not had any maintenance expense in the recent past, you will probably find a trade off in the overall condition of the property.

Utilities

This is probably the most difficult portion of the operating statement to complete accurately. This information is most easily obtained from the owner. NOTE: If the owner is paying the utility bills and is then reimbursed by the tenant, the full utility cost will be listed here and the amount reimbursed to the owner would be listed as other income (this is referred to as R.U.B.).

Accounting and Legal

This is the amount for the bookkeeping required on the property. It will include any amounts paid for payroll reporting or for monthly profit and loss statements. This should also include any legal expenses associated with evictions, drafting of leases, etc.

Advertising, Licenses and Permits

Many larger properties will have ongoing advertising expenses. At the very least there will be some cost at each vacancy. This includes the amount spent for advertising, as well as any licenses or permit charges; e.g., city business license, pool inspections, and/or housing code inspections.

Supplies

This might include supplies for the vendors mentioned previously: Bug spray, batteries for smoke detectors etc.

Miscellaneous

That’s right! There should always be a category for those expenses too insignificant to warrant their own category. This would include any additional expenses which were not accounted for elsewhere in the analysis.

 Contract Services

These are services which are supplied by outside vendors not already accounted for under fixed expense categories. These are additional services such as maintenance contracts, design services, appraisals and as many others as necessary.

Here is a list of the more common expenses in alphabetical order. Some of them we list without explanation because they are rather obvious:

  • Accounting and Legal expense
  • Advertising
  • Gas
  • Insurance
  • Licenses and permits
  • Miscellaneous and other expenses Property Insurance
  • (Property) Management
  • Payroll and Workers Compensation
  • Real Property Taxes
  • Repairs and Maintenance
  • Services
  • Sewer
  • Supplies
  • Telephone
  • Utilities (Such as the electric bill)
  • Water

Total Operating Expenses

This is the total of the expenses calculated. This is not to include vacancy or credit losses. Remember that what we are attempting is to give as accurate a picture as possible of the property’s financial condition. The property’s value will be dependent upon the ability to produce income, so it is important to be as accurate as possible in estimating both income and expenses.
The total operating expenses are now subtracted from the effective gross income.

Example:
Effective Gross Income $11,400
Total Operating Expenses (4,500)
Net Operating Income $ 6,900

Net Operating Income (NOI)

The net income that a property is capable of producing will be one of the first indicators of the worth of an investment. Later when we begin to apply the capitalization rate to the property, the NOI will be used to estimate total investment value.

The calculation of the net operating income does not take into consideration the effect of any potential financing of the property. This may seem odd at first, but in consideration, it will not take long to realize that the property should have a value that is completely independent of any financing that an investor might use to acquire that property.

Measure NOI correctly in order to properly value property

NOI is arrived at as follows:

Gross Operating Income
– Operating Expenses
– Capital Expenditures
Net Operating Income

Sales Proceeds

The sales proceeds that come from divesting yourself of a property are as follows:

Sales Price
– Selling Expenses
= Net Sales Proceeds
– Adjusted Basis _
= Taxable Gain
– Depreciation _
= Capital Gain / Loss

 

Data Analysis

Having discussed the income and expense analysis in detail, we will concentrate on the balance of the data and other considerations. The property will be analyzed for the following:

  •  Income quantity
  • Income quality
  • Income durability
  • Special risks

All of these considerations will be compared to other investments available in order to determine the appropriate rate of return and measures of value for the property being analyzed.

Test Your Knowledge: Data Collection and Income & Expense Analysis Questions

1. What is the chief component in the calculation of effective gross income?

2. How do you come to Effective Gross Income?

3. Circle the following that are considered an operating expense:

Property taxes Insurance The owner’s income taxes
Mortgage debt service Payroll taxes Utilities
Property maintenance

4. How do you arrive at NOI from Gross Operating Income

5. How do you arrive at the capital gain / loss from the sales price?

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How to Minimize the Risk of Owning An Apartment Building

How to Minimize the Risk of Owning An Apartment Building

A question was poised on the SDICA forum that I thought would be a good one to address.

The question was, “what steps can I take to minimize my risk of buying and owning an apartment buildings right now”?

Great question

Ask and you shall receive. Here is what I am doing to keep my properties operating effectively.

    1. Tenant retention
      • You’ve heard the old saying in business it’s easier to keep a client than to get a new one. Well, your tenants are your clients, and unless you’re grossly under-rented, you need to retain as high a percentage of possible of your current apartment tenants.
        • Keep a reminder in your calendar for 60 days before their lease expiration, so you can talk to them about renewing. If they are going to move, it’s best to find out as soon as possible. It’s helpful to find out why because sometimes you may be able to convince them to stay if its an issue that is rectifiable.
      • Have a Nicer Product or Better Rents (Or Both)
        • Tenant Improvements
        • Start by spending money on items that are unsafe or may cause emergency calls. These issues will happen, and if possible deal with them before it becomes a problem. Being proactive goes a long way. It also saves a lot of money and aggravation not to get calls at midnight.
        • When making improvements to the units, some of the best ways to get maximum bang for your buck is to:
          • Paint the unit – Two-tone color choices (wall color and white ceiling) are always a good idea. This will cost more initially, but once it is complete you will rarely ever have to paint the ceiling. You also want to paint the base, case, and doors a nice white color in semi-gloss. The more you can make the place feel like a home rather than an apartment the better rents and retention you will get.
          •  I like to make sure the texture looks well-done. It does not have to be perfect,  but you definitely do not want patches everywhere.
          • If you’re looking for a good painter, I highly recommend TruLine Painting. I’ve used them on all of my projects and they really do a great job of giving my units a quality facelift.
        • Update the interior doors & hardware
        • Flooring – I like to use as much tile and or laminate (the stuff that looks like wood) as possible. It costs a little more the first time but lasts 5 times as much as carpet and you will probably get about 5% more in rent.
    2. Get ahead of the game
      • If you have vacancies coming up get on it quick and return calls immediately.
    3. Track the market
      • Do rent surveys & talk to other apartment owners of similar buildings in the area where you own property (send me an email or drop a comment if you want to know how to do rent survey report & spreadsheet). This is also a great way of finding properties for sale. Make sure to give everyone you talk to your information and let them know that if they ever think about selling to give you a call.
    4. HAVE GOOD SYSTEMS IN PLACE
      • We automate as many of the processes as possible by having good checklists of activities we do repetitively. Instruction sets are created on each item to make sure that we do it correctly and consistently. It’s hard to figure out what is and is not working if you don’t do things consistently so you can track them. It makes it so much easier to improve on what we are doing. In addition, it allows me to easily hire people and get them up to speed quickly, or, if I lose someone, I know how to do that task and I am not held hostage or overly dependent on any one person.

Here is a quick example of sample turnover procedures.

  • Once someone gives us notice to vacate (sample of one of our move out inspection flow charts)

For example we have our systems for

        • Pre-marketing,
        • Final walk through (see sample flow chart of walk-through) letters go out to tenant with instructions on ours and their responsibilities.
      • Once it is vacant we will: walk through checklists for repairs, vendor coordination, property showing, applications etc.)
        • A few things we do to make it more efficient: Use an electronic Realtor (sentry) lock box. This device allows my assistant to generate up to 10 random codes daily from the office. When someone calls my google voice number, I get a text with the voice message which I forward to her which goes in our database. She then calls them back to get the rest of their contact info including an email. We then send the prospect an email with instructions on how to get to the property, how to enter, and THEIR OWN code which we inform them to not give out to anyone because it is tracked (see sample form letter below which we EMAIL to prospects). We are then able to log on to see who looked at the property so we can follow up to see if they are ready to fill out an application and why or why not. Also now that we have their email address, if they decide not to rent with us we now can update them in the future about upcoming vacancies 6 ,12,18,24  months from now when they may be thinking of moving again. This is crucial for renting out units fast.
        • Viewing instructions for our units

          • If they want to fill out an application, we  use my smart move/transunion credit/criminal check which they do online and either pay for or they give us the cashiers check and we then pay for (I like this way better because they are more committed after giving us the credit check fee) which we get a copy of along with the prospect. With this service, I do not have to collect social security codes and worry about certain compliance issues. In addition, it also speeds up the process. We then get an approve or disapprove based on our criteria and can then make a decision.
          • Once an application is accepted we send them an approval letter/email/phone call and let them know they will shortly receive a lease package via email for electronic signature using a service called docusign which is legally binding.
          • My assistant puts together the resident package which includes some of these items
            • lease agreement
            • resident welcome manual which spells out the rules in detail and what is expected from all parties
            • non smoking/drug addendum
            • maintenance addendum (look on blog for sample)
          • All of these are put into docusign for email/electronic email distribution. An email get’s sent out which is signed by both parties (legally binding) and no paper has to be printed. The fully executed copy goes in their file which is on our computer server for any reference in the future.

Hopefully this can give you some ideas on better ways to operate your apartments which will reduce your risk. As always feel free to give me a call or drop me an email to discuss further.

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Curtis Gabhart and Gabhart Investments, Inc – 2018 All Rights Reserved
The material contained in articles that appear on gabhartinvestments.com is not intended to provide legal, tax or other professional advice or to substitute for the proper professional advice and/or commercial real estate due diligence. We urge you to consult a licensed real estate broker, attorney, tax professional or other appropriate professionals before taking any action in regard to matters discussed in any article or posting. The posting of an article and of any link back to the author and/or the author’s company does not constitute an endorsement or recommendation of the author’s products or services.

 

Funding Your Real Estate Deals

Funding Your Real Estate Deals

 

Our workshop series covers the 5 F’s of Residential Redevelopment: Finding, Feasibility, Funding, Fixing, and Flipping. In our upcoming workshop we will be focusing on FUNDING.

Some highlights include:

  • The 3 most important things an Equity Partner looks for.
  • Hard Money Loans: How to get them and how to make them work for you.
  • Private Lenders and Trust Deeds
  • Leverage: When it helps & when it hurts.
  • How to determine what souce of funding is right for you.

 

We are hosting this event at our Ciera Project, located in the prestigious Heritage Community in Poway. We we will use the Ciera Project as a case study for applying the various funding methods in relation to high-end ‘flipping’. For more information on the Ciera Project visit our WEBSITE.

 

Visit EVENTBRITE to register!
Thanks to our sponsor

 

I like to get our name out there.


Thanks




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Our Real Estate Goals for 2012

We are big on setting and achieving goals so we’d like to share our 4 main goals for 2012:

1) We will exceed the return expectations and needs of our investor partners.

Thus far, 3 of our funds have been completed. We are pleased to report that our investors received the following average IRR on their capital:

Fund 1 – 24%
Fund 2 – 26%
Fund 3 – has only one property (rincon) remaining in escrow to sell in early March and we are projecting a 22% average investor IRR for that fund.
Fund 4 – 33%
Fund 5 – has two properties left, linwood which went into escrow the first day on market and they both look solid. This may be our best fund to date.
Fund 6 – We have purchased a $510,000 property on a golf course with minimum work & a condo so far with a few more in the pipe.

2) We will purchase 30 properties and 20 sales in our single family funds

while continuing to maintain a conservative selection process and high profit margins. We have increased our manpower here in the office by hiring Max Frank for accounting support and Tamara Peterson for administrative and project support. We have the team and resources to expand on our current model and start exploring new opportunities within our residential niche.

  • 4 Properties in the first quarter
  • 6 properties in the second quarter
  • 8 properties in the third quarter
  • 12 properties in the third quarter

3) We will diversify our funds with some higher-end homes.

With the success ($140k profit in one month) of the Via Divertirse project, a 4,000 sf home in San Clemente, we have started exploring opportunities in the higher-end $600k+ markets within the jumbo loan limits. We are seeing some price compression and much fewer competitors chasing deals in that market. More of our time could be spent on fewer projects with higher profit margins.

4) We will open a separate fund to buy and hold property.

Returns have been good, but our investors have expressed interest in the returns and capital gain tax advantages of buying and holding property. Values are firming up in San Diego and the availability of longer term private financing for stabilized rentals has prompted us to open a fund to capture returns from rental cash flow and longer term appreciation.
Here is a couple of links to our most recent posts on goal setting taken from our workshop “goal setting & business planning”

Goal Setting & Modeling others

Goal Setting

Here is a great video from Brian Tracy on goal setting. If you’ve never heard of him, you should strongly consider hearing what he has to say. He is a great teacher and motivator and has inspired me for years.

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planning for the FUTURE of your business

planning for the FUTURE of your business

Our workshop series covers the 5 F’s of Residential Redevelopment: Finding, Feasibility, Funding, Fixing, and Flipping. None of which would be possible without the “6th F” (we had to use an “F”): planning for the FUTURE of your business. Having a successful real estate business starts with knowing what you want to accomplish and then creating a plan you can execute.

With the new year upon us, it’s a great time to step back and evaluate your Real Estate business and set some measurable goals for 2012. In this workshop we’ll share with you our plans and goals for 2012 as well as the process we’ve used to develop our plan.

 

Some highlights include:

  • Developing a business plan for yourself and to give to investors and lenders.
  • Setting, tracking, and measuring goals.

Space is limited, so visit EVENTBRITE to sign up & reserve your spot!

 

Thank you Trilion Capital for sponsoring this event.

 

 

For the most updated information & news on real estate & Gabhart Investments go to our Facebook & twitter pages

 

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