Due diligence - Verifying Income and Expenses

What is the best way to verify the income and expenses of a property? If a property management company was involved would you trust anything that was asked of them?

On verifying the income, would you want to see canceled checks? Deposit slips? Would tax returns be sufficient?

When verifying expenses, being that most places want to be more secure with information, how do you get verification for different utilities and services in case the owner doesn’t have them documented well enough? :bobble

Thanks for any thoughts… I tried to look around on this board for more on due diligence information and found some information, but it was not to detailed.

Have a good day… and thanks in advance for your thoughts.

Bill

No matter what you’re told by any seller, the key is independent confirmation of the numbers from entities that have no vested interest in the sale.

Almost anything can be forged or exaggerated and often is. These are big dollar sales which unfortunately, bring out the worst in some people. Unless you are actually managing the property, you have to rely on what people tell you. It‘s sort of a contradiction, and this might be obvious, but the more open and forthright a seller is with information, the less I demand. To verify income, I will at least ask for:

  1. Copies of the leases (originals to be provided at closing)
  2. Estoppel certificates signed by the tenants confirming rent and security deposits
  3. A schedule E for the property (assuming the seller doesn’t consolidate properties).
  4. Walk thru every unit to confirm vacancies. Don’t just duck your head in to see a couch. Look in cupboards and closets to confirm someone actually lives there. Ditto the garages.

I have been involved in deals where the seller claimed a particular rent roll (confirmed by leases and estoppels certs) only to find out that yes, this is what the tenants are supposed to pay, but the property manager accepted whatever they could from them for that month. Assuming you run a business more efficiently, an independent way to confirm rents is to take what the seller says with a grain of salt and do a rent survey for the area. This number will tell you what you can actually expect, rather than relying upon what the seller say he’s getting. Hopefully, of course, the seller’s numbers are less. Talk to local property managers about what they think the rental market will sustain (Note: These people are trying to get your business, but if they all say the same thing, it’s probably reliable). I’ve also done some pretty accurate rent surveys, for neighborhoods thousands of miles away, using Craigslist.

For expenses, I ask for a years worth of receipts - all of them, including all utility and maintenance receipts. It’s amazing how many sellers “conveniently” lose these. I always go to the utility companies and tax offices to get independent corroboration, as well as talking to any vendors who received a disproportionate percentage of the expenses. As an independent confirmation, if it turns out that an old building is running at a 35% or lower expense ratio I won’t use it anyway and will base my offer on something like 45% or 50%. Few sellers will exaggerate expenses beyond that, which indicates a building with serious problems and an opportunity to profit by fixing them.

Of course if you’re dealing with an REO, you can’t expect the lender to possess any of this information. The inherent risks and associated sales price should reflect this. The bank will likely have the records they obtained when the building was originally financed, however. Request these. No matter what you’re told by any seller, the key is independent confirmation of the numbers from entities that have no vested interest in the sale.

Lastly, always talk to the pest control company, roofing, gardener, and any other maintenance companies since they often know of any skeletons in the closet of this property and are usually independent and honest. Same with the local police and community development office at City Hall. Sometimes, they know the specific building – and this isn’t always good.

Did I say that no matter what you’re told by any seller, the key is independent confirmation of the numbers from entities that have no vested interest in the sale?

Good luck.

Equity,

Thanks for the great response! I see my due dilegence sheet getting longer. :biggrin
Bill

That’s a whole bunch of time and effort that you don’t need to put yourself through. Put in your contract that you get to review and approve every current lease. Put in there that all rents and security deposits are to be brought to current before closing. Estimate your expenses at 50% and that takes care of that. If a buyer asked me for all my receipts I’d laugh and decline.

If you need to find out how much the owner is/was paying for utilities just call and give them the property address and they’ll fax you a 12 month history.

Good luck.

Yes, you can trust the property management company. In fact, if it is a reputable company I am inclined to believe their figures more than the sellers! The underwriter will need seller tax returns and “actual” income operating statements with current rent rolls. You can usually contact the utility company and let them know that you are considering buying the property and want to see a 12 month summary. They will usually provide you one. If not, they will definitely provide it to the seller who can provide it to you.

All the best,
Susan

Though a bit dated, this is a pretty good article:
http://www.creonline.com/articles/art-148.html

Don’t be afraid to ask for what you want.