Financial Statements Supporting a Residential Investment

Investors are often out of their depth producing required documents for lenders and investors. They feel inadequate or poorly prepared to accomplish this end. However, preparing the documents is really mainly a function of knowing what the documents are and how they interrelate.

The key documents for a rental investment whether it is a single family home, a duplex, a four plex or an apartment complex of several hundred are:

1. The residential rental property information including age of construction, number and type of units, amenities, acreage, number of buildings, features per unit (appliances, flooring, carpet, heating, air conditioning, bathrooms, bedrooms, etc.), and address;
2. Debt information including term, amortization, rate, interest only or not, and amount plus broker and lender information fees and origination costs;
3. Capitalization table with investor information including name, address, email, phone, fax number, amount invested, price per unit, number of units purchase, total equity invested, and management interest;
4. Sources and uses showing debt (from the debt information), equity (from capitalization table), fees, improvement reserve, operating reserve, purchase price with sources equal to uses;
5. Balance sheet showing assets consisting of operating reserve, improvement reserve, buildings, land, and other, liabilities showing all debts, and owner equity. Assets will equal liability plus owners equity. Buildings and land will include the capitalized costs of the purchase price and fees;
6. Pro Forma financials showing revenue, expenses, debt service, improvement costs, net cash flow and operating reserve;
7. Occupancy assumptions per month over the life of the project. Most banks will want to see a minimum of three years and up to seven years. Normally five is a number of years that works for all;
8. Key metric calculation for Net Operating Income, estimated value based on assumed capitalization rates, loan to value ratios, and debt service coverage ratios; and
9. Return calculations including Internal Rate of Return (IRR), cash on cash performance, and return on investment as a ratio of cash flow annually to cash invested.

(The following examples are generated by our financial statement tool.)

With these defined, investors can easily pull the information together, ask there accountant to pull the tables together, or use a service or tools to complete these documents. In fact, we have prepared a package of tables that allow simply filling in the blank to produce all the tables automatically. As an investor, the onus is limited to knowing your expected debt terms, investments by investor, property information, planned improvement costs, and expected income and expense. The worksheet then automatically produces the entire set for you.

Keep in mind as you consider this information, that regardless of how you produce these statements, you should examine the documents to assure that they make sense at each level. When completing this you should be checking balancing amounts on the balance sheets, verifying expense totals, verifying revenue totals, verifying income, verifying cash flow, and so on.

by Blake Ratcliff

Investors’ Pro Forma and Financial Workbooks

I am preparing a financial workbook and pro forma for investor.  This items will include:

1. Property description factors including address, acreage, unit mix, key  unit descriptions, amenities, acres, and buildings,
2. Expense table to be input  by the investor,
3. Income table to be input by the investor,
4. Occupancy table to be input by the investor,
5. Economic assumptions to be input by the investor,
6. A debt table to be drawn from the lender’s offer or the input from investor assumptions and will include debt tranche / draw inputs,
7. Key metric calculations including Debt Service Coverage, Loan to Value, and Value based on 6%, 7%, 8%, and 9% capitalization rates annually and annualized for the last 90 days of each year,
8. capitalization table including investor information for investor communication,
9. Sources and Uses of equity and debt for the project,
10. Return  tables stated  as IRR and cash on cash results over 3 year, 5 year, and buy and hold annual return on invested cash.
11. 5 year improvement cost table to be input by the investor
12. 5 year proforma financials including Net Operating Income projections, Cash flow projections.
13. Appraisal inputs for building and land value.

The document will include a legend of investor inputs (cells highlighted to indicate investor input), calculated values, and which tables require investor input.

Non-Investor input cells will be locked (this will include descriptions and calculated fields).

All documents will be set up to print cleanly in portrait or landscape format.

This complete set of documents will allow investors & principals to quickly produce all required financial tables for their supporting investors or lenders.  While no pre-prepared tables can meet every scenario, I believe this tool can satisfy most investors needs.

Unfortunately, because of the complexity of this document and likely required refinements in the future, this cannot be offered for free.  The anticipated cost is under $50.00.

I am very interested in investors input on any additions or changes they would propose to this material.

Photos

Due diligence is a great time to capture a photo perspective of the property.  Photos should accomplish a number of items:

1. The best faces of the property will give a good start for the property website later.  These photos may be where you begin before you are able to capture professional staged photos of views and residents later on.
2. Photos should capture each critical view of the units, the buildings, the grounds, amenities, nearby shopping, neighborhoods, nearby sites.
3. Photos should provide critical information for planning improvements, staging the office and a myriad of other items.

Photos are one of the critical items for showing the property to investors, to lenders, to staff and support contractors as you develop initial operations and business plans.

General Guide to Multifamily Investment Due Diligence

Successful multifamily investment requires careful consideration of a range of areas supported by carefully prepared information, research, and analysis for these areas. This is known as the due diligence process. A well executed due diligence assures appropriate funding, strengthens the total financial plan and therefore potential returns, and finally leads the way to completing a successful investment.

This article does not seek to provide all the necessary steps to effective due dilingence. The point of this article is to highlight in as a great of detail as possible what each of the due diligence areas are and the importance or purpose of the particular area.

Due diligence can be divided into some key general areas:

1. Sales contract negotiation and details,
2. Financial needs including the appraisal, debt & equity structure, budgeting, and distribution & exit plans,
3. Operational expense needs,
4. Physical infrastructure needs and inspection including associated reports,
5. Legal and title requirements,
6. Market factors,
7. Management and staffing,
8. Operating agreement / investors contract,
9. Resident issues and analysis

Each of these areas is multifaceted bringing information demands, investment opportunity, and risk management requirements. We will explore each of these in limited detail below as a foundational comprehensive look at the due diligence discipline required evaluating multifamily projects for investment or acquisition.

The sales contract is not normally considered a due diligence item by most investors. Nevertheless, we recommend reviewing the contract specifically focusing on:

1. Items to be provided during due diligence,
2. Requirements to maintain occupancy, revenue, and quality of residents in place and being added,
3. Requirements to allow ongoing inspection by the purchaser,
4. Requirements to correct day-to-day maintenance,
5. Processes should an insurance company repair occur during the contract period as well as guidelines for value adjustments should units be lost to acts of God or other insurance addressing repairs,
6. Requirements regarding background and credit check of the existing residents and new residents added while under contract, and
7. Pre existing liabilities

The sales contract should have specific financial considerations protecting the integrity of the investment post closing.

Financial requirements will include past utilities costs, recent property improvements, dates of roof replacement, dates of paving and sealing, a review of the appraisal, project budget, historical income and expense statements, and project pro forma financials. Additionally, the investment should be supported by a fixed investment management, exit, lending, and banking service plan.

Operationally and physically, the keys inspection areas are type of electrical wiring, HVAC, roofs, termite inspection, metering, trash, age of appliances, acreage, unit by unit inspection, building inspection, grounds inspection, paving and sidewalks inspection, amenities facility inspections and punch list development, development of and review of environmental and property condition reports. This should include photos showing the best of the property for marketing, investor development, and lender support purposes. Also, photos should capture and record major structural and physical issues.

The operating agreement should be reviewed for budgeting, capital expenditure management, sales and acquisition rules, status with state and local authorities, occupancy certificates if applicable, status of tax payments, survey encroachments, survey parcels, and other legal guiding documents and forms.

The market and submarket studies are critical elements for due diligence. The study should result in a detailed marketing plan that flows down to a set of actions designed to:

• Improve customer satisfaction,
• Improve retention,
• Drive traffic,
• Close leases,
• Increase revenue

Developing the marketing plan and market information includes collecting the following:

1. Economic trends,
2. Major employers,
3. Economic demographics including per capita income, industrial employment breakdowns, etc,
4. Lists of local businesses, shopping and restaurants of interest to residents,
5. Lists of local churches and religious groups of interest to residents,
6. Lists of clubs, schools, government facilities, colleges, universities, points of interests,
7. Ethnic, racial, education, and age demographics,
8. Comparable rents and amenities,
9. Comparable sales,
10. Housing inventory, price, and rental information

Additionally, the marketing information should include photos of nearby shopping, schools, points of interests, signage, comparable properties, etc. These photos combined with the other information will be a part of the larger plan for the investment, part of property websites, ILS website info, etc.

Today marketing should include a clear and detailed management plan for online marketing plans.

The Company should have an articulated proven plan for screening and managing resident issues from initial contact, to day-to-day operations, and finally to eviction or moveout.

The management company must demonstrate proven accounting, reporting, leasing, property maintenance, improvement management, resident screening, resident management, expense management, and investor reporting capability. Also, the management company should a clear concrete resume of skills, education, and experience relevant to delivering all of the above items. Further, the management company should have articulated plans for acquiring and maintaining management skills needed to support the investment.

Finally, the investor should spend enough time with the principals to assure comfort and trust regarding communication and management capacity to assure the success of the investment.

In summary, the above article provides a general outline of the major due diligence issues. While in no way, conclusive and totally comprehensive this article can serve as a good starting point for an effective due diligence process.