Evaluating Deals Series 1: The Profit and Loss Statement

You sent out your yellow letters and waited patiently. Finally, you got a call. There’s a guy wanting to sell his apartment building and you ask him about his numbers. At a certain point, you will want to have a T12 from him. That’s a statement of profit and loss for the trailing twelve months prior to today.

The first thing to look at is whether the seller knows what a T12 is. If not, that’s OK, but they are probably not too sophisticated. This might mean they have inefficiencies elsewhere, so keep your eyes open. If the seller can give you a T12, you will have a wealth of information on how the property has been doing for the past 12 months. The T12 is just a Profit and Loss statement given over the previous 12 months rather than for a certain year.

Take a look at the top and make sure the dates are correct. You don’t want the seller to be giving you last year’s numbers and conveniently leaving out the unexpected loss he took this year. The T12 needs to have a few important items. If any are missing, you need to ask the seller why they are not on the sheet.

I’ve had a seller ‘forget’ to put on his management fees. When I asked about it, he stated that my management fee would probably be different and he didn’t think it necessary to add it in. Of course, I promptly figured the typical management fee I pay. I’m amazed that sellers try to do this. There must be inexperienced buyers out there paying too much because the expenses were lower from the lack of management fees. When that buyer takes over, he will be in for a surprise: pay the typical 8% or manage it himself.

Profit and Loss (P&L)

This statement gives a quick overview of how the property fared over the dates listed on the P&L. It doesn’t show anything about the value of the property (the asset) or how much is owed in back rent, just how the cash is flowing into and out of the company. On the top, we usually have the Income, on the bottom, the Expenses. The bottom line just subtracts the Expenses from the Income to arrive at the Net Operating Income.  

Income

The income part is usually short. There will be a line for rents. This is the actual rent income that was received. It won’t tell you details on how many people owed back rent, or how long units were vacant. Line items from your analysis like the vacancy loss will not be on here. Those aren’t necessary; the actual income already accounts for rent not received due to vacancy or nonpayment of rent.

Income will also have items like garage rent, laundry rent, utility paybacks, and late fees. Add these all up and you will have the Total Income line. These amounts can be verified with the seller’s tax return which you will have no-doubt requested. You also should call the rental office posing as a renter and see what they are asking for rent. If that is different from the Income statement, you have a problem.

The seller could falsify income to increase it on paper, making it look like the property is doing better, and therefore, the sale price should be higher. In practice, I don’t think this is done much. It is too easy to discover that lie.

Expenses

This is the largest part of the P&L and the one most susceptible to creative accounting. Sellers will neglect to put certain expenses on here and claim they didn’t think they belonged on the P&L. For instance, they might have been paying themselves a management fee and argue that the buyer won’t be doing that so it shouldn’t be on there. Worse, they might have been paying for expenses out of another account or business and fail to report it on this statement. An example would be that they have two different apartment buildings, each owned by a different company. One company pays for snow removal for both. The P&L might truthfully have $0 for snow removal but this is really a falsification because it is an expense for the property. It’ll fall on you to realize that $0 for snow removal is impossible.

Expenses will have things like utilities, taxes, insurance, repairs, management, lawn and snow, garbage, accounting, legal, internet, telephone, and perhaps some others. If these aren’t listed, it’s a red flag. Most properties need these and when you take over, you will too.  

Add up all these expenses and you have the Total Expense.

NOI

Net Operating Income is easy, just subtract the expenses from the income.

Net Income

Sometimes sellers will tell you how much they paid back to the bank for their mortgage. That is then subtracted from the NOI to get the Net Income (also known as Cash Flow or Profit). This isn’t really important for you. Your mortgage payback is important but it’ll be different from the seller’s.

Don’t use the P&L to determine how well the property will perform. That is a different calculation. It should be used to gather data for your calculations and as another way to verify if you are being given accurate numbers or not.

Dr. Equity

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