the-abcs-of-real-estate-investing-ken LifeFeeling

6
Number
of Units
Toted
Toted Rent/
Type Sq. Ft. Sq. Ft. Rent Rent Sq.Ft.
1/1 650
2 2/1 750
8 Averages 675
3900 $422 $2,532 $0.65
1500 $480 $960 $0.64
5400 $437 $3,492 $0.65
Now that the actual rent numbers are in this table, it is clear that the rents used by the
seller or broker were a full $63 per unit higher than what the property is actually generating.
Over a twelve-month period, that equates to $6,048. If you would have bought this property
based on the seller’s pro forma, your income would have been more than $6,000 below
what you expected. That’s not good.
But what if the seller doesn’t reveal the actual rent numbers in the small print on a
brochure pro forma, and they usually aren’t. Then you must request a rent roll and use those
numbers for your calculations. You should even verify the small print rents on a brochure
such as this one by comparing them to the actual rent roll. Trust, but verify.
WHAT ABOUT VACANCIES AND OTHER INCOME?
At this point, we have verified the actual potential income for the property. Remember
that’s the income the property could generate at current rents with 100 percent occupancy.
But certainly, it is highly unlikely that this property is or will be 100 percent occupied every
day of every year from now until eternity. So we have to take into account vacancy and
turnover from residents moving in and out. And while we’re at it, we should consider any
other income generated from sources like laundry facilities, parking, and so on.
The typical pro forma lists these values as well. And surprise! these numbers, too, I have
found to be inaccurate most of the time. Vacancies are usually understated and other income
is usually over-inflated. The key here is to try to project what the vacancies and other
income will be in the future. It’s nice to know where you’ve been, but where you’re going is
really more important. That’s why the windshield is so big and the rearview mirror is so
small.
Common sense will tell you that if an apartment is not rented, it is not producing
income, and that reduces your cash flow. Even if the vacancy rate is listed on the pro forma,
verify it with the property manager on your team. He or she will be able to tell you if the
vacancy rate listed is at, above, or below the average of the market and will know this
because vacancies are mostly a function of supply and demand within the market. You can
also find this information by looking at the monthly rent rolls and move-in dates on the
leases.
The income section on the pro forma is where the seller lists the property’s income and
the vacancy rate. It shows the income from rent, minus the average vacancy for the
property, and adds to it the other income the property generates. The typical pro forma
income table looks like the one below, which contains numbers taken directly from the
property in Phoenix. In this real-world example, the seller or broker is reporting a total
income for the property to be $45,120 per year, using a 7 percent vacancy rate and $480 in
other income. That seems pretty good. But look at the rent figure. It’s based on the inflated
rent numbers listed on the unit mix and rent schedule. You remember those; they were the
ones with the asterisks. That's not good.