Income and Expenses
A very important part on an analysis of any income producing property or even a business opportunity is to have accurate and relevant information concerning income and expenses. A form often used in commercial real estate is called the APOD and stands for "Annual Property Operating Data". This is a great form, but often not used correctly. For instance the first line ask for "Projected Income", in other words if you have 15 units in an apartment house what is the total amount of income when 100% full, 100% of the time at the maximum rental amount that the market will sustain. What I really look for and require from an owner is actual income, what is the owner actually collecting in income? That is Key. Start with projected income and then reduce it to actual income with the vacancy factor.
Projected income is like saying if I had a PhD I could make $150,000 a year. Well if I didn't have to make payments I would not be selling real estate!
The second line in the calculation process is the "Vacancy Factor", how much money do you expect to lose due to no income from several units, 5%,10% or even 25%? What the vacancy factor can do is reduce projected income to actual income or vice versa. Actual income divided by projected income will give you a vacancy factor, or "Income Loss Factor". One of these figures will have to be true to real life. Either use actual income or get projected income down to actual income by using the vacancy factor. One or the other has to be true or your figures from here on out will be at best "speculation" an could be the difference in having a good property that will make money or go broke.
The next line item is Income and Expenses. I always use true real life figures and even add in things that I know will change or that the owner missed. Probably the largest single expense item missed is property taxes. Taxes always go up and if you mis-figure this expense, it can cost you big time. I have seen properties with low tax rates, more than double or triple with a new owner. The reason is the taxes usually are looked at about every 3 years and a new buyer may have a low rate for a year or two and then when the assessor picks up the new value the taxes will go up. Now, if you missed that in your analysis, you may not have any money left to pay yourself a dividend or make loan payments. The figure that is so vitally important is NOI or "Net Operationg Income". That is what is left after vacancy and expenses. This figure is what will pay the mortgage and give you an income, so it is the most critical figure in your analysis. If Net Income is not good, you most likely will never see a profit or even get a loan.
Lenders look very closely at projected versus actual income, and they certainly look at the reasonableness of expenses and then compute the Debt Coverage Ratio and then adjust either expenses, income and loan amounts. Can this kill a deal? You Bet if your analysis is suspect or plain old amateurish then you will not get a loan or put the lender at risk.
That is why it is vitally important to hire a CCIM commercial broker to help with the analysis and presentation package. A 5 year analyis is critical to a commercial or multi-family project. Due diligence and proper analyses of income and expenses will save a lot of problems in the future.