Apartment Building Income and Expense Analysis: Your X-Ray of Financial Health
Investments in apartment buildings
As the residential real estate market continues to slide, many real estate investors have been drawn to what could be the next big financial boom market: apartment buildings. An ancient Chinese blessing says “may you live in interesting times”. Well, if exciting times are seen as a blessing, then the real estate market must be full of opportunity. We probably haven’t seen such an “interesting” real estate market since the 1950s.
When it comes to investments in apartment buildings versus investments in single-family homes, I have found that it is easier to make a sound financial judgment on investments in apartment buildings than on single-family homes. The reason is simply because when you buy an apartment building you have the ability to view historical financial statements. These financial statements are called operating income and expenses, and the buyer of the apartment building can generally obtain these financial statements that are three years old. The great thing about viewing the financial statement is that you can see exactly what your gross income and expenses have been for the last three years. This allows you, the investor, to roughly determine the value of the property and what the expected rate of return will be.
The operating income and expenses or financial statement of the multi-family investment you are considering is a tool that is like an X-ray to a doctor examining a patient. By looking at the income and expenses of your multifamily property, you should be able to determine a number of things that will affect the overall “health” and monetary returns on your investment.
The first task to do when analyzing income and expenses is to take a close look at all expenses for each year and find out which expenses have increased or decreased from year to year. For example, you may find that the expenses listed for landscaping increased from $4,000.00 in year 3 to $7,000.00 in the most current year. This could be because the owner has made significant improvements to the landscaping of the property, which could add value, or it could be because he hired a new landscaper who charges more for the same service. The new apartment investor should examine all expenses listed for each year and make comparisons for all years to ensure there are no discrepancies. When there are differences, the investor must act like a detective to find out the reasons. Sometimes discrepancies can represent hidden value. Using the example above, you may know of a landscaping company you currently use that will maintain the landscaping at a lower cost. This difference alone could completely change your financial analysis of the property. This concept is known as forced appreciation. I discuss forced appreciation in much more detail in my “Buying Your First Apartment Building E-Course” linked at the bottom of this article.
In contrast, when you buy a single-family home for investment purposes, you don’t have a historical record of the rents you can expect to receive in the future. If the home was not formally a rental home, then you should rely on a market estimate given to you by your real estate agent. This estimated rent may or may not be accurate. You also have no way of knowing what your expenses will be for that particular property. Most homeowners do not keep a separate balance sheet for their household expenses.