Episode 102 – Real Estate Asset Management Part 2: Financial Analysis

Being an asset manager means being in control of the assets for your real estate syndication or real estate investment fund. The job itself is like property management, but you can think of it as the higher-level decisions that go on to ensure the asset performs the way it’s supposed to. We talked in the last video about property analysis; this video talks about the financial analysis that takes place. Again, the purpose here is to set a baseline for the existing performance so we can measure against it and identify issues before they become problems. This is also where you may start to see it’s time to exit the property, either here or in the market analysis, which is our third video. I hope you find these videos helpful.

We’re talking about operations, custody, and in this video, we’re talking about financial benchmarking. We’re discussing this here because, under the custody portion, we’re setting a benchmark. This is something you’ll regularly do either every month or every quarter to keep track of where you’re at with your property. We’re trying to set a benchmark to ensure we’re on the right track. It lets us know where we’ve come from and where we’re going.

First off, this is not your underwriting portion. The underwriting portion actually comes under rally and undefined, where you’ll be mostly doing your underwriting, as well as in the finance section. I’m going to go through this in some level of detail, and it’s going to be repetitive to some extent because I want to make sure we’re getting this. This is the basis of all real estate, one of the most important issues. By far, understanding how the money works helps you understand how a syndication works, and then ultimately, you can talk to an investor.

To get started, we need a few things. We need a rent roll, which you may have already done in your lease analysis. If it’s not done yet, you will need to generate a rent roll because you’re trying to find out who all your tenants are, what the rent is, and what operating expenses they pay to put into your financial benchmark. It’s also very helpful to have three or more years of operating history. You may or may not have this, but it certainly helps to figure out costs, income, or vacancy rates to accurately predict them. Then we’ve got our Loan Summary because we’re trying to find out the cost of the money we’re using, the cost of the debt we’re applying to this syndication.

What we’re going to do is take a snapshot. This snapshot can take place on a month-to-month basis, and I encourage you to do it that way to ensure you’re on top of your finances at any point. This feeds directly into the information that’s valuable when giving your investors their updates, which will be either monthly or quarterly.

Let’s start with these two ideas: we have our above-the-line costs and our below-the-line costs. That line is drawn at NOI (Net Operating Income). Everything above the line goes into calculating NOI; everything below the line is used to take that NOI and figure out our cash flow.

Let’s start with all of our above-the-line costs. We begin with income. Since you’ve already got your rent roll, we’re trying to project for that past month what our rental income was. I would do it based on the total potential income. This is an advanced technique that’s really useful. We’re saying, of the leases in place, what’s the total amount we could have turned in. If somebody hasn’t paid their rent, we’re still counting that. Same thing with vacancies – we would put the market value of that in and then subtract out that vacancy cost.

Next, we subtract out vacancy and credit. We do that because it’s simple for us to see a historical basis for our vacancy costs and nonpayment costs. When you take rental income minus the vacancy, you get the effective rental income. But that’s not the end of the story because not all of your buildings sometimes have additional sources of income. For example, in an apartment building, you may have laundry, which becomes other income. We add other income to the effective rental income, and we get our gross operating income.

Now, let’s look at expenses. I like to do my expenses in a specific order because it’s what most commercial real estate brokers are used to seeing. It’s also the same order used by organizations like CCIM. So I follow this order: taxes expense (property tax, personal property tax), insurance (property insurance), and management fees.

Management fees can be broken down into more categories depending on how extensive your management is. If you have a third-party manager, you probably just have a straight management cost. Other categories might include payroll, management company expenses (like postage), taxes, and workman’s comp.

Then we have repairs and maintenance. I like to break these down into three categories: non-capital repairs, capital repairs, and maintenance. The difference between non-capital and capital repairs has more to do with how you’re going to depreciate it. After capital repairs, I include maintenance and janitorial services.

Next, we have utilities. There are many buildings where tenants are paying part of their utilities, but the bill is coming to the landlord. I count CAM (Common Area Maintenance) reimbursements here. Under Utilities, we’ve got electricity, water, gas, and trash.

Then we have accounting and legal. These are things that affect the property, not items for your syndication. I would not include things like lawyer fees for your PPM or taxes for your K-1s. What I would include is any accounting and legal that pertains to the property itself.

Licenses and permits can include everything from your business license to your elevator license. Advertising can include advertisements for vacancies. Supplies cover everything from toilet paper to cleaning fluid. Other contract labor includes pest control, HVAC service contracts, roofing service contracts, and snow removal.

We add all of these up to get our total operating expenses. Then we subtract our total operating expenses from our gross operating income to get our net operating income (NOI). This completes everything above the line.

Now let’s do our below-the-line calculations. We start by subtracting our debt service interest and debt service principal. I separate these out because it makes my calculations about different ways of doing our ROI better and easier to see. It also sets me up for seeing what my after-tax situation is.

Then I subtract out anything I put away towards funded reserves and any leasing commissions paid. This equals our cash flow before taxes.

I typically do this on a monthly basis, sometimes quarterly, but then I backtrack to make it a monthly thing. When I syndicate, I generally don’t do my own property management; I hire a property manager. I get them to fill out the income and expenses, and I finish up the other expenses.

At the very outset, you’ll probably be doing a one-year snapshot, dated at the time of purchase and the year previous to it. I would add any changes in taxes on the front end. It’s kind of a pro forma, but I’m not doing it based on changes in rents or any sort of added value. I want to see what it would look like for a year where I owned the property but did absolutely nothing, so I can set a benchmark.

The cash flow before taxes is ultimately what your investor cares about. Your above-the-line cost is what a buyer cares about. Not that your investor doesn’t care about it, but your true performance for the investor is that cash flow before taxes.

That was financial benchmarking for monthly or quarterly time periods. I hope you found that video helpful. This was made for my High Level Mastermind, top real estate professionals that I helped coach to become investment managers and real estate syndicators themselves. They go from working at a high level either as high-level brokers, high-level property managers, even members of REITs, so they can take on the mantle themselves and establish their own investment company.

My name is Tilden Moschetti. I am a syndication attorney for the Moschetti Syndication Law Group. If we can help you be successful by doing the legal work necessary to help you do your first syndication or put together an investment fund, we’d be happy to help. Not only do we help you with the compliance piece, we also have a background and expertise in the business side as well. We can use our expertise to help you and make sure that you’re successful.