Friday, December 11, 2015

Beyond The Cap Rate - "Financial Due Diligence"

Investors typically outline their investment objectives based on a cap rate target. In examining properties on the market that are advertised within the objective range, the next step is to take a detailed look at the legitimacy of the numbers which the CAP RATE is based on.

On the income side, start with a thorough review of the current lease agreements. The rental income needs to reconcile back to the $ amounts presented on the financial statements as provided. Additionally you will want to confirm lease terms, future increases, renewal options, deposits held etc. You also need to note any special provisions – such as early termination clauses, future rental caps, expiration of personal guarantees, and first rights on adjoining space. Best practice here, is to ensure the revenue numbers add up and are supportable based on the terms contained in the lease(s).

On the expense side, annual reports are typically provided and are a good place to start. However, you need to go further – verifying the expense amounts shown, based on actual invoices paid. An additional step, particularly on smaller properties, is to call for the Seller’s tax returns against the corresponding years. Again best practice, is to confirm and legitimize the expense side and make sure they reconcile back as presented.

A proper Due Diligence should confirm the figures as presented – and in doing so legitimizes the CAP RATE. In any type of income property investing, the ‘devil is in the details’. Make sure you verify those details before moving forward on any purchase.

Welcome hearing about any DUE DILIGENCE stories based on your experience – either good or bad. Or any comments you care to share. Look forward to discussing investment opportunities here in Windsor-Essex – feel free to connect with us.

Mark Lalovich
Office: (519) 966-0444
Cell: (519) 259-5434

No comments:

Post a Comment