If you own a small apartment building, you realize the ultimate goal is to optimize cash flow, and tax write offs. To get this you need knowledge.  Knowledge is really about facts and ideas that we acquire through study, research, investigation, observation, or experience. Wisdom is the ability to discern and judge which aspects of that knowledge are true, right, lasting, and applicable to your life.  When that knowledge is learned and it is applied appropriately, it then becomes wisdom.

The goal of Apartment Owner’s Wisdom is to bring Californian Small Apartment Owners of 5-50 units together to learn and grow their business. A rising tide lifts all boats.

Disclaimer: The following are just suggestions.  It is not legal or tax advice.  Please seek the help of a professional for further confirmation.

To help you stay organized as an owner/manager have these saved and filed (Preferably online through Google Drive or Box).  

• Tenant rental application and screening reports
• Correspondence regarding approval or denial of rental application
• The signed lease or rental agreement, plus any changes or updates added during tenancy
• Security deposits, security deposit refunds, and an itemized list for any deductions
• Move-in inspection paperwork completed by you and your tenant
• Move-out inspection paperwork, especially as it relates to a tenant’s security deposit
• Rent payment records
• Rental fee records (late fees, cleaning fees, pet fees etc.)
• Pet policy agreement and pet deposit records
• Written requests for entry
• Rent increase notices
• Property maintenance notices
• Work order or maintenance requests, and details of how and when they were handled
• Lease violations and corresponding action records
• Eviction paperwork and records
• Legal notices and corresponding actions
• All emails and correspondence with tenant
• Requests and approval for property maintenance, and details about how and when they were handled
• Management Fee payment records
• Owner rent payments and payments using owner funds
• All emails and correspondence with owners/property management
• Move-in inspection paperwork at the start of each tenancy
• Move-out inspection paperwork, especially as it relates to damage, wear & tear, and required maintenance
• Work Order repair requests, and details of how and when they were handled
• Property deeds and mortgage information if applicable
• Property Tax records
• Inspection records and maintenance updates
• Insurance policies
• Marketing information and property photos
• Photos related to property maintenance and property damage
• Invoices and receipts for property maintenance
• Vendor screening files
• Vendor contracts
• Work orders requests, bids and details of how and when they were handled
• Vendor Email and correspondence
• Vendor Invoices and receipts
• Vendor Payment records
• Vendor 1099-MISC documents
• Bank statements
• Proof of Deposits/Bank Deposit Slips
• General Ledger/Check Register
• Copies of checks
• Owner Ledgers
• Tenant Ledgers
• Personal Funds Ledger
• Invoices and receipts (both incoming and outgoing)
• Purchase orders
• Security deposit refund and deduction records
• Business licenses and permits
• Property Management or Real Estate Broker’s licenses as required by your state
• Insurance documents
• Tax Returns and supporting tax documents
• Audit Records
• Employee records
• Legal documents and records

When buying…

• You want to be able to walk every vacant unit a few days prior to closing
• Every vacant unit needs to be in a make ready status or you need to get a credit
• Any unfinished city inspection findings should be paid by the seller
• Be careful on the contracts you might assume such as laundry, electrical
• If the seller received one time fees for items such as cable then prorate
• If seller defaults Buyer should be compensated for money spent
• Always have an extension period in case you need it
• Ensure property has Certificate of Occupancy
• Is separately deeded be sure to know if there is not an HOA

When submitting a contract to buy, include….

• Parties buyer and seller
• Property
• Price
• Financing type
• Earnest money
• Survey and Title
• Seller Representative / Property Condition
• Inspection/Feasibility Period
• Assignment
• Closing Obligations
• Prorations – rents, property taxes, other contracts
• Default – what remedy does seller have if the buyer does not move forward, what remedy does the buyer have if the seller does not move forward
• Agency disclosure
• Dispute resolution- trial, mediation, arbitration
• Addendums, Financing, Inspection, Lead pain, IABS form (Information About Brokerage Services)
• Seller disclosure – not common at all
• Amendments – change/credit in price, charge in closing date
• Termination notice
• Other Provisions

When buying have the seller provide…

• Lease Information
• Rental Information
• Tenant rent
• Marketing/Unit Information
• Operating financial statements
• Bookkeeping reports
• Occupancy history
• Leasing reports
• Management reports
• Taxes
• General and Administrative
• Staff Payroll
• Utilities
• Repairs and Maintenance
• Insurance
• Inventory
• Studies
• Legal documents
• Construction documents
• Contracts/Service agreements
• Seller has to take it off market if have under contract
• Confidentiality.  Only $10 in Transfer Docs.
• NOI cant shrink by _% during pendency of transaction, or credit owed at Closing.
• Use exhaustive DD list
• Earnest money deposit doesn’t go hard until after Inspection Period and delivery of all agreed upon DD docs.
• Forece Majuere – Legal doctrine that is included in contracts to remove liability for natural and unavoidable catastrophes that interrupt the expected course of events and restrict participants from fulfilling obligations.

Rules of thumb when underwriting an apartment to buy…

• Closing Cost = 2-4% of sales price
• Economic Vacancy = 10-12%
• Expenses 50% (excluding debt service) – 50% of total income (rents and other income)
• Expenses increase 2-3% a year

Understanding the value of an apartment building…

When buying ask these questions to the owner/property manager…

• Are there any month to month leases?
• How many units have been upgraded?
• How do you screen tenants?
• When is the last time rents were increased?
• How much extra rent is being achieved for upgraded units?
• Can I get a copy of current market rent amounts?
• Are there any drainage issues?
• Is there crime on the property?
• Are there any Section 8 tenants, if yes what %?
• What is your income requirement for perspective tenants?

Be prepared for questions the lenders will ask…

• Where is the property located?
• What is the purchase price?
• Is the property stabilized (yield play) or is it distressed (value play)?
• What is your experience with Multifamily (5 units and above)?
• What is your net worth and liquidity?
• Will there be a property manager?

Here is the timeline to close…

• Day 1 Submit Letter Of Intent
• Day 5 LOI Accepted
• Day 7-10 Receive Contract
• Day 20-25 Attorney Contract Review and Negotiation
• Day 26 Sign Contract
• Day 28 Earnest Money, Seller Provides Due Diligence Material
• Day 31-33 Start Due Diligence.  Loan Application.
• Day 40 – 50 Due Diligence Ends
• Day 55 Finalize Docs
• Day 60 Loan Closes

If you have hired a property management company, your job is to mange them.  Do the following…

• Set strategic and capital decisions that manages the property management company
• Calls/meetings with property managers
• Review weekly report (occupancy, new leases, revenue, issues, notice to vacate, traffic
• Set direction when you want to sell/refinance.
• Remember property mgt. companies get compensated based on revenue, not based on NOI
• Oversee rehab
• Ensure tender required repairs are completed in the required timeframe
• Capital Expenditure approval

When you hire a property management company they can handle…

• Marketing
• Leasing
• Collect rent
• Other income
• Management (application, late fees, evictions)
• Maintenance

How to reduce expenses?

• Evaluate current contracts and bid out (utilities, landscaping)
• Water conservation
• LED Lighting
• Cost Segregation for tax benefits (allowing some items to be depreciated sooner)
• Evaluate property taxes (rates vary significantly by state and different rules by state)
• Thermostats
• Federal programs
• Require liability insurance for tenants
• Look for city program (toilets)

Rehab options…

• Plank flooring
• Resurface counters and tubs
• Backsplash
• Appliance
• Lightning
• Landscaping
• Signage
• Paint
• Rebrand

When submitting an offer..

• If needed, revise the Letter Of Intent to reflect seller changes and resubmit
• Revise your analysis at each step if needed
• Less is better than more
• Offer less than what you can pay
• Know your strike price
• Make it know you have done your home work
• Have references
• Your Bio
• Your Team
• Proof of Funds
• Earnest money is 1% (have timing when will go hard)
• Due Diligence Period 21-30 Calendar days
• Do not put Financing contingency in LOI.  Put the deal in front of a lender to get their preliminary thoughts/term sheet

Miscellaneous…

• Review the settlement statement closely and pay attention to the prorations, credits, earnest money put down.
• Expect to receive many versions of the settlement statement.
• Sign the contract always in blue ink.
• With the Rent Roll, look at recent move ins and their current rent if recent move in rents are higher that is good
• Know the Loan terms, amortization period, rate, fixed period
• Know estimate for required rehab
• Know your budget once under operation (work with property management for this).

Know the various Cap Rates…

• General Cap Rate = Rate of return for single year without taking into account debt
• Submarket Cap Rate = What properties are selling for in the submarket (example a neighborhood or zip code) for a given NOI.
• Subject property Cap Rate (in place).  NOI on t12 and divide by sales price. T12=The trailing 12 months of the property’s profit and loss income statement.
• Subject property Cap Rate (adjusted) NOI on t12 based on what expenses will be once take over.  Divide by sales price.

Understanding Capital Expenditures…

Money spent on CAPEX purchases is not immediately reported on an income statement. Rather, it is treated as an asset on the balance sheet, that is deducted over the course of several years as a depreciation expense, beginning the year following the date on which the item is purchased.

• Here is a sample:Site preparation, Demolition
• Sewer laterals / Septic
• Well / Water
• Concrete / Foundation
• Framing
• Electric – rough in
• Electric – finish and fixtures
• Plumbing – rough in
• Plumbing – finish and fixtures
• Heating / Air Conditioning
• Siding
• Roofing
• Masonry / Chimney / Fireplaces
• Windows / Doors
• Sheetrock and Taping
• Interior Trim and Floors
• Deck
• Painting, Interior
• Painting, Exterior
• Kitchen Cabinets and Appliances
• Carpeting
• Security / Alarm System
• Paving
• Landscaping
• Elevators

What are the various types of expenses for operating an apartment building?

• Advertising and Marketing
• General & Administrative
• Bank Fees
• Legal, Accounting, and Professional
• Office Supplies
• Postage and Delivery
• Licenses and Permits
• Technology and Related Services
• Insurance
• Landscaping
• Pest Control and Termite
• Maintenance and Repair
• Maintenance Supplies
• Payroll
• Management Fees
• Employee Healthcare
• Employee Net Wages
• Employee Workers Compensation
• Payroll Service Fee
• Payroll Taxes
• Property Tax
• Electric Bill
• Telephone/Internet
• Water/ Sewer
• Sanitation and Hauling Service