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Financial Statements for Passive Investors

A Real Estate Investing Course for Members of Lifestyles Unlimited, Inc.

Presented By:

JB Durham Investor & Multifamily

MentorJB.Durham@luinc.com

What we will cover today

• Having realistic expectations• Understanding the seasonality of income

and expenses, especially turnover costs• Understanding how the income and

expenses affect the balance sheet• How to look for trends• Understanding the flow of transactions to

reports• What type of financials are there?• How to read financials and what to look

for

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JBs Mission Statement is: To Enhance, Increase, Improve, and Sometimes Protect Your Assets.

EnhanceIncrease Improve

And Sometimes

Protect

Cashflow Yield

NOI Value

Know where your market is so that you have realistic expectations. (Train versus Bullet)

Demand

Concessions

JobsOccupancy*

Rent *

IncomeNOI

ValueCash flow

Cap RateTurn over

costs

Enhance,Increase,Improve

PROTECT!

Know Your Demand

• Demand = Job Growth– Bureau of Labor Statistics– Total jobs, % growth– Per capita, per unit

• Creating Demand = Concessions– www.alndata.com– Yardi Matrix– Axiometrics– MPF Research– Smart Data

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Know Your Occupancy

• Physical occupancy = people

• Economic occupancy = $$

• Rent revenue collected / effective gross potential• GPR- LOL = EGI• Peak delta = 2%• Accelerate• Free fall rate

Know The Industry Standards

• Industry cash flow formula• Accepted operating standards• Bridge• MF Documents

Know Your Industry Standards

• The annual NAA income and expense survey– The industry’s most important

document.• Glossary, Language, Acronyms • Industry cash flow formula• Base line metric• Deviations = Lines of Understanding

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Using the NAA Income and Expense Survey

DALLAS-PLANO-IRVING, TX MARKET RENT PROPERTIESOPERATING INCOME & EXPENSE DATA

INDIVIDUAL METERED AND RECOVERY SYSTEM PROPERTIES*Garden

Number of Properties 201Number of Units 62,772Avg. No. of Units/Property 312Avg. No. of Square Feet/Unit 890Turnover rate in % 51%

$ Per $ Per % ofUnit Sq. Ft. GPR

RevenuesGross Potential Rent 12,300 13.81 100.0%

Losses to Vacancy 632 0.71 5.1%Collection Losses 70 0.08 0.6%Losses to Concessions 146 0.16 1.2%

Rent Revenue Collected 11,451 12.86 93.1%Other Revenue 691 0.78 5.6%Total Revenue 12,143 13.64 98.7%

Operating ExpensesTaxes 1,967 2.21 16.0%Salaries and Personnel 1,232 1.38 10.0%Repair and Maintenance 459 0.52 3.7%Management Fees 341 0.38 2.8%Contract Services 258 0.29 2.1%Utilities 254 0.28 2.1%Insurance 221 0.25 1.8%Administrative 211 0.24 1.7%Marketing 174 0.20 1.4%Total Operating Expenses 5,116 5.75 41.6%

Net Operating Income 7,026 7.89 57.1%

Capital Expenditures 1,027 1.15 8.3%

Source : National Apartment Association 2016 Survey of Operating Income & Expenses in Rental Apartment Communities

© 2016 by National Apartment Association. This table may only be used, copied, and/or distributed in accordance with the License

Agreement and may not be posted on the Internet. * Individual Meter and Recovery System (submeter, RUBS, flat fee) for primary utility.** Master Meter Owner Paid for primary utility.

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2017 NAA SURVEY OF OPERATING INCOME & EXPENSES IN RENTAL APARTMENT COMMUNITIES

Total Garden Mid- & High-Rise

Number of Properties 3,428 2,910 518Number of Units 937,431 799,702 137,729Avg. No. of Units/Property 273 275 266Avg. No. of Square Feet/Unit 931 935 904Turnover rate in % 50% 50% 49% $ Per $ Per % of $ Per $ Per % of $ Per $ Per % of Unit Sq. Ft. GPR Unit Sq. Ft. GPR Unit Sq. Ft. GPR

Revenues Gross Potential Rent 14,260 15.32 100.0% 13,190 14.10 100.0% 20,467 22.64 100.0%Rent Revenue Collected 13,169 14.15 92.4% 12,209 13.05 92.6% 18,743 20.73 91.6%

Losses to Vacancy 852 0.91 6.0% 759 0.81 5.8% 1,387 1.53 6.8% Collection Losses 90 0.10 0.6% 90 0.10 0.7% 88 0.10 0.4%Losses to Concessions 149 0.16 1.0% 132 0.14 1.0% 249 0.28 1.2%

Other Revenue 772 0.83 5.4% 698 0.75 5.3% 1,199 1.33 5.9%Total Revenue 13,941 14.98 97.8% 12,908 13.80 97.9% 19,942 22.06 97.4%

Operating Expenses Salaries and Personnel 1,338 1.44 9.4% 1,278 1.37 9.7% 1,688 1.87 8.2%Insurance 236 0.25 1.7% 226 0.24 1.7% 293 0.32 1.4%Taxes 1,741 1.87 12.2% 1,529 1.64 11.6% 2,968 3.28 14.5%Utilities 345 0.37 2.4% 316 0.34 2.4% 518 0.57 2.5%Management Fees 395 0.42 2.8% 359 0.38 2.7% 603 0.67 2.9%Administrative 272 0.29 1.9% 252 0.27 1.9% 388 0.43 1.9%Marketing 188 0.20 1.3% 160 0.17 1.2% 350 0.39 1.7%Contract Services 392 0.42 2.7% 354 0.38 2.7% 610 0.68 3.0%Repair and Maintenance 462 0.50 3.2% 454 0.49 3.4% 508 0.56 2.5%Total Operating Expenses 5,369 5.77 37.7% 4,929 5.27 37.4% 7,926 8.77 38.7% Net Operating Income 8,572 9.21 60.1% 7,978 8.53 60.5% 12,016 13.29 58.7% Capital Expenditures 1,478 1.59 10.4% 1,473 1.57 11.2% 1,509 1.67 7.4% * Individual Meter and Recovery System (submeter, RUBS, flat fee) for primary utility.

All Market Rent Properties Operating Income & Expense Data

Individual Metered and Recovery System Properties*

Source : National Apartment Association 2017 Survey of Operating Income & Expenses in Rental Apartment Communities

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National NAA Survey

Ways To Measure & Compare

• Budget Comparison Report• Trailing 12 months Profit and Loss• Trailing 3 months Profit and Loss• NAA Income and Expense Survey- the most important

document in our Industry– $ per unit– $ per square foot– % of Gross Potential revenue

• Annualize the property data• Divide by number of units or square footage to

compare

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Lead Investor Expectations

• 100% in control• 100% accountable• 100% responsible• LU community expects more• Management Company• Asset Management• Prompt, accurate financial reporting

Investor Expectations

• White paper Compliance• monthly reporting• Year end reporting• Complete reporting• Responsive• Understand each others role

• Commit to communicating clearly and concisely– Regular meetings – Financial reporting – Monthly statements - with a

cover letter providing a summary narrative

– Form K-1 for each investor in advance of the IRS filing deadline

From the Rules & Suggested Best Practices for Lead Investors

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• Allow investors, at their own expense, to conduct a third-party audit of the company’s financial statements (per the operating agreement).

• Supervise all bookkeeping functions, which include detailed and timely reviews of all financials.

• Provide monthly financial statements to all Passive Investors within 30 days of month end – One exception might be the first of the month due

to utility switchovers and initial billings.

From the Rules & Suggested Best Practices

• Include the following in monthly financial statements:– Provide a budget alongside actual

performance numbers.– Income statement with capital replacements

and budgets.– Balance sheet with capital contributions.– Capital contribution of each member must be

delineated separately on the balance sheet.– Rent-rolls.– Delinquency report.– Unit availability report.– Resident activity report.

From the Rules & Suggested Best Practices for Lead Investors

From the Rules & Suggested Best Practices for Lead Investors

• DO NOT commingle cash or other Passive Investor investment assets with your personal accounts or with accounts related to other separate deals in which you may be involved.

• DO NOT utilize any company funds for any purpose other than the operation of the company (including maintenance and operation of the property owned by the company).

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• Make purchases directly from vendors on account to minimize petty cash and/or reimbursements.

• Make cash distributions based upon real earnings generated by the property. – Any deviation from the formula outlined in your

Operating Agreement must be approved by the portion of company members specified in the Operating Agreement.

– Distributions must be accompanied by a detailed explanation of the amount distributed and how it was calculated.

From the Rules & Suggested Best Practices for Lead Investors

• Use property management software specific to multifamily operations. Generic accounting software such as QuickBooks is not adequate.

• Pay close attention to the numbers each month and take the appropriate action to maintain the financial success of your deal.

From the Rules & Suggested Best Practices for Lead Investors

Transactions to reports

• Phone Calls – traffic log• Service Request – work order report• Rent Charged – rent roll• Rent Paid – bank deposit report• Rent NOT Paid – delinquency report,

accounts receivable• Vendor Invoice – accounts payable• Cash Flow Profit – credit to balance sheet• Cash Flow Loss – debit to balance sheet

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Monthly reporting

• Executive Summary- narrative• Variance Report- narrative, variance to budget• General Ledger- individual transactions• Rent Roll- physical occupancy• Profit and Loss – economic occupancy

– Budget Comparison– Current Month– Trailing 12 month– Balance Sheet- cash position, A/R, A/P

Rent Roll

• *Physical Occupancy*

• Unit types• Move in dates• Security deposits

Profit and Loss

• *Economic Occupancy*• Break even economic occupancy• Feeds the balance sheet• Target NOI• Ebb and flow of income and expenses• Annualize / per unit• Compare to NAA operating standards• Budget comparison• Trends 3, 6, 12 months• Monthly report card

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Balance Sheet

• The most important document• Transcript• Month over month change• Assets• Cash / savings, retained earnings- how much $ ?• Rehab funding• Accounts receivable – delinquent rent• Improved value – depreciation basis• Property tax escrow• Prepaid insurance• Reserve replacement escrow

Balance sheet

• Liabilities– Security deposits– Accounts payable- vendors owed– Partners– Month over month change

Tips

• Study• Apply yourself• It’s a process• Comfort, competence, confidence• Understand your role as a Passive• Don’t be “ that guy”• Be a participant in the process not the details

and operations

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Action Items

• Know your Market Cycle• Know Your Economic Occupancy• Know The Industry Standards

• Understand Financial Reports: – Occupancy – Revenue – Income – Expense – Accounts Payable – Balance Sheet – Replacement Reserves

References

NAAIncomeandExpenseSurvey

TheMultifamilyHousingTextbook

www.naahq.org

www.alndata.com

www.bls.gov/news.release/pdf/metro.pdf

www.weareapartments.org

Thank You for Attending!

JB Durham Investor & Multifamily

MentorJB.Durham@luinc.com