I-A-Q #20: The Financial Statement You NEED to Know About
Happy Monday!
Here is an Idea, an Action, and a Question to consider this week.
Idea
Ding ding ding! Class is in session! Let’s do some real estate term talk.
In the exciting world of real estate, there's a financial statement called the "Trailing Twelve Months" or "T-12" that gives us a peek into a property's financial performance over the past year. It's like a little treasure trove of information for real estate investors, buyers, and lenders who want to know the income potential and value of a property.
The T-12 includes figures like the total rental income, operating expenses, net operating income (NOI), and even sometimes capital expenditures. Let's break it down:
Total Rental Income: This represents the total amount of income generated by the property through rental payments from tenants. It includes both base rent and any additional income from sources such as laundry income or late fees.
Operating Expenses: These are the expenses associated with operating the property. They include costs such as property management fees, utilities, insurance, property taxes, repairs and maintenance, and any other relevant expenses. Operating expenses are deducted from the total rental income to calculate the NOI.
Net Operating Income (NOI): NOI is a crucial figure in real estate analysis as it represents the income generated by the property after deducting operating expenses but before considering financing costs (i.e. debt servicing). It is calculated by subtracting the total operating expenses from the total rental income.
Capital Expenditures: These are significant expenses incurred to improve or maintain the property's long-term value, such as replacing a roof, upgrading HVAC systems, or renovating common areas. Capital expenditures are typically not included in the T-12 statement, as they are viewed as one-time or irregular expenses.
The T-12 is like a crystal ball that lets you see the property's income potential, cash flow, and overall financial well-being. It's a game changer for making smart decisions about buying, selling, or financing the property. Lenders even use it to see if the property can generate enough income to cover loan payments. It's a big deal!
Just remember, the T-12 statement is like a glimpse into the past. To really see into the future, investors and analysts need to dig deeper and consider other factors.
And BEWARE of misclassification! Some sellers may try to misclassify operating expenses to make them appear as capital investments, thus reducing their impact on the T-12. By disguising expenses as these one-time costs, they can artificially inflate profitability and value.
For example: Let’s say a unit within an apartment complex needs a “turn.” The turn process typically includes a range of activities such as cleaning, repairing any damages, repainting walls, replacing fixtures or appliances if needed, and performing necessary maintenance tasks. This should be considered an expense, but some sellers might try to classify this as a capital expenditure. If it’s classified as a capital expenditure, it won’t show up on the T-12, and it could mislead the buyer.
Look closely, friends.
