Reading operating statements a seller prepared

Seller-prepared operating statements are the primary financial document in most small commercial transactions, and they are prepared by someone with an interest in the outcome.

They are not usually false. They are frequently incomplete, inconsistently presented, or describing a period rather than a run rate.

What to request

Three years of operating statements, and the trailing twelve months separately.

The trailing twelve is the most relevant, since it reflects current operations, and comparing it against prior years reveals trends.

Also request: the general ledger or bank statements, tax returns for the property, the current rent roll, all leases, service contracts, property tax bills, insurance policies and declarations, utility bills, and a schedule of capital work performed.

Sellers resist providing tax returns. Where they do provide them, the comparison is informative — the return generally reports income conservatively and expenses fully, which is the opposite bias to the marketing package.

The reconciliation

The core exercise: match reported income to actual bank deposits, month by month.

Discrepancies indicate either uncollected rent presented as collected, or income from sources not disclosed, or bookkeeping that cannot be relied upon.

All three are worth knowing.

The expense lines to interrogate

Repairs and maintenance. Look at the trend across three years. A number that is very low in the most recent year, after being higher, frequently means deferral ahead of a sale rather than improved efficiency.

Ask for the detail. A dozen invoices for the same recurring problem tells you something a single line item does not.

Capital expenditure, which is usually excluded from the operating statement entirely.

Request the capital schedule separately. A property with no capital spending over five years has five years of accumulated need.

Management. Frequently absent where the owner self-manages. Add it at market rate.

Property taxes, which must be adjusted to the post-sale figure in reassessment jurisdictions.

Insurance, which must be replaced with your own quote.

Utilities. Compare against the actual utility bills, and check for unusual patterns. A sharp increase in water usage frequently indicates a leak that has not been found.

Payroll, on larger properties. Check who is employed, on what terms, and whether you will retain them.

Owner expenses. Personal items run through the property — vehicles, travel, phone — which inflate expenses and which sellers frequently add back. Some add-backs are legitimate; verify each.

The income lines to interrogate

Base rent against the rent roll and the leases.

Vacancy and credit loss. Frequently shown as a percentage assumption rather than actual experience. Ask for actual vacancy by month and actual write-offs.

Concessions, which are often netted invisibly or omitted. Ask directly what concessions have been offered in the past twelve months.

Other income. Parking, storage, laundry, pet fees, application fees, late fees, utility reimbursement.

Late fees deserve scrutiny. Substantial late fee income indicates a tenant base with payment problems, which is a risk indicator rather than a revenue line.

Non-recurring items. Insurance proceeds, legal settlements, one-time recoveries. These are not income and should not be capitalized into value.

The presentation tricks

Not necessarily dishonest, and worth recognizing.

Annualizing a partial period. Taking three good months and multiplying by four, which ignores seasonality and irregular expenses like insurance and taxes.

Mixing actuals and pro forma in one column, so that some lines are historical and others projected.

Expense ratios that are implausibly low. A ratio well below the typical range for the property type is a signal to look for what is missing.

Presenting stabilized figures for a property that is not stabilized.

Rebuilding it

The output should be your own statement, built from verified sources.

Income from leases and bank deposits, adjusted for concessions and realistic vacancy.

Expenses from source documents — tax bills, insurance quotes, utility statements — plus management at market and reserves from your own capital inventory.

Then compare your NOI to the seller's. A difference of ten to twenty percent is common. A larger difference means either you have missed something or they have.

Either way, find out which.

The single most useful question

Ask the seller directly: what would you fix or change if you were keeping it?

Sellers frequently answer honestly, and the answer identifies the deferred capital, the operational problem or the tenant issue faster than any document review.

General information about real estate due diligence, not investment or accounting advice. Verify all financial information independently for any specific property. Consult qualified professionals.