Okay, you’ve been looking at a real estate investment property for some time and are about to write an offer.
You’ve driven by the property and like it’s curb appeal, and you like the fact that there appears to be little deferred maintenance. Plus, you’re fond of the neighborhood because it’s highly residential and yet close to buslines and shopping areas. Moreover, given the overall condition of the tenants’ cars, you’re encouraged about the quality of tenants who might be renting there.
Most importantly, you’ve reviewed the annual property operating data (APOD) and other income and expense statements and you like the bottom line. You’re attracted to a great rental income, low vacancy rate, and annual operating expenses in the range of a reasonable percentage of GSI. According to your calculations, after your mortgage payment the property will indeed produce a very favorable positive annual cash flow.
In other words, this rental income property is just the investment opportunity you’ve been looking for. Or is it?
Obviously your offer will include the typical walk-thru and professional property inspections to validate the property’s condition. And closer examination of a current rent roll, tax, utility, and other records will shed light on the rents and operating expenses. But what about the property’s performance? How can you be sure that the property has been able to generate the kind of numbers suggested by the data you’ve been presented? Perhaps the favorable numbers are an apparition without a past reality.
One sure-fire way to know is for you to ask to see the seller’s tax return (Schedule E). Why? Because the owner’s Schedule E is what the owner has actually reported to the IRS about the property’s performance. And given that it’s unlikely that an owner will claim inflated income or too little expense on a tax return, it becomes an illuminating source of information about the property apart from the statement of cash flow you were given during the sales presentation.
Of course don’t expect to get the Schedule E up front (the owner is not likely to submit tax return information without an acceptable offer). Just be sure that your offer includes a contigency provision for you to see and approve it. And don’t be shy to ask for the past several years of returns. If the seller objects, simply point out that a Schedule E tax return is not unrelated to the property and is a vital part of your normal due diligence and decision making.
