It is not uncommon to make a mistake when creating a proforma income statement for presentations to real estate investors. We have all done it, and chances are the next time we work up the numbers on a rental income property we will do it again.

Some mistakes, however, can be avoided simply by understanding a couple of rules about creating an income and expense statement.

Most of us who have been involved with real estate investing for any length of time understand these rules. Real estate agents who are just starting out might not; so it seems fitting to discuss three of the most common errors realtor’s make with real estate investment numbers.

Vacancy Rate Factor

The rule is, include a rate for vacancy.

Regardless whether or not the current owner has experienced 100% occupancy since the Flood, always show a realistic percentage for a vacancy allowance (let’s say 5%). Bank appraisers do, and it always makes you look better when you compute one into your proforma for your investor.

Why? No one knows for sure why the owner had such good fortune (maybe the tenants are relatives or just getting a good deal). The real estate investor looking at the property will never run the risk of assuming that a complex will continue remaining with minimal vacancy, and will always make an allowance for it when considering the investment.

Repairs and Maintenance

Here again, agents generally tend to report on numbers achieved by the owner. This can be a two-edged sword that should be avoided.

If the owner was a poor manager, costs for repairs and maintenance can be skewed higher than reality; if the owner is a fix-it type of person, or has a relative that is, costs for repairs and maintenance can be skewed lower than reality.

It is always best to include repairs and maintenance as a percentage of income in the proforma rather than the owner’s numbers (these will be looked during the buyer’s due diligence). The rate will vary depending upon age and condition of the property, but generally falls somewhere between 4-8% of GSI.

Replacement Reserve

Real estate investors may not actually set money aside for a future replacement of things like roofs and appliances, but it should be accounted for in the pro forma. Again, no hard-fast rule, but generally replacement reserves are included in the operating expenses computed as $200-300 per unit per year.

A sample APOD created by ProAPOD Real Estate Investment Software is available for preview at www.proapod.com.

The other day I was called by the listing agent about a multi-unit apartment complex and told it had a 7.2% capitalization rate. This is very a favorable ratio for residential income property in Salem, Oregon so I requested an APOD and called my real estate investor.

Upon receipt of the APOD, however, a closer examination revealed that the listing agent computed the operating expenses at just 13% of the rental income; naturally, too low for an income property, and the full explanation for the favorable cap rate.

It was clearly a rookie error that could have been avoided with a simple rule of thumb about an income property’s operating expense ratio.

Of course I am not advocating a rule of thumb. Operating expenses need to reflect current and reasonably anticipated expenses required to keep the property in operation, and should never be inserted irresponsibly as if one-size-fits-all. A rule of thumb, however, might help new investors and real estate agents just starting to work with real estate investment property to track their numbers in accordance with some level of real estate investing reality.

1-4 Units

Operating expenses for single-unit, duplex, tri-plex, and four-plex units are typically between 25-35% of the property’s gross scheduled income.

5 + Units

Operating expenses for larger complexes range between 35-45% of gross scheduled income.

Why the difference? Owners of the smaller units generally shift the cost of water and sewer, trash, and landscaping to the tenant; whereas, owners of the larger complexes often pay for these charges as a normal operating expense. Why the range? Costs vary from city to city, and in some cases may even warrant a much higher percentage rate. One real estate investor I work with, for example, automatically calculates an operating expense of no less than 45% based upon other property’s he owns in his area.

If you plan to work with rental income property, you would be best served to a little homework about typical operating expenses ratios used for residential and commercial real estate in the geographic location where you work.

Once you discover a commonly-used range, use it to test the validity of any numbers you run. It helps to know what is realistic, and might spare you from getting overly excited about nothing later.

ProAPOD real estate investment software did a complete facelift on its website at www.proapod.com. Please check it out and tell us know what you think.

Foremost, we rearranged the menu and body of text. Rather than having the menu located on the right side of our pages and the description of our real estate investing software solutions on the left, we flipped them. The menu is now located on the left side of the pages, and the description of our real estate software is on the right. We believe the result makes the text easier to read and the menu easier to see.
We also reformatted the colors and trimmed the graphics down a bit; the pages generally feel less cluttered now and it is easier to locate hyperlinks to our real estate investor software, mortgage calculator software, learning center, and other web pages. Moreover, we increased the number of sample reports. Visitors to ProAPOD’s real estate investment software site can now open and preview about twice as many reports than before.

We also want to remind you to take advantage of several features on ProAPOD’s real estate investment software website provided to you FREE in the hope that they may be helpful to your real estate investing business.

1. Mortgage Calculator. This allows you to calculate a mortgage payment that includes principal, interest, taxes, and insurance (PITI) right on our website. FREE to use.
2. Glossary of Terms. We’ve assembled over 400 real estate terms and definitions in an easy-to-read list. FREE to access.
3. Real Estate Investing Articles. Read over 20 articles covering real estate investment, rates of return, tips and other helpful rental property information. We are hoping to make these printable within the next several weeks so you can take them with you. FREE to access.

All three features, by the way, are available for you to post on your own sites. This is FREE. Simply contact me and I’ll explain how to do it.