Part 5 of our 6 part series on apartment financial statements. Theo will be covering a few different documents today, including the OM. So without much more explaining from me, hit play and learn more about the financials from Theo. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
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Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.
Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the Apartment Syndication School, go to syndicationschool.com, so you can listen to all the previous episodes.
Theo Hicks: Hi, Best Ever listeners. Welcome back to another episode of the Syndication School series – a free resource focused on the how-to’s of apartment syndication. As always, I am your host, Theo Hicks.
Each week we air two podcast episodes that focus on a specific aspect of the apartment syndication investment strategy. Typically, we’ll do four, six or eight-part series, so two to four weeks’ worth of podcast episodes. The episode you’re listening to now is going to be part five of a six-part series, so we’re gonna complete a series about breaking down the financials for underwriting apartment deals, as well as managing apartment deals.
For the majority of these series we will typically offer some sort of document or spreadsheet for you to download for free, that accompanies the series. All of these free documents, as well as previous Syndication School series can be found at SyndicationSchool.com.
As I mentioned, this is going to be part five of a six-part series entitled “Breaking down the apartment syndication financials.” If you haven’t already, I recommend listening to parts one through four. In parts one and two we broke down the rent roll, and in parts three and four we broke down the T-12. Those are the two main documents you need in order to underwrite apartment deals, as well as documentation that you’ll wanna provide to your investors on an ongoing basis.
The last piece of the puzzle isn’t necessarily a requirement, but it’s more of something that is helpful when underwriting, and that is the offering memorandum. We’re gonna follow a similar structure to the T-12 and rent roll episodes. We’re gonna go over what the OM is, what it’s used for, take a big step back and discuss big picture what the OM is used for and how to use it, and then we’re going to walk through an example OM and essentially just like the other episodes, go page-by-page, line by line, and explain exactly what each of the items mean as it relates to underwriting.
For this particular documentation you don’t necessarily need this on an ongoing basis, however there are a few other things that you will use it for that you didn’t necessarily use the rent roll and the T-12 for.
Let’s jump right in with what is an offering memorandum. I’m gonna refer to it as an OM, just so I don’t have to say offering memorandum over and over again… So shorthand for the offering memorandum is the OM. Essentially, it is a sales package that highlights the ins and outs of an on-market investment offering. An offering memorandum is something that is created by the broker who is listing the deal, and it is used to essentially market the property to interested investors.
The OM is actually used for multiple purposes. Number one, you can use it to actually screen deals. Within the first few pages of the OM there will be an executive summary that basically summarizes everything that’s going to be in the following pages. The OM we’re gonna go over today is about 50 pages long, and it’s broken down into different sections about the market, and the property, and the financials, and the business plan… And the executive summary essentially summarizes all of that. If you read that, you can see what type of property this is, what’s the expected business plan, and determine if it meets your investment criteria.
Your investment criteria, if you remember from previous Syndication School series… Which is not from one series – we kind of went about creating it over multiple episodes, but that’s going to be the submarket of the neighborhood; the first page, you’ll be able to tell where the property is located – “Okay, it’s in California; my target market is Texas, so I can completely ignore this one.” If it’s in your market, then you can look at the number of units, date of construction and the property class to determine if it meets your investment criteria, as well as the business plan.
Typically, when the property is listed for sale and you’re sent the listing, it will say “This is a turnkey property/This is a highly distressed property/This is a value-add property.” So essentially, one of the ways you can use the OM is to screen deals, and that’s as simple as reading that executive summary.
Secondly, it will be used during the underwriting process. However, it will only be used as a guide, because the information is likely biased. I was trying to think of what would be a good analogy for the OM and the T-12 and the rent roll, and I was going to say that that T-12 and the rent roll are kind of the — I’ll do a movie analogy… There are always those movies that are based on a true story, but they’re typically exaggerated, and the actors are much better-looking than the actual people, and the events seem to go faster, and it’s more entertaining and engaging, and it’s used for marketing purposes… Because obviously, if they just made a movie on exactly what happened, it would be too boring and it wouldn’t grab people’s attention.
Well, the offering memorandum is like the “based on a true story” movie, whereas the T-12 and the rent roll are what actually happened. And when you’re looking at deals, you wanna know what’s actually going on, not what some movie producer – which is the broker in this case – is telling you. But still, just because the information is likely biased, there’s still some very good info in there that you’ll be able to use when underwriting, as well as when you are preparing an investment summary, which is the third thing it could be used for.
The investment summary – we haven’t talked about this yet on the Syndication School series, but essentially, once you put a deal under contract, you’re going to want to create your own offering memorandum, which is ideally not based on a true story, but is the actual true picture of the actual deal… And it’s going to look similar to the OM, they’re gonna have similar sections. You’re gonna have your executive summary, you’re gonna have your market information, the property description and your financials.
So one, you can use the structure of the OM as a guide to create your own investment summary, but also, you might be able to pull some of the information that the brokers have already found and include that in your investment summary… Specifically, the market data. Typically, the market data in these OMs are going to be accurate. The only thing that you necessarily don’t want to follow is the financials, but we’ll discuss that here a little bit later in the episode.
Lastly, you are going to use an OM when you are selling; not the same OM, but when you are getting ready to sell your property and you go to your broker and let them know, then they are likely going to create that OM for your property so that they too can market your deal to interested investors.
Before we go over to the example OM, I wanna discuss a couple other things about the OM as a whole. They keyword when I said what an OM is is a sales package. As I said, the info is likely going to be biased, because if you think about it, obviously the listing broker’s goal is to sell the property at the highest price and as quickly as possible. Now, I’m not saying that every single broker is going to do this, but they may have a tendency to not include certain pieces of information and only include certain pieces of information that make that property look as good as possible, so that they can achieve their goal of making money.
At the end of the day, a good philosophy to have is trust, but verify. You’re gonna look at the OM, and you’re going to see the information that’s in there, and rather than just take it at face value, you’re going to be like “Okay, let’s confirm this is true. Okay, everything the broker said is true. That’s great, I’m looking forward to working with them.” Or, on the other hand, “Oh, this information is incorrect. The broker either made a mistake, or is lying and this might not be someone I want to continue to work with in the future.”
Now, every offering memorandum that you come across is going to include different information, it’s going to be structured differently. Typically, if you’re working with a brokerage or this deal is listed by a brokerage, they’re gonna have some sort of template that they use, and they’ll just plug in pictures, data tables and words into that template. But for the large brokerages you’re gonna find OMs that are very detailed. If you’re getting it from maybe a small-time broker, it’s not going to be as detailed or as aesthetically pleasing from a design standpoint than ones that are made by the big boys, like Marcus & Millichap and Cushman & Wakefield and CBRE and places like that. Regardless, the information in there should be the same, they just might look a little bit different.
So in order to obtain the OM for a property, it kind of depends, but typically what happens is that the on-market deal is listed on the brokerage’s website, as well as an e-mail blast that’s sent out. If you’re on the e-mail list, you’ll get the e-mail and it should have a link. If you click on it, it will bring you to the page on the website that’s listing the property, at which point there should be some sort of instructions for downloading the offering memorandum and the financials. So you might just be able to download it right away, you might need to create an account, and then you’ll have access to some sort of portal. You might have to sign a confidentiality agreement, at which point you’re e-mailed or given access to the documents at a later date, or instantly… But either way, go to the website where the property is listed for sale, and there should be instructions for obtaining the offering memorandum.
Now, we’re gonna go over underwriting in a lot of detail in either the next series or the series after that, Syndication School-wise, but I just wanna mention that when you’re underwriting, you’re not going to want to read through the entire offering memorandum. Typically, what you wanna do is you wanna read through it up to the financials, so up to when they start talking about what the rents are going to be, what the expenses are going to be… So you’ll wanna read up to that point, and then stop, and then you’ll input your data into the cashflow calculator, and based on reading the OM and that inputting process you will create a list of questions to go back and ask the listing broker.
The point I wanna get across is that you don’t wanna just read through the entire offering memorandum first when you’re underwriting; you only wanna read up to the point where they go over the financials, because again, that information is based on what the broker says is going to happen, where we don’t necessarily care about what the broker thinks; it’s more of what we think and what our team thinks.
So now that we’ve gotten that out of the way, let’s go ahead and go through the sample offering memorandum, which you can download at SyndicationSchool.com, under this series, which I believe is series number 13, “Breaking down the apartment financials.” It will be available for download under parts five and six. Or if you’re listening to this now, you can find the link to download this in the show notes.
This is a much older offering memorandum for a deal that was listed for sale back in 2015, but it is very detailed, which is why I wanted to go over it, because it includes essentially all the information you’ll ever find in an OM. As I mentioned, sometimes we might find less information, more condensed information, but this is one of the most detailed OMs you’ll see. It’s 50 pages long, so I wanted to do that so that we could hit on everything that you could possibly see, so that you know exactly what each of these sections mean.
In the rest of this episode, as well as in the next episode, we’re going to go through this 50-page document page by page, so let’s dive into it.
The first couple pages are just gonna be pictures of the property, just to kind of start off the bat with some aesthetically pleasing images of the property, ideally professionally. Then it’ll have the name of the apartment community.
The first important page in this particular OM is going to be the fourth page – it’s actually labeled as “IV”, but it’s going to go over 1) the offering procedures; that’s something that you’re gonna wanna know. You’re gonna know what the offering process is, so if you do underwrite the deal and you wanna submit an offer, what you are supposed to do.
For this particular property, they request that you submit a letter of intent, you submit a resume and/or a business letter indicating the assets owned and assets purchased in the past year, so the portfolio of your properties from the past two years. They’re gonna want transaction references and banking references, as well as the source of equity for your acquisition – who’s supplying the debt, and who is going to be supplying the equity. Then it mentions that upon an accepted LOI, the person who submitted that LOI will be supplied with a purchase sales agreement.
This particular deal – there’s a call to offers, but there’s not a best and final sellers round. So you submit your LOI and basically your resume, and then if you win, you get a PSA; if you don’t, then you get turned down. It also mentioned the brokerage commission on the deal, as well as who you should be contacting. As you remember, I said that you’re gonna be creating a list of questions to ask the broker who is listing this property; well, on this page it tells you the five different parties who are listing the deal, and that’s who you can contact.
And then lastly, it mentions that they don’t want you to contact the property owner to schedule any tours; you wanna do that through the same broker. Essentially, the point people are going to be these brokers; here’s their names, their titles, their address, phone numbers, and — on here there’s no e-mail address, so it looks like you’ve gotta hit them up on the phone.
Next page just goes over a confidentiality agreement about the property and the financial documents that are provided (the brochure etc.) Then once they kind of get the housekeeping out of the way, you’ll see a table of contents page that will outline exactly what you should expect to find in this OM. In this particular OM, it starts off with the executive summary; then it goes over to the property description, then the location analysis, then the rent comparables and the financial analysis.
As you remember I said, you wanna read up to the point where it starts discussing the financials. In this case, I would read the executive summary, the property description and the location analysis, at which point I would start underwriting the deal myself. Then when I was done, I’d go back and look at their rent comps and their financials to see how they match up.
So for the executive summary, as I mentioned, the first true page in this – the first page is actually labeled after the table of contents – is going to be the executive summary. [unintelligible [00:16:13].00] summary page, with essentially a written explanation of the property. First it goes over the market highlights and what’s good about the market in which the property is located; then it will go over what the listing broker believes would be the best business plan for this deal. For this deal it says that “It’s an excellent opportunity to complete a value-add unit enhancement program.”
Next it discusses “This is the business plan. This is what the business plan should be, but here’s more specifics on the business plan.” It mentions how many units the current owner renovated, what those renovations were and how much money they’re currently demanding. Then it discusses what you can do – essentially, continue this upgrade plan if you want to, and “This is how much it’s gonna cost, and here’s how much rent you’re gonna be able to increase it by.”
Then it goes over some of the key amenities of the properties: state of the art fitness center, resort-style swimming pool, spacious business center… That’s kind of where that “based on a true story” is. Instead of saying “There’s a fitness center, a swimming pool…”, it’s “a state of the art fitness center, a resort-style swimming pool, a spacious business center.” But still, at the end of the day, it’s important information to know what amenities are offered at that property.
Then next it just kind of wraps it all up and just has a closing statement saying basically how great this deal is for investors. Then it’s got a data table of the investment summary, so it goes over some of the key, important piece of information that you can use to initially screen the deal, as I mentioned, based on your investment criteria. It’s got the year built, number of units, average rent per square foot, the current occupancy rate…
The next page goes into more details on the expected business plan. As they mentioned in the executive summary, they believe that this is an excellent opportunity for a value-add business plan, and it kind of explains why; when the property was built – it was built in 2002 – and what it would benefit by from upgraded appliances and adding washer and dryers to make it more competitive.
It goes over, again, what renovations were performed by the current owner, as well as what you can expect renovation-wise and rental premium-wise, and then it kind of goes over exactly what renovations were done by the owner.
So whenever they’re discussing a value-add business plan – and again, we’re gonna go over this a lot more in the underwriting phase, but you’ll wanna know 1) did the current owner begin to implement a value-add business plan? If the answer is yes, how many units, and what renovations were done, and over what timeline were those renovations done?
The first three or four pieces of information are in here, but you don’t have a timeline of when the renovations were done… Because if you do 100 units in a year, versus 10 unit in a year, then the rental premiums are going to be different to you. If they did 100 units in a year, then those rental premiums are likely more accurate, whereas if they only did 10 units, that’s not enough of a sample size to use that as your rent premium assumption.
For here, it says that the current owner spent about $2,000/unit and achieved a rental premium of $110 on 200 units. So a question I would ask is over what period of time were these 200 units renovated? If he says ten years, then I’m gonna be like “Okay, well that’s not necessarily gonna help me out here”, but if he says one year or two years, then that’s gonna be a bit more accurate on my end.
Now, that concludes the executive summary, where again, it summarizes everything that’s going to be explained in more detail later on in the offering memorandum. So now on page four it moves into discussing the market. We’ve got the market highlights – it talks about the demographics and the future rent growth. It says “The household income is really high (twice the national average). Here’s an award this market received, and the jobs are expected to increase.”
Again, the information here is gonna vary depending on the market. In some markets it’s jobs, in some markets it’s rents, in some markets it’s population… It really depends. It’s also gonna go over “This is an outstanding location, and here’s why. The property is right next to a highway, and it’s an amazing school district, and the airport is really close.”
Then it’ll also discuss some employment drivers – what’s the job situation like, what are some of the major companies around there, what’s the projected job growth, how many workers live in a certain radius of the actual property.
So demographic-wise, you’re gonna want to know about any awards, or anything special about the area, as well as information about jobs. Then after that, typically it will have a map. When they explain “Here are the big companies, here are the good school districts”, then they’ll have a map saying “Okay, here’s where the property is and here’s where all of these highways and businesses and country clubs and schools and hospitals are located compared to the property.”
Next on this particular one, again, it just keeps going into more detail about how great the market is. It explains how there’s gonna be a highway expansion, and it also talks about the city itself.
Next, once it moves on from the location analysis, it will start talking about the actual property itself. As you’ll see on page nine of the offering memorandum, there’s a bunch of data tables that kind of look like the auditor’s site, where it kind of goes over in extreme detail everything you need to know about the property. You’ve got the address information, you’ve got your built number of units, the size of the units and the overall building, what’s the laundry situation, what’s the parking situation, what’s the personnel that’s currently working at the property, what are the school districts, what are the leasing fees – that’s gonna be pretty important when you’re underwriting, what types of fees they’re charging to tenants who are interested in renting. Tax information, utilities, who pays for what, and then the construction type of the property.
On the next page it goes over the interior highlights. It explains — earlier it said that they renovated the units, so now they’ll go over in bullet point form “Here’s exactly what amenities are offered for the interiors of these units, as well as some pictures.” It talks about nine-foot ceilings, crown molding, microwave, tub, refrigerator with an ice maker, ceiling fans… Again, at this point you probably haven’t seen the property yet, so you wanna know “Okay, what do the interiors look like and what amenities do the interiors have?” This section will help you out with that.
They’ll do the same thing for the exteriors – it’ll tell you what exterior amenities are offered. For this particular deal it’s a clubhouse, state of the art fitness center, business center, pool, dog park.
Next it will have the floor plans. It will have a 2D snippet of what the floor plans look like. It’ll have “Here’s where the bathroom is, here’s where the kitchen is, here’s where the little bedroom is, here’s what the size of the bedroom is”, so kind of just how the units are arranged for each of the different unit types at the property. For this particular deal there happens to be six units types, so there’s six different designs of what the floor plans are.
Then it’ll have an actual overall site plan, so it’ll show you where all of the different exterior amenities are, as well as where the units are, where the parking is, where the entrance is, where the clubhouse is. On this particular deal it gives you a 2D Google Earth view of the same image that was shown earlier during the location analysis. So rather than straight up bird’s eye view of the surrounding area, this one’s more at an angle and it kind of show you “Okay, here’s where the property is, highlighted, and here’s where all the great nearby businesses are.” It does that through different pictures that give it a 360 view.
I think I misspoke earlier; when I was going over the location analysis earlier, that was actually the executive summary portion of it, so it was just the highlights of the location. Here it goes into a lot more detail on the location. It talks about the overall MSA – Dallas-Fort Worth, and then it will talk about the demographics of that area the educational attainment of Dallas-Fort Worth, the economy, what’s the GDP, how many Fortune 500 companies are there, what companies are moving to Dallas-Fort Worth; it’ll do a labor analysis, so how many people actually work in the area, what’s the growth going to be, what sectors and industries they work in.
Then it also goes over an apartment overview of Dallas-Fort Worth – how many units are there, what’s the annual rent growth, what’s the annual rent, what’s the average occupancy. Then similarly it does for the submarket; the submarket in which this property is located is Mansfield, and the larger MSA is Dallas-Fort Worth, so it does all this information for the MSA, as well as the actual submarket.
If I was underwriting the deal, this is where I would stop, because now it starts going into the rent comps and the financials. So just like I would be if I was underwriting, we’re gonna go ahead and stop for today, and we’ll continue with the rent comps and the financial analysis in tomorrow’s episode.
To listen to parts one through four and listen to other Syndication School series about the how-to’s of apartment syndications and to download the offering memorandum that we’ve been discussing today, go to SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow.