Mark Kappelman, Co-Founder of RealEstateAccounting.co, is well versed in multifamily investing and syndications, as well as the back end accounting world. Focusing 100% on the real estate industry, Mark discusses the types of investors that could benefit from outsourcing their accounting, and how to balance expensing vs. capitalizing. Mark and Joe also talk about real-life scenarios where outsourcing accounting services could have caught fraudulent activity.
Mark Kappelman Real Estate Background:
- Co-Founder RealEstateAccounting.co
- 8 years experience
- He’s a CPA as well
- Rehabbed and now own multiple multi-family properties (BRRR strategy) – approx 40 units as of today
- Syndicated (from private investors) on nearly all deals so understands the financing side of things well
- Say hi to him at: www.realestateaccounting.co/
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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the Best Real Estate Investing Advice Ever Show. I’m Joe Fairless. This is the world’s longest-running daily real estate investing podcast where we only talk about the best advice ever, we don’t get into any of that fluffy stuff. First off, I hope you’re having the Best Ever weekend. Because today is Saturday, I have a special segment for you called Situation Saturday, and here is the situation. Well, accounting is something that you –unless you’re an accountant– are probably not a fan of. But guess what? We all have to deal with it and we all get to deal with it. Is it going to be a positive influence on our business or a negative one? That’s really the choice that we need to make with our business. The situation is that, well, we’re all in a spot where we have someone working on our books, but who is it? Is it ourselves? Do we have the expertise to do so? Or is it a firm that can help us with that and help us make more money? Today, we’re going to be talking with a sponsor of the podcast. He’s the co-founder of Real Estate Accounting, Mark Kappelman. How are you doing, Mark?
Mark Kappelman: Doing great, Joe. Thanks for having me.
Joe Fairless: Well, I’m glad to have you on the show, because this is something that we can all get a refresher on at a minimum, and at most, start taking some action on. First off, a little bit about Mark. He’s the co-founder of Real Estate Accounting, he has eight years of real estate experience, he is a CPA, he’s rehabbed and owned multiple multifamily properties, he did the BRRRR strategy starting out, and now he’s got approximately 40 units he’s syndicated, so he’s one of us… But he’s also an accountant and he’s the co-founder of an accounting firm, Real Estate Accounting, where you can outsource your accounting to. That’s a little bit about Mark.
Let’s talk about the situation, because that’s what the meat of this conversation is going to be about. The situation is, we don’t have an accounting firm yet, but we have properties. Let’s talk about that scenario, Mark. Can you, first off, tell us a little bit about your company, and then let’s roll into that scenario?
Mark Kappelman: Sure. Like you said, I’m the co-founder of realestateaccounting.co. We’re outsourced accountants for the real estate industry. 100% focused on real estate. Really, there are three types of customers we work with. First and foremost, there’s just the traditional third-party property manager that manages residential and commercial properties. They’re the ones that if you own properties, like probably a lot of your listeners, and you’re getting reports for property management every month, we may be the accountant that’s doing the accounting for those property management companies. They might decide to outsource their books or outsource their accounting to us. That’s the first type of customer that we work with.
The other customer is the syndicator that self manages. They’ve gone out, they’ve raised money, and not only do they have to report back to their LPs, but they actually are doing the property accounting. They’re the property accountants. They’ll bring us in because we understand the reporting to the LPS, as well as just the day-to-day blocking and tackling of property accounting. I think what you were asking about, Joe, was the syndicator that is outsourcing their books, that has probably raised some money from outside investors, has bought a few properties or one property, and now needs to report out to their LPs every month. We assist those types of clients as well.
Joe Fairless: What about the investor who has a W2 job, is not syndicating, but just building their own portfolio, but they’re getting these reports back from a property management company? Because that’s a scenario I was in before I started doing the syndication business, where I started out with three single-family homes in Texas. I’d get these reports every month, but I wasn’t paying a whole lot of attention to them, honestly. I probably should have, in order to maximize the ROI. Do you work with people like that?
Mark Kappelman: We do. I would say that’s less common. Usually, it’s people that have, I would say, slightly larger properties than a couple of single-family homes. But I think the notion of what we do – and in that instance, we call it CFO services – it’s the same concept. I’ll give you a perfect example. We’re working with a client right now that owns 10 properties. They’re not single-family homes, these are larger properties, 16 to 20 unit buildings. But this individual has got a highly paid W2 job, works a ton of hours, and he’s getting eight reports every month. Currently, he’s owned them for a couple of years and he wants to refinance the properties. As he’s looking at the reports, the NOI looks lower than he would expect. If he’s applying a cap rate that he thinks fair, the valuation looks like less than he’s paid for. But the reality is, he’s raised the rent rolls, so it just doesn’t make sense.
He brought us in, we spent a couple of hours looking at these reports, quickly realized that the property manager that’s been sending him his report has been expensing a tremendous amount of cap-ex to repair and maintenance. This is great from a tax perspective, because your taxable income is lower, but when you’re going to either sell the asset or refinance it, the underwriters and the appraisers are going to look at the NOI. So now we’re having to go back to those property managers and say, “Hey, guys. There’s a handful of $10,000 items in here that shouldn’t have been expensed. Let’s capitalize it.” Now, the NOI is significantly higher. As all your listeners know, now the valuations higher, the refi is higher, and that’s really the name of the game.
Joe Fairless: I could see the value of that, especially from an owner standpoint who has multiple properties, as you mentioned in this example. If you have a W2 job, you’re at least focused on it 35 hours a week, I would imagine, at minimum; maybe 70. But at least 35 hours a week if you have a high-paying W2 job. As you’re trying to scale – yeah, you’ll need to have someone in your corner from a financial analytics forensics standpoint to see what’s taking place at your properties.
Mark Kappelman: Right. I just thought of something else. Another perfect example is he doesn’t have budgets set up for his properties. It’s really not the third-party manager’s job to develop budgets, that’s not really their scope. Their scope is to collect rents, make sure the properties are filled up, and manage them effectively. But in this case, he doesn’t have any budget, so now we’re collecting three years of data, we’re putting it into Excel, we’re lining it all up, and then we’re going to develop budgets that we’re going to give to his property manager. So now, not only when he gets –he or she, but in this case, it’s a he– when the reports come in, not only is it just an owner statement that says cash in and cash out, also you can get a P&L that says “Here’s how we did and here’s how we thought we were going to do.” Now there’s a variance.
That just becomes a really quick report to review. Hopefully, there are no big variances, but that’s just a common thing that people aren’t looking at. It’s a pretty easy analysis, but if you don’t have time, you got to put in the time to put that together to develop the budget. It’s a time thing. Do you want to focus on finding new deals? Or do you want to focus on putting a financial package together? This is just all we do. It’s the only industry we work with. As you said, I’ve done this myself, so I kind of understand it from both the operator and the accounting side, since I’ve been a CPA for 14 years now.
Joe Fairless: Having that variance is so important, but like you said, there is no variance if there’s nothing to measure the current results against.
Mark Kappelman: Corrent. 100% variance every single month.
Joe Fairless: Right. [laughs] When you’re working with a client –perhaps you need to define which client type we’re talking about when you answer this question– what are some common mistakes that you see that they’re making, or their team is making, or some things that you all can help correct?
Mark Kappelman: I think I kind of gave that perfect example on the syndicator that’s outsourcing their books… But I think just what you’re capitalizing and what you’re expensing – it doesn’t matter on a day-to-day basis if there’s not some outside party that needs to use this data. But within real estate, pretty much everybody’s financing properties, so there is always going to be an outside provider, like a bank, that’s ultimately going to want to see those. That’s just a really common mistake – expensing too, much versus capitalizing. Now your NOI looks lower. In multifamily, it’s all about NOI and the cap rate.
Joe Fairless: How do you balance that? Expensing versus capitalizing. Tax benefits versus valuation.
Mark Kappelman: That’s a good question. It really just depends on the person. I think there are two schools of thought. One school of thought is you just expense everything and then when you go to sell it, you might make adjustments in the books to show it to say, “Hey, our tax books and our real books are different.” Some companies just do that.
Joe Fairless: What’s wrong with that approach? Anything?
Mark Kappelman: Not necessarily… Though, I would say the tax code doesn’t allow you to just expense anything. If you go replace the boiler at a property or put in a new HVAC system, you can’t expense that. Generally speaking, I would say the rule of thumb is 1,000 bucks and under, you expense it, $1,000 and over, you capitalize it. Do people expense things greater than 1,000? Of course, they do. A paint job maybe, you might expense that even if it’s a couple of grand. So you really just have to look at it. But you can’t just do whatever you want, because on some level, the tax code has language to say these items need to be capitalized and depreciated over this many years, versus not.
Joe Fairless: Okay. Got it. When you’re working with a new client, what type of questions do you all ask in order to see what’s the root of the issue or challenge that you all can help solve for?
Mark Kappelman: It’s usually “Hey, why did you reach out?” Everybody’s always reaching out for a reason. If it’s the third-party manager client, oftentimes they haven’t reconciled their bank accounts in six to eight months and an audit is coming up. Because if you are a third-party manager, and you’re handing client money – they call that trust accounting – you’re subject to audits by your state board. But you’re handling other people’s money, and there’s a license with that, and there’s a high degree of care that needs to be done. That’s a very common one.
The other one, which probably your listeners can appreciate, is just an entrepreneur that’s scaling. Whether they’re a third-party manager, or they’re a syndicator that has been doing the reporting out to their LPs, or that has been doing the accounting, but just doesn’t have time. It’s that classic spend time on things that generate revenue for your business, and accounting, for a lot of people, that’s not their core competency. That is our core competency. That’s all we do.
So I would say it’s somebody’s behind on bank RECs, somebody scaling that just doesn’t have time for it… A big one is just, “Hey, somebody quit.” With COVID there was a lot of that, “Hey, if you hired somebody, or somebody quit…” That’s what we always tell people – if you hire us, we can be up and running in two days. It’s not, “Hey, we need to go post an ad.” This is really the insource versus outsource.
Our staffs are fully trained. All we do is real estate. You give us a call, we have an onboarding call, and we’re up and running in a couple of days. It’s not hiring, training, W2 payroll, and all that. But I think the third one I would just say is with syndicators that are just realizing, “Hey, I need to start doing reporting to LPs. I said I was going to do that. I’m not really comfortable with this.” There’s a lot of people that are doing real estate deals that don’t have a financial background and don’t know how to put the P&Ls together. Yes, your property manager is going to send your reports, but it’s not always in a format that might lend itself to… Chances are you gave your LPs a proforma and now you need to compare, “Here’s how we’re doing, here’s what I said in the proforma how we’re going to do, and then add some color to how we’re doing better or worse.” You’re just not going to get that from a property manager.
Joe Fairless: You won’t get that, that is correct.
Mark Kappelman: That’s a fact.
Joe Fairless: Let’s go with that example. Proforma versus how we’re doing, with someone who has – let’s say it’s a mobile home park. This is their first mobile home park, and they say it was a $2 million purchase. It’s a relatively small mobile home park, but it’s not a $500,000 one. They come to you all and they say “Okay, yes. I’d like help reporting to my investors in a sophisticated way, because I want to scale my business the right way.” How do you all get into the business plan enough so that you know “Okay, here’s the proforma you had, and here’s how we’re doing numbers-wise…” It seems like there needs to be some context, like kind of a storyline. How do you get involved there?
Mark Kappelman: Yeah, there are two things, I would say. First and foremost – I’ll just think of a client that’s not doing mobile home parks, but is doing large multifamily 200-unit properties. The first thing we did when we onboarded, we said, “Hey, look. Give us the fundraising deck. Hey, give us your cap-ex budget.” Because once we read the fundraising deck, now we know what they were thinking when they were doing the deal. Once we had their cap-ex budget, we know if there was a big cap-ex plan or not. Then when the financials come in, we see the actuals. We’ll see, “Hey, we’ve spent 200k on cap-ex.” That won’t be a surprise to us when we see it in the OM. “We were going to spend a bunch of money in year one, and the budget is 800k, and we’ve spent 200k. Okay. Now we have context.
Then once we’ve lined up the numbers, so we received the report for the mobile home park, to use your example, let’s say there’s a third-party manager – we’ve got the numbers, we’ve got our own template that we’ve developed that people like, so we kind of put it into this Excel template… So we take the OM, put in the budget, get the actuals from the property manager, do a comparison, and then we’ll just schedule a quick call with the mobile home park owner to say, “Hey, guys. Here’s what we see. Does this make sense?” “Hey, these expenses are super high. Does this make sense?” That’s where the syndicator, more often than not, I would say, when we send out these, when we assist them with reporting, we give them the numbers, and then the syndicator writes up the operational findings. That’s [unintelligible [16:36] if that makes sense.
We aren’t the deal guy or girl, so we don’t know exactly that there’s something going on here, occupancy is about to spike… But we get a lot of contexts from that OM, the calls with the client, and the numbers, and you just triangulate it.
Joe Fairless: One thing that happened to me on a deal that I’m a general partner on is that a property manager was committing fraud because she was greedy. I guess that’s why, that’s the because. She was committing fraud by –that’s the word I was looking for– by artificially inflating the rent roll to hit a leasing bonus. That took place for a couple of months before we figured out what was going on, and then we corrected it. But that’s something that would have been helpful, to have someone even looking at the books. We were looking at the books, but we just missed it. It was a mistake on our part. I bring this up because it’s likely that that is taking place on other people’s portfolios. It’s probably not a common thing, but it’s a thing. How that could hurt you is in multiple ways, if it happens over a long period of time, where if you don’t catch it, I think we can all imagine how that could hurt us. It does hurt us from an NOI standpoint. It could really set you back on your proforma and your whole business plan. It depends on how long it takes place. So that’s something else that I just thought of that this would be really helpful for.
Mark Kappelman: Yeah. Let me just give one other quick example on that. One of our syndicator clients works with a very large and well-known, respected multifamily property management company. We review their books in detail thoroughly every month, and we’re asking about variances. Why is electricity up? Why is gas up? On more than one occasion, we’ve found instances where expenses from completely other owners’ properties have hit the books of our client’s properties. They actually paid an electric bill for 123 Main Street, which is not owned by our client, and put it out of our clients’ 456 Main Street property.
Joe Fairless: That’s a problem.
Mark Kappelman: Yeah. Does it happen all the time? No, of course not. But if you’re actually looking deeply… The property manager didn’t even realize it. Then they had to do a little receivable and reimburse them and we got it fixed. But it’s a human element business, and if you’re not looking at things, chances are you’re going to miss things.
Joe Fairless: That’s right. I always say that the main risk of any deal is in the execution, because you’re dealing with so many people and so many different moving parts. Whether it’s something that happens maliciously or something that’s just an innocent mistake… I go back to the Jim Rohn example, where he talks about your worst enemy can give you a cup of sugar and your best friend can give you a cup of cyanide. You’re going to die, even though your best friend had the best intentions.
One of the takeaways here, the main takeaway is we’ve got to have someone else looking at our books from a financial analysis standpoint. It has to take place if we’re scaling properly. One of the things that come to mind is it’s almost like you all serve as an asset manager; not the full scope of an asset manager, but a certain role as an asset manager for these properties.
Mark Kappelman: Yeah, I’ve worked with some asset managers that understand accounting at a deep level, and some that do not, so I think, in some respects, it’s a decent comparison. We also have clients that have asset managers that we’re still here because we’re the CPAs, we understand it, they want our expertise on just really kind of the accounting and the numbers. But I think, yeah, in some instances, maybe for a smaller client that doesn’t have asset managers, in some ways we function like that a little bit. We’re just not physically going to the properties.
Joe Fairless: Right, I get that. Anything that we haven’t talked about that you think we should before we wrap up?
Mark Kappelman: No, I just want to piggyback on one point you just said… It was something that I was thinking about before this call. I’ve worked for PWC, Ernst & Young, so I started in the accounting world, then I worked at a tech startup, then I started developing real estate, and now I’ve got an accounting firm, and I would just say – regardless of what industry you’re in, you made the point of you need somebody or yourself looking at the numbers. The best organizations I’ve ever worked in, or best clients I’ve worked with – we have a monthly call to just review the numbers. There’s always a set call, it doesn’t get missed. Of course, sometimes it gets pushed a little bit, but it’s just financial discipline, operating discipline to say, “No, we’re going to look at the numbers. Let’s just look at it. Does anything look funky?” You always find something, or you always learn something, which is like, “Oh, wow. We need to tweak that, because we’re spending way too much money on site maintenance.” Or “Site maintenance salaries are crazy. We need to bring that down.” There’s just always some sort of learning when you commit the time to review your numbers and just understand your business financially.
Joe Fairless: Isn’t that the truth? I love that. It makes me think… First off, I would suggest everyone have that type of call each month. Our firm certainly does have that type of call each month… And continue to have it until you don’t learn something from the call. I think that’s a fair challenge. As long as you’re optimizing from that call every month, then it makes sense to keep it, because you’re talking about numbers. You’re not talking about some tangential thing that doesn’t directly impact the bottom line; you’re talking about numbers. So as long as you are continually optimizing based off of that call – what’s this expense? This income used to be much higher this time last year, what changed? Whatever it is, then keep having the call.
But if at some point you don’t learn anything from it, you’re not optimizing maybe two or three in a row, then okay, maybe you don’t do a call. But my assumption is that you’re going to learn something every month, and you’re going to be optimizing, tweaking something every month. Because, again, we’re dealing with human beings, and we make mistakes, so things are gonna happen. Human error is going to take place, so we’ve got to be on top of it.
Mark Kappelman: Yeah, I totally agree. If monthly is too much, do it quarterly or do it every other month, but do it. You’ve got to do it on some cadence.
Joe Fairless: Mark, how can the Best Ever listeners learn more about what you and your team are doing?
Mark Kappelman: Go to our website, realestateaccounting.co and schedule a call. We’d be happy to chat with you, we’d love to chat with you. If you’re in real estate, this is all we work on.
Joe Fairless: Mark, thanks for being on the show. Hope you have the Best Ever weekend and talk to you again soon.
Mark Kappelman: Thanks so much, Joe.
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