As seen in Mini Storage Messenger - November 1, 2006
After selling several facilities over the past few years, I’ve come to discover that there is a broad spectrum of ideas regarding what is necessary for a pre-purchase audit. Most prospective buyers who are new to the industry, or even new to real estate investment, hire a CPA firm to conduct an audit. Others decide to tap into our industry’s many management or consulting experts to help them determine the value and financial status of a facility. In assisting an audit, I have been asked to provide as few as a handful of reports going back to the Certificate of Occupancy (CO) of the property, to printing every financial and occupancy report that was ever created at the store. I have spent as little as 3 hours on site with an auditor, and as long as 3 days digging through years of files to satisfy an auditor’s need for knowledge. Somewhere in between is that happy medium that will provide a prospective owner with the information that is required.
Hiring someone from outside of the industry seems to be a sure way to spend a lot of money unnecessarily. Self-storage is really very simple. Where our industry is concerned, CPA firms tend to make things much more difficult and more time consuming than they need to be. Please understand that I use a CPA to audit my books quarterly, and could not live without his help and financial expertise. However, for a pre-purchase audit, less is sometimes considered more. We have some very qualified industry experts who can determine the value and profitability of a facility within a short period of time, and without great financial strain to the buyer.
What’s the point?
The first thing to determine is what, exactly, are you looking for as a prospective buyer. I would hope that you are looking for an income producing property, or at least one that has that great earning potential. The whole idea is to see if what the seller is telling you is, in fact, reality. Every sales package should provide you with a Financial Model similar to the provided below:
Financial Model
|
A. Statement of Cash flow
|
Annual
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Annual $/SF
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Monthly
|
Monthly $/SF
|
|
Gross Annual Rents
|
$450,000
|
$9.00
|
$37,500
|
$.75
|
|
Other Income
|
$22,500
|
$0.45
|
$1,875
|
$.04
|
|
Total Gross Annual Income
|
$472,500
|
$9.45
|
$39,375
|
$.79
|
|
Vacancy/Collect Loss
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($47,250 )
|
($0.95)
|
($3,938 )
|
($.08)
|
|
Effective Gross Income
|
$425,250
|
$8.51
|
$35,438
|
$.71
|
|
Operating Expenses
|
($140,000)
|
($2.80)
|
($11,667)
|
($.23)
|
|
Net Operating Income
|
$285,250
|
$5.71
|
$23,771
|
$.48
|
|
Debt Service
|
($167,489)
|
($3.35)
|
($13,957)
|
($.28)
|
|
Before-Tax Cash flow
|
$117,761
|
$2.36
|
$9,813
|
|
It is now your job to determine how these figures were calculated. Knowing what to ask for is important so that you can begin to verify that the information provided is complete and true.
Most operating software has a complete index of reports that will help you to ascertain the financial status of the property. A list of reports to request from the operating software follows:
Occupancy Report by Unit Type – 1 year or from opening of facility
By unit size, this report will give you a breakdown of the occupancy of the facility over the last year. Most will also tell you the rent rate for that size unit. Of course, what you would like to see over the past year is an upward trend. If there appears to be a lag in lease-up, ask why. Sometimes the explanation can be as simple as management change, or just a seasonal lull. This report may also provide street rates and projected rent totals that can be matched to the information given by the owner.
Rent Roll - Most current
This will list all the current customers and which unit they occupy. It should also give you the current rent of each unit and may provide a comparison to the current street rate. It usually provides a projected rent total. Once again, all of the numbers on every report should match, or at least be very close, depending on the ending date used. This is also the report that you will use when you make your physical walk-through inspection. Each unit that is listed as leased should have a lock on it. If it does not, ask why. A customer may have moved out between the time the report was produced and the time you conducted your physical inspection. If there is a big discrepancy, then walk away. Something is not right.
Pre-Paid Rent Report – Most current
This report will state how much of the rent collected is paid in advance. There will always be a certain percentage of customers who pay months in advance. That money is received in one lump sum and then distributed over the months as payment. For example, if you offer a special for “6 months pre-paid with a 5% discount,” that money is received all at once but is allotted over the next six months as rental income.
Accounts Receivable (Past Due Customers) – Most current
This is a list of all customers who have not paid on time. If it is above 6 percent of the rents, then there is a big problem collecting money. Ask what their policy is regarding late customers and what their auction procedures are. It doesn’t do any good if the potential rents are $34,000 a month but you can only collect $20,000!
The financial software used by the facility to execute the actual accounting process may be different from the operating software. Most operating software will download into financial software, such as QuickBooks or PeachTree. The actual accounting is done within this system. However, it is imperative that the figures that come across from the operating software match the figures that end up on the financial reports. For example, if the deposits reflected in the operating software total $25,000.00 for the month, the Income Statement should reflect that same amount. All figures must balance.
Income Statement– 1 year
This is the basic accounting document for the property. This will reflect the true financial condition of the facility and will tell you what the cash flow is after expenses. Each line item should have some detail to it. In other words, expense categories should not be completely totaled. If there is a major category for Marketing, then line items should reflect Yellow Pages, Newspapers, Internet etc.
This handful of reports will give you a basic idea of what the financial health of the facility really happens to be. It will also enable you to tie back to the proforma that was provided in the sales package. These reports allow you a starting place to jump off and ask for other pieces of information. Many times potential buyers will ask for property tax statements or utility bills to insure that the items on the Income Statement are accurate. These are expenses that are static, unlike marketing that can be changed or completely deleted from one year to the next. Be sure to ask for explanations concerning items that just don’t look right… and don’t stop asking until you’re comfortable with the answer.
At the same time, don’t get wrapped up in requesting information and documents just for the sake of having them. Going back to the first month of operation on a five-year-old property and checking deposit slips to the bank statement is a gross waste of time. It really does not provide any knowledge about the value of the property at that specific time. What you need is accurate information reflecting that the property is an income producing property.
Once again there are many well-qualified consultants who will be happy to do a pre-purchase audit for you, but confirm in advance that they are willing to explain their findings to you and give you their recommendations. A large report with facts and figures with no explanation is not worth the money spent to obtain it. Negotiate upfront what information will be provided so you will not get caught in the trap of an on-going outflow of cash to find out if the property is worth buying.
In closing, pre-purchase audits should be kept as simple as possible. Basic accounting principles should always be in practice when investigating your next profitable investment!
by Ann Parham, president of Joshua Management