Why Gross Rents Are Misleading in an Acquisition

Gross rents are the headline number sellers and brokers use to describe a property. They almost always overstate the real income.

Understanding why protects you from buying a property at a price that does not pencil.

Concessions Hide in Plain Sight

A 1100 dollar lease with one month free has effective rent of 1008 dollars per month. The gross rent looks like 1100. The collected rent over the lease term works out to less.

Sellers love to quote contract rent without disclosing the concession. The rent roll might show 1100 but the actual cash flow shows 1008. The difference compounds across many units.

Loss to Lease

Even without concessions, in place rents are often below market rents. A property might have advertised rents of 1175 but have in place rents averaging 1050.

That loss to lease is upside on paper. It is not income today. The pro forma assumes you capture it through renewals and turnover, which takes time.

Delinquency

The rent roll shows what tenants owe. The bank deposits show what tenants paid. The difference is delinquency.

A property with 4 percent delinquency has 4 percent less actual income than the rent roll suggests. On a 380 thousand dollar gross rent property, that is 15 thousand dollars of fictional revenue.

Bad Debt and Write Offs

Some tenants leave owing rent that will never be collected. Sometimes the property writes off the loss. Sometimes it sends to collections at 10 cents on the dollar.

Bad debt is a real cost. It shows up on the operating statement as a deduction from revenue. It often does not show up in the marketed gross rent.

Vacancy

Vacant units generate zero rent. The rent roll shows what occupied units pay. The marketed gross potential rent assumes all units are occupied at market rent.

If the property is 92 percent occupied, you are losing 8 percent of theoretical revenue right now. Stabilized underwriting needs to account for this honestly.

The Calculation Sellers Run

Sellers present gross potential rent times 12 months as the property's earning power. They subtract a token vacancy figure, often 5 percent, and call that the realistic revenue.

The actual revenue is gross potential minus real vacancy minus concessions minus delinquency minus bad debt. That number is usually 10 to 20 percent below the seller's quoted figure.

How to Verify

Pull the trailing 12 month profit and loss. Compare to the rent roll annualized. If the P and L revenue is 15 percent below the annualized rent roll, that is your real gap.

Ask for bank statements. Match deposits against the P and L. Confirm the income is real and where it comes from.

Do not underwrite on the seller's quoted gross. Underwrite on verified collected revenue. The difference can be the difference between a good deal and a bad one.