Is bad debt typically assumed in MF?
I've seen a couple motivated sellers with off-market deals that are a bit underwater trying to offload deals, and as market rents have taken a hit as well as rents, I've also noticed that bad debt in some of the class B properties sent to me have increased.
As the economy is a bit shaky, I was interested to hear how bad debt is typically treated specifically in multifamily? I work on all asset types, and commercial properties typically don't assume owed money, rather it's a clean slate with the tenants in place. Delinquency would be known of course and there would be risk when you acquire, say, an office building, but you don't have receivables on your balance sheet denoting what the previous owner was trying to collect.
Is this the same case with multifamily? If not, why? Why would I want to assume and right off $20-$30k/mth in some of the bigger properties after acquisition from a previous owner?
If I understand what you're asking, then yes, arrears are bought and sold in multifamily investment sales. Usually for some fraction of their face value, or there is a waterfall for collections in the first 3-6 months whereby arrears get reimbursed back to the Seller.
But generally, the idea is that you sell the building and take the loss on any bad debt as a write off, not that the buyer purchases the arrears at par. Obviously there is a whole spectrum of how this is dealt with, but if I was buying a property that was underwater and had a ton of arrears, not only would I not put any value on purchasing that AR, I'd also be assuming a much bigger annual economic vacancy in my underwriting, which would depress the price I'm willing to pay for the asset
So after acquiring the asset, do you take the losses on bad debt on your income statement from the prior ownership, or is it treated like office in which you are effectively only looking at delinquency post-acquisition?
You treat the asset as if you're buying a blank slate. I mean, if you pay for the arrears and never collect, then sure, you can write that off as bad debt.
It works exactly the same as you described it working in office. Unless otherwise specified, you are buying the rent roll, not the receivables. Think of your new ownership as a blank slate; you should have provisions in your contract for apportionments of all sorts of things; taxes, monthly insurance premiums, and yes, the rent roll. The whole reason for that is because you don't want to come in and have a liability to pay anything that was a cost incurred by previous ownership. This extends to arrears. Obviously as a Seller I want you to pay me as much as I can for them, because there is a chance you collect, but at the end of the day the Seller is going to write those off as a bad debt and go on their way.
Got it, thanks for clearing that up.
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