T12s
How are T12 / Operating statements made? Specifically how are the individual line items accounted for? Does the property management team do this? Does a third party accounting team put these together? How accurate are these statements?
Usually some sort of accounting / property management software. I’ve mostly seen Yardi
In my experience, your property manager produces these reports using property management software, like Yardi or RealPage.
How line items get accounted for is often a conversation between the property managers, especially if they're third party (they may have their own ways of booking things that their staff is better trained in) and ownership. FYI this is a really good question, and one I get the feeling most WSO users wouldn't bother to ask.
Generally, T-12s are pretty accurate in their entirety, since providing someone with materially false T-12s would certainly be a violation of a PSA. However, it's really important to look at them closely, since it's not uncommon to see some costs moved around or misapplied. Buying 100 new sets of kitchen cabinetry and booking it as a capital expense is not exactly a lie, but if you really intend on only replacing normal wear and tear over time and not doing an actual rehab, then you may distort your actual opex in a meaningful manner.
I'll echo Ozy that this is actually a great question despite it potentially coming off as "rudimentary" to some of the WSO crowd.
Every T12 tells a story...about the asset, the on-site team, the market/submarket, and ultimately ownership. It can give you intel on if the property is being taken care of (i.e. are they actually doing appropriate preventative maintenance via service contracts, etc), what sort of shape the physical plant/units are in (any big ticket one-time R&M items, persistent R&M fixes like plumbing or HVAC, what are turnover costs like after tenants leave, etc), how the deal is being operated (number of on-site employees, are they sharing staff with another property, what the burden/benefits are running for that particular management company, any leasing bonuses or locators, is owner charging back anything to the property for corporate expenses, etc), what sort of ancillary income is the property generating (and does that match what you've been told about current tenant fees/billbacks/CAM), what the AR/bad debt picture looks like (not only within write-off lines, but things like excessive legal expenses). I'm in multifamily now which a number of the examples above apply to, but the thought process behind it was the exact same as when I was in the office world.
You go through enough of them and you start to intuitively understand what the story is every time you look at a set of financials. You'll see which property management firms run lean or fat, which owners skinnying things up ahead of a sale, ownership who will try to capitalize everything they can below-the-line or are stuffing things like gift cards (effectively concessions) into marketing lines, which owners are litigious, etc. Eventually you'll know that if you see a set of financials from certain firms, you won't put a whole lot of stock in what those financials say...not outright "lies", but certainly could be seen as "creative accounting".
You'll also start to get a feel for how lenders will look at these sorts of things
For anyone who looks at a ton of T12's (i.e. acq folks), it makes a huge difference having a defined lens through which you "code" things internally. Every owner and PM team codes things differently (classifies revenue & expense items differently), and if you're not consistent with how you bucket things for yourself, it will be very difficult to accurately benchmark across various deals.
As an aside, would highly recommend that anyone starting out in either Acq or AM work to get at least a basic grasp of how accrual accounting works. Vast majority of financials you see will be accrual-based, but every once in awhile you'll see someone on cash books and it can really throw you for a loop if you don't know what you're looking at.
Lastly, if possible, spend some time chatting with the property accountants and on-site teams at your firm (or the third party) to understand how the financial reporting process works (what are the cutoff dates for revenue/expenses, how often are certain things updated, how the budgeting/reforecast/variance reporting processes work, capitalization policies, etc). Even if you're in Acq and you won't be looking at your own deals' financials, the knowledge will serve you well when you're looking at new deals out in the market.
Edit - most common systems for these in the multifamily world are Yardi, Onesite (RealPage), and Appfolio. Yardi also does commercial (office/retail) and is IMO the best overall interface. MRI is used on the commercial side as well, and while I haven't personally used it since 2018 since moving to the multifamily world, I can tell you that it felt incredibly archaic at the time.
Ozy & Ricky - thank you guys for the thoughtful responses here. As a newer analyst who is looking through multiple new T12s a day this really helps. I definitely notice the “creative accounting” you speak of, but sometimes we will only recieve a T12 that does not provide any items below NOI. In this situation would you deem it appropriate to ask for the “full” T12? Are some T12 statements only for operating expenses? I’m on the brokerage side (sorry Ozy lol) and a lot of times don’t have direct contact with the seller who is providing the statements. I guess what I’m asking is, is it industry standard to provide the “full” T12 or will sellers sometimes purposefully delete out these below the line items to try and sell a better story? Thanks again guys
It's rather common to not include what's below the line. They're most likely removing it before sending the T12s, although it is possible they are actually booking the items to the balance sheet as capital items. That's rarer though.
Really a T12 should have what's below the line since it's a T12 Income Statement, but good luck arguing that if they don't want to send it.
You'll rarely get someone who gives you a "full" T12 that includes below-the-line items...I'd say only 2-3% of the deals I see has anything on BTL CapEx, and most of that is just less sophisticated sellers who don't think to take it out of their chart of accounts during a sale. Frankly I wouldn't ask for more than just the income statement they provide.
Know this isn't a super helpful answer to someone starting out, but the intuitive understanding really does come with getting reps in. For instance, I know that if I'm looking at a ~10 year old, institutional/Class A, surface-parked multifamily deal and they are showing ~$400/unit of combined R&M/turnover/contract services, I know that they are running a fair amount below the line or have cut expenses down artificially since this would typically be more in the $900 - 1,150 range for that vintage/product (obviously depending on location). I don't have to see the below-the-line items to know that this is not a "market" expense load and I certainly wouldn't UW it to stay that way.
Similarly, if someone shows T12 payroll at $1,200/unit but I run the math on a full payroll matrix (i.e. actual positions with market wages/bonus/burden) and it spits out $1,900/unit, I know they are either (a) running short staffed/have had vacant positions in the last 12 mont, or (b) are coding something elsewhere/using contract labor.
Given that you said you look at multiple T12's a day, I'd look into how you could efficiently benchmark/track all those that you seen based on location/product type/vintage. If you can manage to code everything that you see from those into consistent categories for your own analysis, after awhile you'll have some good perspective on where "market" is for the various income/expense items.
We used MRI at my previous shop. I’ve used countless number of systems in my career thus far and it is bar none, the worst system I have used/seen.
Would imagine even more sophisticated regional firms are still going to have historicals on a cash basis, not accrual.
Some idiot making 40k inputs it into Yardi and then some idiot making 250k makes him move R&M expenses below the line. This is how they are made.
This is the correct take^
not sure what you are getting at here, as whether it is R&M or capex is entirely up to how you want to classify the cost(notice I didn't say expense). Also has to do with the capital treatment implications.
It's a joke
Two things that tripped me up a bit on T12s when first getting started were:
And to answer your question, most owners either have in-house or 3rd party teams of managers and accountants that input everything into a software program (Yardi, Appfolio, etc) that generates the T12s, and then they go in and manually adjust for errors/accruals/reconciliations.
I would also note that accrual on the income side is equally, if not more important to understand.
Most of the time, the rental loss you see in an accrual statement under bad debt is only reflective of unpaid rent for tenants that have vacated their unit. If a resident is not current on their rent, that non payment accrues on the balance sheet but typically doesn’t flow through to an income statement.
For any property reporting on an accrual basis, at a minimum, you need to be looking at the “balance” column in the rent roll. If a unit has a positive balance, that is some form of accrued nonpayment. Best practice would be to request a detailed Aged Receivable (AR) report and know how to properly analyze and interpret that data. This will show you a breakdown of what comprises a tenant balance (rent, utilities, parking, lease break fee), and for what time period the nonpayment occurred. A 0-30 day balance carries different weight than a 31-60 day balance or a 90+ balance. AR reports are such a crucial element in understanding the story of an asset, and I can’t emphasize enough how valuable it is to be fluent in this topic.
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