Few apartment buyers in the private mid-market never request the balance sheet. Many of them don’t know what to look for. That’s the gap this post is about.
This post covers the dreaded balance sheet. Costs that exist, were paid, and should have reduced NOI. Except they didn’t, because they got parked on the balance sheet instead. The cash went out. The expense never hit the P&L. The trailing twelve looks clean because the cost is sitting on a document the buyer rarely sees.
Anything a competent buyer can fix in their own underwriting is not on this list. Insurance premium, property tax, the management fee, etc. Those get re-underwritten on every deal. This post covers the games that survive normal diligence because they live on the balance sheet, in shared corporate accounts, or in supporting detail buyers don’t think to request.
Some of what follows could be fraud. Some is sloppy bookkeeping. Some is GAAP-permitted treatment that doesn’t transfer to a new owner’s economics. Accrual accounting permits substantial capitalization during development and stabilization. The buyer’s job isn’t to police the rulebook. The buyer’s job is to underwrite to a number that survives close.
Here are few areas to look at before you close your next deal.
𝟭. 𝗔𝗹𝗹𝗼𝘄𝗮𝗻𝗰𝗲 𝗳𝗼𝗿 𝗗𝗼𝘂𝗯𝘁𝗳𝘂𝗹 𝗔𝗰𝗰𝗼𝘂𝗻𝘁𝘀
Allowance for Doubtful Accounts, or AFDA, is a contra-asset. A negative number that sits on the balance sheet against gross accounts receivable. Its job is to estimate what portion of the rent owed but uncollected will never actually be collected.
Gross AR of $50,000 minus AFDA of $2,500 equals net AR of $47,500. That net number shows up on the balance sheet as the “real” asset.
AFDA does double work. It reduces the asset on the balance sheet AND it determines bad debt expense on the income statement. So an under-sized AFDA inflates the asset AND suppresses bad debt expense at the same time. NOI is overstated. The asset is overstated. One manipulation. Two benefits. And the methodology is whatever the seller says it is.
Where this hides in normal due diligence. Most buyers ask for an AR aging report. Some management software defaults to a 30-day to 60-day current views. Anything older than 60 days drops off the standard report. So a resident who hasn’t paid in 3 months and is still occupying the unit doesn’t show on the AR report the buyer received. The rent roll shows them as occupied. Occupancy looks like 94%. Bad debt looks like 2% of GPR. The reality might be 87% economic occupancy with 5% bad debt.
Did the seller lie? Maybe or was it unintentional. I have seen both.
𝟮. 𝗟𝗲𝗮𝘀𝗲-𝗨𝗽 𝗟𝗮𝗯𝗼𝗿 𝗮𝗻𝗱 𝗠𝗮𝗿𝗸𝗲𝘁𝗶𝗻𝗴 𝗖𝗮𝗽𝗶𝘁𝗮𝗹𝗶𝘇𝗲𝗱 𝘁𝗼 𝗗𝗲𝘃𝗲𝗹𝗼𝗽𝗺𝗲𝗻𝘁 𝗖𝗼𝘀𝘁
Properties going through lease-up, new construction, major rehab, or repositioning generate enormous costs that should hit OpEx but get coded as “development” or “lease-up” instead.
Capitalizing a cost means putting it on the balance sheet as part of the property’s basis instead of running it through the P&L. The cash leaves the bank. The expense never reduces NOI. The cost just sits there, waiting to depreciate over decades.
Some of this capitalization is legitimate. Direct lease origination costs and certain pre-opening expenses can be capitalized under accounting rules. The buyer’s job isn’t to police the rulebook. The buyer’s job is to forecast the run-rate after stabilization. If the T12 shows leasing payroll at $150 per unit because the property is still capitalizing labor, and the buyer’s underwriting needs $500 per unit going forward, the gap is real money. Year one operating budget is wrong by thousands of dollars before anyone discusses motive.
The most common parking lot is onsite leasing payroll capitalized well past stabilization. Property manager, leasing agents, leasing manager, runners, the entire team. By month 12 of stabilized operations they should be hitting Personnel on the OpEx side. If they’re still on the development budget in month 18, something is wrong. Marketing gets the same treatment. SEO spend, paid search, signage, model unit furnishings, photography, drone footage, leasing brochures, the property website. Some of this is legitimately capitalized during initial lease-up. None of it should still be on the balance sheet two years after stabilization.
Then come the smaller items. Property management software, marketing automation, lead-gen tools, annual subscriptions capitalized as “intangibles” rather than expensed monthly. Pre-leasing concessions and gift cards are parked here too. And the most aggressive version, allocated G&A, where some operators capitalize a slice of corporate overhead , CFO time, accounting time, legal time, to active development projects. Sometimes legitimate. Often abused. Look for line items called “Allocated G&A” or “Capitalized Corporate Costs” on the CIP detail. If the dollar amount is large, dig in.
How do you check for this? Build a stabilized operating a monthly budget at industry-realistic per-unit costs and actual service contracts from scratch. Don’t anchor on the T12. Compare your bottom-up budget to what the trailing twelve actually shows. Where the gap is large, do more research, get your own bids. The gap between your stabilized model and the T12 is the surprise that’s coming.
𝟯. 𝗖𝗼𝗿𝗽𝗼𝗿𝗮𝘁𝗲 𝗖𝗵𝗮𝗿𝗴𝗲𝗯𝗮𝗰𝗸𝘀
Multi-property operators run shared services. Accounting team. IT system. Marketing platform. Asset management software. Someone has to pay for them. The standard solution is to allocate those costs across properties, usually by unit count, sometimes by revenue. Each property gets charged a slice every month. The slice shows up on the property P&L as an admin expense.
That’s the legitimate version.
1) The thing being allocated is a capital cost, not an operating cost.
The seller buys a $35,000 lift truck and pressure washer rig for fleet-wide breezeway and sidewalk cleaning. Real equipment. Useful life of 7 to 10 years. Should sit on the balance sheet and depreciate.
Instead, the cost gets allocated across the portfolio as “shared cleaning services” at $35/unit/year across 1,000 units. The CapEx line stays clean. NOI absorbs the hit, but it’s spread thin enough that nobody notices on a single property.
The buyer of one of those properties sees $35/unit in shared cleaning expense on the T12. Looks normal. Doesn’t know the line item is paying off a piece of equipment that the seller keeps when the deal closes.
2) The allocation is uneven on purpose.
Stronger-performing properties absorb a larger share of the corporate cost. The deal being sold absorbs a smaller share. The deal that’s being marketed shows light admin expense. The other properties in the portfolio carry the load. The buyer of this deal sees a clean admin number on the T12 and doesn’t know it’s been subsidized.
You will not catch this by reading the financial statements. The line item just says “Corporate Allocation” or “Management Services” or “Shared Services” or something equally vague. The dollar amount looks reasonable. The allocation methodology is buried in a spreadsheet at the corporate office that the buyer will never see.
How can you tell? Build a detailed month-by-month operating budget from the ground up. Every line item. Every vendor. Every staffing position at market rate. If your bottom-up admin number is materially higher than what the T12 shows, the difference is being subsidized somewhere. Either the seller is absorbing the cost at the corporate level, in which case it disappears at close, or the seller is allocating unevenly, in which case the property has been on a subsidy that ends the day you close.
𝟰. 𝗣𝗿𝗲𝗽𝗮𝗶𝗱 𝗘𝘅𝗽𝗲𝗻𝘀𝗲𝘀
Prepaid expense is the balance sheet’s holding pen for cash that’s gone out the door but hasn’t been expensed by the property yet. Insurance paid annually. Software paid annually. Property tax paid in advance. Annual association dues. Marketing contracts paid in lump sums.
The asset shrinks each month as the property “uses” it, with the corresponding amount hitting the P&L. By month 12, the balance is at zero and a new prepaid is created when the next year’s invoice gets paid.
The game. Seller pre-pays things in lump sums and parks them as prepaid expense. Cash leaves the operating account in November or December. The expense doesn’t hit the P&L. The asset sits on the balance sheet. NOI looks higher than reality.
The buyer who only sees the T12 thinks operating costs were lower than they actually were on a cash basis.
Ask for the prepaid expense schedule, monthly, for the trailing 12 months.
𝟱. 𝗖𝗼𝗻𝘀𝘁𝗿𝘂𝗰𝘁𝗶𝗼𝗻-𝗶𝗻-𝗣𝗿𝗼𝗴𝗿𝗲𝘀𝘀 𝗮𝗻𝗱 𝗖𝗮𝗽𝗶𝘁𝗮𝗹𝗶𝘇𝗲𝗱 𝗥𝗲𝗽𝗮𝗶𝗿𝘀
Construction-in-progress, or CIP, is the balance sheet account where ongoing capital projects live. A renovation that’s mid-stream sits in CIP until completed, then gets reclassified to the building or improvement asset and starts depreciating.
The game. Keep projects open. Code routine repairs to the open project. As long as CIP doesn’t close, the costs don’t depreciate and don’t hit OpEx.
What this looks like in practice:
• Routine paint and carpet on turn units coded to “Renovation Project Phase II” that’s been open for 18 months
• Plumbing repairs coded to “Plumbing Upgrade Initiative”
• Roof patches coded to “Roof Replacement Project” that hasn’t actually started
• Appliance replacements coded to “Unit Upgrade Program” instead of routine R&M
A standard apartment turn runs $1,500 to $2,500. New paint, carpet cleaning, appliance repairs, minor drywall. That’s R&M, expensed. Aggressive operators recategorize turns as “unit upgrades” or “value-add capex.” Same scope. Different account. NOI improves.
The journal entry version is more direct. Month-end JE moves $40,000 from Repairs and Maintenance to Capitalized Improvements with no supporting vendor invoice. The CFO needs to hit a covenant. The JE makes it happen.
The forensic test. Ask for CIP detail by project. Every open project should have a defined start date, defined scope, defined budget, and an expected completion date. Open projects more than 12 months old without measurable progress mean the project is a parking lot. A unit-level walk against the capex ledger will surface the gaps a standard PCA misses. If the books say $400,000 of “interior renovation” was capitalized in the last year and the units don’t show $400,000 of work, the cost was something else.
𝟲. 𝗔𝗰𝗰𝗿𝘂𝗲𝗱 𝗟𝗶𝗮𝗯𝗶𝗹𝗶𝘁𝗶𝗲𝘀
Accrued liabilities should be costs the seller has incurred but not yet paid, with the offsetting expense already booked to the P&L. That’s the legitimate function of the account. The game is using it as a parking lot instead.
Turn invoice arrives for $3,000. Painting and cleaning a single unit. Normal accounting debits R&M expense and credits accounts payable. R&M is high, for window dressing the T12. So the journal entry gets routed differently. Debit Accrued Liabilities. Credit accounts payable. When the invoice gets paid, the cash leaves and AP clears, but the offsetting account is on the balance sheet, not the P&L. R&M expense never moves.
This is a corporate accounting move, not a property-level one. Site staff don’t often have full GL access. The reclassification happens at the seller’s home office, often as a month-end adjustment.
Multiply across hundreds of turns over 12 months and the R&M line is wrong by thousands of dollars. Payroll works the same way: leasing commissions and bonus accruals booked to liabilities and never amortized into Personnel expense.
The buyer can ask for GL detail. Most sellers won’t share it. Detection has to come from the other direction. Build R&M from the ground up using actual turnover ratios and your own vendor pricing. Compare your number to the T12.
If your number is higher, that’s the question, not the answer. Could be manipulation. Could be your vendors cost more, your scope is tighter, or the seller has better procurement. The buyer’s job is to figure out which.
Two takeaways that change how a buyer reads any apartment deal .
First, get the bank statements. Most sellers won’t hand over a balance sheet, and asking won’t change that. Bank statements you can get. Twelve to 24 months of operating account statements show what cash actually moved. Reconcile against the T12. Where cash left the account and the P&L doesn’t show it, you may have found a parking lot.
Second, build the operating budget from the ground up before you accept the T12. Every line item. Every vendor. Every staffing position at market rate. If the bottom-up budget doesn’t match the trailing twelve, the gap is what’s coming after close. The majority of broker T12 shows R&M and capex running too low.
The T12 is a sales document. Treat it like one.