As a condo manager, a real estate agent, or even a real estate attorney, being able to review a Condo financial statement is very important because it gives you an idea of how the association is managed and also sets your expectations with operating expenses once you decide to go ahead with the property investment.
For real estate agents, having the ability to critically analyze condo financial statements gives you a huge edge over other agents who do not. Also as a home buyer, looking to invest, having basic finance and accounting knowledge will do you better. The same goes for your attorney who will need to look up financial statements and interpret them since numbers can be closely tied decisions for the apartment you’re looking to pay for. You don’t want to be in some trouble later because of mistakes from reviewing financial statements. There are seven important things for you to look out for in Condo Financial Statements and this blog post is geared towards making them crystal clear, conversational, and simple.
Are the financial statements properly audited?
If the financial statements are properly audited, you would know because it says so right upfront. What you should be looking for are audited financials, however, a small building or apartment (normally under 10 units) might look for ways to not spend money verifying an audit.
These small buildings will look to have their certified public accountant (CPA) prepare the statements without a proper audit verification. In a large building or apartment, anything that happens to not be a verified audit financials screams suspicious so you’re best if you avoid it.
If a financial statement is not audited, what it means is that the actual accountant is not preparing and providing an opinion as to what is contained within the financial statements themselves.
Does the Audit have a “Clean” opinion?
Once more, you’re sure to find it in the CPA’s report before you deal with any other number. It is important that you check the auditor’s opinion section as it contains a simple greenlight. What you are looking for in the auditor’s opinion is actually a simple phrase.
It should simply say that the statements “present fairly the financial position and cash flows of the apartment or property”. What this simple statement or phrase means is that there are no issues that the auditor has discovered which may be worth mentioning. The keyword or phrase worth looking out for is “Present fairly”.
What you don’t want to see in the auditor’s opinion are phrases like “subject to” or “except for”. If you come across any other complex info other than the simple statement, you should approach it with caution as it screams a red flag.
Have a good look at the Balance Sheet
It is important you analyze the balance sheet well, if possible, you should get the services of a real estate attorney if you can afford it. The balance sheet is important because it lets you know what the current cash holdings are for the apartment or condo.
Here are some of the things you should look out for in the balance sheet.
- Cash: Has the cash amount changed from the previous year? How long can the cash support the building expenses? Ideally, the amount of time it should take to support the building expenses should be between 3 – 6 months.
- Account Receivable: The account receivable is important because it gives the buyer a general sense of the health of the building. In other words, this is the money your soon-to-be condo neighbors owe the building. If it is more than 10%, it means some of you might be having big financial issues.
- Account Payable: This is the money that the apartment or condo pays for taxes, employers, and vendors. Ideally, the condominium or apartment should be paying its bills on time. Anything larger than 10% of the actual income of the building means that they are having some major cash flow problems. It could be that they take too long to pay up and as such, bills increase so you should definitely lookout for this.
- Mortgage Payable: This is the Condo’s mortgage, not the mortgage you will have on your unit. It is important that you lookout for the notes at the end of the CPA’s report to see when the mortgage will be due and what the interest rate is. If the interest rates happen to be going up and the due date is approaching, you’ll know that your monthly fees will most likely go up.
- Retained Earnings: If the retained earnings have a large negative number, it shows that the building is running at a loss, which could lead to an increase in maintenance fees.
Look at the Income statement
It is a good idea to analyze the composition of the income. You want to check if the building receives money from the owners. Normally you would see a phrase like “common charges” – this is a good sign that the building receives money from the owners.
A red flag would be a phrase like “Flip Tax”. This is when businesses in the condo or apartment are charged fees that are used to maintain the building. What this means is that the building maintenance is fully dependent on how successful the business is being run so you can see why that can be an issue.
Look at the Cash Flow
It is crucial you understand the cash flow as it gives you insight into the likely increase of fees in the building or apartment.
Here are some things you should look out for.
- Is the building cash positive, i.e. Is the building taking in at least as much money as it pays out? If not, your monthly fees will likely increase.
- Are there any unusual items compared to the previous year? Perhaps there are big expenses for capital improvements (new elevators, roofs, hallways, and the like). That would be good news because you would not be hit by those expenses.
Properly evaluate the Condo’s Reserve Fund
A well-run condo will have enough money in reserve funds to cover around 3 to 6 months’ worth of expenses. However, there are apartments that keep maintenance fees low. As long as you know how the building operates, you can budget your expenses accordingly.
Read the notes to the Financial Statements
This is one part that you should read very thoroughly. If there are any potential dangers in the building’s finances, this is where they are mostly hidden. Look out for statements about tax problems, pending litigation, upcoming major repairs, and expiring commercial leases. These are the types of problem areas that can have a severe impact on your fees and maintenance, or result in an assessment.
If you ever need to employ our wealth of experience with managing finances for condo associations, feel free to read this sister article.