Apartment Offering Memorandum Red Flags: How to Read One Without Getting Fooled

The big number on the cover of an offering memorandum is a marketing number, not a real one. That's not me being cynical, it's just how the document works. The OM is a sales brochure with a spreadsheet stapled to it, and its job is to make the building look as good as legally possible. Knowing where the polish hides is the difference between buying a solid deal and inheriting somebody else's problem at a premium. Let me show you where I look first.

I've written these, I've torn hundreds of them apart for buyers, and the tricks are almost always the same five.

1. "Pro forma" is a wish, not a fact

The first word to hunt for is "pro forma." It means projected, as in what the building could earn if everything went right. You'll see a pro forma rent column sitting proudly next to the actual rents, usually a couple hundred dollars higher per unit, with a footnote about "market rents." Ask the obvious question: if these units could rent for that today, why don't they? Sometimes there's a good answer. Usually the answer is that the number is aspirational and you'd be paying today for rents you'd have to go create yourself.

Always find the actual, in-place rent roll and underwrite off that. The building earns what it earns right now. What it might earn is a project you're taking on, and you shouldn't pay full price for your own future work.

2. The expenses are too clean

This is where the real games happen, because every dollar they shave off expenses is roughly fifteen dollars they add to the price at a 7 cap. Two things I check immediately.

Is there a management fee in there? A shocking number of OMs on smaller buildings show no management line at all, as if the property runs itself. Even if you self-manage, put a real fee back in, because your time isn't free and the next buyer will price it. And look hard at insurance. If the OM shows an insurance number from three years ago, it's fiction. In Florida especially, that line has climbed hard, and an old insurance figure can hide tens of thousands in annual expense that lands squarely on you the day you close.

3. The taxes are the seller's, not yours

Nearly every OM shows the current property tax bill, which is the seller's bill, based on an assessment from years ago. The moment you buy, the county reassesses, usually somewhere around 80 percent of your purchase price times the local millage rate. On a building that's appreciated, that reassessment can be a serious jump, and it comes straight out of your NOI in year one. Always re-run the taxes at your purchase price, not the seller's stale number. The good buyers do this automatically. It's the single most common way an OM overstates income.

4. The cap rate is calculated on the fantasy

Now watch how they get to that attractive cap rate on the cover. They take the pro forma NOI, the one built on wishful rents and clean expenses, and divide by the price. Of course it looks good. Recalculate the cap rate on the actual, in-place income with honest expenses and reassessed taxes, and the number almost always drops. That's the real cap rate, the one your lender is going to use anyway.

5. What's not in the pictures

The photos are always of the one renovated unit and the freshly mulched entrance. The roof age, the condition of the other units, the deferred maintenance, that stuff lives in the inspection, not the brochure. An OM that's heavy on lifestyle photos and light on a straight answer about the roof, the plumbing, and the electrical is telling you where to point your inspector.

The one that sticks with me

I had a buyer bring me an OM once, all excited about a 6.8 cap. I ran it on the actual rents, put a real management fee and a current insurance quote back in, and reassessed the taxes at the asking price. It was a 4.9. Same building, same rent roll, honest math. Not a scam, exactly, just every optimistic assumption stacked on top of each other until the number on the cover had almost nothing to do with what the building actually earned. We passed, and I've never regretted it.

How to read one in ten minutes

Ignore the cover. Find the in-place rent roll and the actual trailing expenses. Add back a management fee, drop in a current insurance quote, and reset the taxes to your purchase price. Whatever NOI you're left with, divide it by the price, and that's your real cap rate. If it's a lot lower than the cover, now you know your first counteroffer.

That honest underwriting is exactly what my valuation model runs, the same income approach I'd use to price a building for a seller or vet one for a buyer. Run a deal through it before you get attached to a cover number.