When you invest in a commercial rental property you’re buying two things: the real estate and the income that the property generates.
It’s relatively easy to determine the value of a property using a metric like price-per-square foot. However, using a rent roll to measure the value of the income stream is a bit more difficult, especially during times of unusual market conditions or economic volatility.
Here’s how to read and use a rent roll to help determine the true value of a commercial rental property before you buy or sell.
What is a Rent Roll?
A rent roll shows the rental income from a real estate asset. It can be constructed for any type of income producing real estate, including single-family houses and multifamily buildings, commercial property such as office buildings or shopping centers, and land leased for agricultural use.
While some people view a rent roll as a simple document, information from the rent roll is used in key rental property financial performance formulas such as net operating income (NOI), internal rate of return (IRR), gross rent multiplier (GRM), and cap rate.
How a Rent Roll Works
Rent rolls can also be property-specific or developed as a master rent roll for the entire rental property portfolio. Although the exact information on a rent roll varies based on the property type, a good rent roll always includes the following information:
- Name of property owner or management company
- Address of property
- Type of property
- Zoning or market area of property (commercial, industrial, residential, mixed-use, urban, suburban)
- Unit number (such as #1, A, etc.) if the property has multiple rental units
- Square footage
- Lot size
- Additional amenities
- Name of tenant
- Monthly rent
- Extra rent (ie. Late fees)
- Rent due date
- Date rent paid
- Past due rent
- Prepaid rent
- Security deposit held by landlord
- Lease start date
- Lease end date
- Rent concessions given by landlord to tenant
Rental Income Summary
- Total monthly rent collected (including extra rental income)
- Total annual rent collected (including extra rental income and any annual fees charge to tenant such as landscaping)
Where Does This Data Come From?
Although there’s a lot of information on a rent roll document, data for the rent roll comes from just a few sources:
- Local tax assessor for property size, lot size, and zoning
- MLS listing information (if property was purchased from an agent)
- Appraisal report for detailed property
- Lease agreement and tenant file for tenant information
- P&L for monthly and annual gross income
Who Uses a Rent Roll?
There’s a lot more to a rent roll than first meets the eye. While many real estate practitioners focus on the P&L and balance sheet, the rent roll for a rental property can provide a surprising amount of detail on a single page. The rent roll is an all-purpose document that can be used by buyers and sellers, property managers, real estate investors and landlords, and lenders.
Buyers and sellers during due diligence
A quick look at the rent roll will tell a buyer and seller whether the property has been generating stable gross rental income. Comparing the fair market rent to the rent the tenant is currently paying indicates the possibility of increasing the value of the property simply by raising the rent.
If the tenant’s lease is coming up for renewal in the next few months, a seller who proactively extends the lease may be able to sell the property at a higher price since the tenant has been “stabilized” for another term. That’s because some buyers are willing to pay more for a rental property when they know the future income stream is predictable.
Property managers and landlords
The rent roll provides an early warning sign to property managers and owners that a problem may be brewing with the tenant.
If a tenant suddenly begins paying the rent late, or if a tenant is a habitual slow payer, it could be a big red flag that the tenant may need to be evicted and the property pre-marketed for lease to reduce the amount of down time due to vacancy and repairs.
Real estate investors analyzing potential deals
Real estate investors use a rent roll to verify the current rental income, search for upside potential in the rental property, and to anticipate problems with future cash flow.
By comparing the rent roll to the income line on the profit and loss statement, an investor can immediately see if the gross income is being accurately reflected on the P&L. After receiving a CMA (comparative market analysis) the rent roll will show whether the rent the tenant is paying is a fair market rent or has room for an increase.
Lastly, the rent roll can help an investor learn if there could be a problem with cash flow in the future. For example, a tenant paying rent late or a lease coming up for renewal may be a sign that cash flow will be reduced if the tenant needs to be evicted or income temporarily stops and vacancy rises when the tenant does not renew the lease.
Mortgage brokers & lenders
Mortgage brokers, lenders, and banks are experts in using the rent roll to evaluate the potential risk of making a loan, a cash-out refinance, or opening a line of credit. Lenders review the rent roll to anticipate the future income-generating potential of the property.
For example, if the historical turnover rate is high and the vacancy rate has been increasing over the last few years, a lender may see that as a sign that there are issues with the condition of the rental property, tenant screening procedures, or the property management company.
Five Ways Anyone Can Use a Rent Roll
Now, let’s look at how anyone can use a rent roll to measure and forecast potential outcomes on the performance of the rental property. For the most accurate analysis, you’ll need copies the rent roll for different time periods which will be used as your baseline data:
- Current month
- Same month one year ago
- Annual rent rolls for the previous two years
- Tenant turnover & renewals
If the name of the tenant changes from year to year – or even within the same year – the property has a turnover rate of 100% or more. Cash flow is reduced during the vacancy period between tenant turns, and money is being needlessly spent in marketing and leasing fees.
The question to ask is why tenant turnover is so high and renewal rates are so low. Turnover may be high due to fixable factors such as poor maintenance or property management, or there may be a property defect that you’re not aware of.
- Rent growth
By comparing same-month reports year-over-year you can see if the rental revenue is increasing and my how much. Comparing that to the average growth rate for your area indicates how the rental property is performing vs. other potential investments in the same market.
- On-time rent collection
Looking at the percentage of time the rent is paid on the due date is an indicator of the quality of the tenant renting the property and the ability of the property management company.
On-time rent payments also help you decide whether to renew a tenant’s lease. If you have a tenant that pays consistently late, it may make good business sense to proactively market the house for lease if the demand for rental property in the market is currently strong.
- Late fee income
Some investors view late fee income as ‘found money’ and an additional source of revenue. For example, if the normal monthly rent is $1,000 and the tenant pays a late fee of $100, the effective rent is $1,100 – or 10% more than the normal rent.
However, if you’re buying a property with an existing tenant who always pays late, beware. If the tenant decides to leave or has to be evicted, you’ll end up spending much more on repairs and legal fees than the few hundred dollars of found money the seller promised you would collect.
- Evictions activity
If you notice that the rental property has a new tenant every year, ask the seller how often the tenant was evicted. And, if the tenant was evicted, ask whether the tenant left voluntarily, had to be taken to court and evicted by the local authorities, and what the costs were in legal and repair fees before the property could be rented again.
The rent roll document is a valuable tool used by commercial rental property investors to maximize gross rental income and improve property performance. Important things to remember about a rent roll include:
- A rent roll is a report that provides detailed information about the property, the tenant, and rents.
- Rent rolls can be constructed for a single property or an entire rental property portfolio.
- Sources for data on a rent roll include the local tax assessor’s office, appraisal report, and lease agreement.
- The rent roll document is used by buyers and sellers, investors and property managers, and lenders.
- Information gleaned from a rent roll report includes tenant turnover, rent growth, and occupancy rate.