Unlocking the Mystery of the Trailing 12 Financial Statement

Financial statements can be easy!

Once you learn what all the labels are of the line items, the T12 becomes fun to look at because the numbers are telling you a story. You can constantly ask why they're spending money on X, why they don't have Y, income, where you can improve Z, etc. It's like you're in overwatch mode and get to move the pieces and make decisions to make the operations better.

What is a Trailing 12? (T12)

It's the financial statements for the last 12 months of operation. It covers income and expenses of the deal.

What is a Trailing 3? (T3)

You might also hear people say "T3." This just means the trailing 3 months of the financial statement.

Oftentimes, lenders or other general partners will underwrite the income based on the T3 and the expenses based on the T12.

This is because the expenses often have a lump sum payment for a contract or other expense due. It's more accurate if it's spread out over a year. If it was based on the T3 and there was a big lump expense (or no expense) the numbers could get skewed.

They often underwrite the income based on the T3 because it's the most current rents.

The warning on this is to always do a lease audit in due diligence. Sometimes sellers will lower their standards on their tenant household income requirements, crime records, etc. just before a sale. They do this to boost temporary occupancy which shows an artificial increase to NOI. If their NOI is higher, they can get a higher price on their sale. What happens is these tenants often don't have the income to afford the rent long term or create problems for other tenants. You'd be left with a big eviction problem along with occupancy dropping probably to the worst it's been.

Why people can get overwhelmed with financial statements

The number one thing is simply that they don't know what the labels or the line items mean.

All that's going on in a financial statement is categorizing where the income is coming from and where the expenses are coming from and how much.

To simplify it, we can look at the first step.

Total income - total expenses = net operating income.

Net operating income - debt payment = cash flow

This really is the heart of the whole thing. You'll see this at the bottom of the financial statement. Everything else is just expanding categories. Take a look at breaking it down the income a step further.

(Maximum potential rental income as if 100% occupied) - (tenants who don't pay + vacant units + old rents that are lower than what you can get today + people behind on rent + rent you'll probably never collect)

= Net rental income

And that's it! It's breaking down the income and expenses into categories.

What you just did there was figure out one of the biggest things people get confused on; economic vacancy. Economic vacancy is just all of those things in the second parenthesis.