Three Red Flags in Every Offering Memorandum

I have read more offering memorandums than I can count. Glossy PDFs. Professional photos. Projected returns that would make Warren Buffett jealous.

And almost every single one is lying to you. Not with false numbers. With framing. The OM is a marketing document, and once you understand that, you can read between the lines and see what the broker doesn't want you to focus on.

Here are the three red flags I see in nearly every offering memorandum, and how to spot them before they cost you money.

Red Flag 1: The Inflated Pro Forma

Every OM includes a pro forma. It's supposed to show you what the property could earn under new ownership with "stabilized" operations. In practice, it shows you what the property would earn in a perfect world where nothing goes wrong and every optimistic assumption comes true simultaneously.

Here's what to look for.

Pro forma rents vs. actual rents. The OM will show current rents on one line and "market rents" or "projected rents" on another. The gap between those two numbers is the entire value-add thesis. But who determined the market rent? The broker. Or the seller. Or someone with a financial incentive to make that number as high as possible.

I pulled an OM last year on a 20-unit in South Omaha. The pro forma projected rents of $1,250 for 2-bedroom units. Actual market rent for comparable units in that submarket? $1,075 to $1,125. The broker was using comps from a recently renovated building two miles away in a better neighborhood.

That $125 gap across 20 units is $30,000 per year in phantom income. Underwrite to that number and you overpay by $400,000+ at a 7 cap.

Always pull your own comps. Not Zillow. Not the broker's selected comps. Go to Apartments.com, call local property managers, and look at what's actually leasing in that specific submarket. Then assume you will hit 90-95% of that number, not 100%.

Pro forma vacancy assumptions. The standard pro forma uses 3-5% vacancy. Actual vacancy in most B and C class Omaha multifamily runs 5-8%. And if the building needs renovations to hit the projected rents, you need to add unit downtime during renovation.

If you're renovating 4 units per year at 3 weeks of downtime each, that's 12 weeks of vacancy on top of your normal vacancy rate. On a 20-unit building at $1,100/month, 12 unit-weeks of renovation vacancy costs $3,300 that doesn't appear on any pro forma I have ever seen.

Pro forma expenses. This is the big one. The pro forma will show "stabilized" expenses that are almost always lower than reality.

Ask yourself:

Does the pro forma include professional management fees? If the seller self-manages, they probably excluded it.

Are insurance costs current? If the pro forma uses last year's premium and rates are up 29%, that's a material understatement.

What about CapEx reserves? Most pro formas either exclude capital expenditure reserves entirely or use a laughably low number like $250 per unit per year. Real CapEx reserves for B/C class product should be $500 to $800 per unit per year depending on building age and condition.

The pro forma tells you what the property could earn in a perfect world. Your job is to figure out what it will earn in the real one.

Red Flag 2: Hidden Capital Needs

The OM will mention value-add opportunities. New flooring. Updated kitchens. Improved curb appeal. It will show the projected rent increase from these improvements.

What it won't show you, at least not prominently, is the full cost of getting there.

Unit renovation costs. The OM might say "light renovations" to achieve the projected rents. In my experience, "light renovations" in an OM means $8,000 to $15,000 per unit in real life. That includes LVP flooring, paint, fixtures, appliances, countertops, and labor. On a 20-unit building, even if you only renovate 10 units, that's $80,000 to $150,000 in capital expenditure.

Where is that money coming from? Your pocket. A capital call. A bridge loan. The OM conveniently skips this part.

Deferred maintenance. I look at every OM with the same question: what has the current owner not spent money on?

The clues are in the details:

Roof age. If the OM says "roof replaced 2008," that roof is 18 years old. It has 2-7 years of useful life remaining. A 20-unit building's roof replacement runs $50,000 to $90,000. Is that in your budget?

HVAC age. Individual furnaces and AC units last 15-20 years. If the building was built in 2005 and nobody has replaced HVAC units, you're staring down $4,000 to $6,000 per unit in replacements over the next five years.

Plumbing and electrical. The OM never mentions these unless they have already been updated (which they will trumpet). If the OM is silent on plumbing, assume it's original. On pre-1980 buildings, that means galvanized or cast iron pipe that's approaching end of life.

Parking lot condition. Walk it. If there are cracks, potholes, and crumbling edges, budget $15,000 to $40,000 for seal coating or resurfacing. This is a common deferred expense that sellers push to the next owner.

How to protect yourself. Build a capital expenditure schedule for years one through five. Walk the property with a contractor, not just an inspector. Add up every major expense that's likely to hit. Then add that total to the purchase price in your underwriting. That's the real cost of the deal.

If the OM shows a 9% cash-on-cash return but you need $200,000 in CapEx to achieve it, your actual return is dramatically different.

Red Flag 3: Creative Expense Categorization

This one is subtle, and it's the one that burns sophisticated investors, not just beginners.

Sellers and their brokers are creative about how expenses are presented. Not falsified. Just... categorized in ways that make the numbers look better.

"One-time" expenses that aren't one-time. The T-12 might show a $15,000 expense labeled as "one-time repair" that gets excluded from the adjusted financials. Sometimes it legitimately is one-time. Sometimes it's a recurring maintenance issue that the seller is framing as an anomaly.

A $15,000 sewer repair might be "one-time." But if the sewer line is 50 years old and the repair was a band-aid, that $15,000 is coming back. Ask for the full maintenance history, not just the last 12 months. Look for patterns.

Management fees buried or absent. If the seller self-manages, there's no management line item. This makes the expense ratio look fantastic. A building showing a 35% expense ratio with no management fee is actually running at 43-45% with professional management included. That changes the NOI, the value, and the returns.

Some OMs will show the self-managed P&L and then add a management fee in the pro forma but use 5% when the real cost is 8-10%. That understatement of 3-5% on a $300,000 gross revenue building is $9,000 to $15,000 in hidden expenses.

Capital expenditures counted as operating expenses. A new roof is a capital expenditure. A furnace replacement is a capital expenditure. But sometimes these show up on the operating P&L as "repairs and maintenance," which inflates the expense ratio and suppresses the NOI.

Why would a seller do this? Because the lower NOI justifies a lower tax assessment. It might also be how their CPA categorized it for tax purposes. But for your underwriting, you need to recategorize capital items properly so you can see the true operating expense ratio and the true NOI.

Utility costs that don't match. If the OM shows utilities at $2,000/month on a 20-unit building with master-metered water and sewer, something doesn't add up. Request actual utility invoices for the past 24 months. Not the seller's summary. The actual bills from the utility company.

I have seen OMs where the utility expense was an average that conveniently excluded the three highest months. When we pulled the actuals, the real annual cost was $8,000 higher than what was presented.

How to Read an OM Without Getting Burned

After years of doing this, here's my process.

Step 1: Ignore the pro forma entirely. Build your own from the rent roll and T-12. Use your own market comps. Use your own expense assumptions. If the deal works on your numbers, great. If it only works on the broker's numbers, walk away.

Step 2: Request the source documents. Tax returns (Schedule E), actual utility bills, insurance policy, property tax statement, maintenance logs, and bank statements if the seller will provide them. The T-12 is a summary someone prepared. The source documents are what actually happened.

Step 3: Walk the property with a contractor. Not a showing with the broker. A capital needs assessment with someone who will tell you what every major system costs to replace and when it will need it.

Step 4: Stress test your own numbers. What happens at 10% vacancy? What happens when insurance goes up 20%? What happens if rents come in $50 below your projection? If the deal still works under stress, it's worth pursuing.

Step 5: Back into the price. Don't start with the asking price and try to make the numbers work. Start with your target return, your actual NOI, and your cost of capital. Back into the maximum purchase price that hits your criteria. If that number is below the ask, make an offer at your number. If the gap is too wide, move on.

The OM Is the Beginning, Not the Answer

Every OM I read now gets the same treatment. I assume every number is optimistic. I verify every material line item. I build my own model from scratch.

It sounds like a lot of work. It's. But the alternative is buying a deal based on someone else's marketing material and discovering the real numbers six months after closing.

I have seen that happen. The investor who trusted the pro forma and ended up $40,000 short on CapEx. The buyer who used the broker's rent projections and couldn't fill units at those rates. The owner who didn't realize the management fee was missing from the P&L until they hired a manager and watched their cash flow evaporate.

Read the OM. Appreciate the photos. Then put it down and build your own model. That's where the real deal lives.

Looking at a deal in the Omaha or Lincoln market? We'll pressure-test your numbers for free. Reach out at Tanner@TopTierInvestmentFirm.com.

Tanner Sherman is the Principal and Managing Broker of Top Tier Investment Firm in Omaha, Nebraska. He co-hosts the Freedom Fighter Podcast with Ryan of Avara Investments.

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