What It Means When The Promises, P&l, And Tax Return Don’t Align

Most every self-storage property you look at buying seemingly has three sets of books: 1) what the seller promises you 2) the Profit & Loss statements they give you and 3) the tax returns. And the problem is that often these three different viewpoints don’t align. What does that mean and what can you do about it?

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Welcome to the Self-Storage University Podcast, where you will learn the correct way to identify, evaluate, negotiate, perform due diligence on, renegotiate, finance, turn-around and operate self-storage facilities. And your host is a partner in one of the largest real estate portfolios in the U.S. with nearly $1 billion of holdings, Frank Rolfe.

Virtually every self-storage buyer faces this predicament because there's three sets of books on every storage facility, normally. You've got the one set of books, which are the promises that the seller gives you on the financial attainment that that facility can hit, but another set is their actual profit and loss statements from what they've been doing, and then finally, the third set of books are their tax returns. This is Frank Rolfe for the Self Storage University Podcast. We're gonna talk about what happens when these three different sets of books don't align; the promises, the actual performance, and the tax returns. So the first question you might ask is, why don't they align? And of course, the common answer, the obvious answer, the common sense answer is because sellers like to lie. They like to lie because they wanna get more for that self-storage facility than it's worth. So do the brokers. So you just have to understand that. There is some degree of monetary value in pretending it does better than it actually does.

And then you have the profit and loss statement, and the profit and loss statement is a little closer to reality, because Mom and Pop can't really lie to themselves, can't lie to their lenders, can't lie to their investors. So the profit and loss statement is definitely a more accurate portrayal of performance than what Mom and Pop tell you. But then, you have the dreaded tax returns. And on the tax returns, reality really lets it all hang out. Now, why are the tax returns the most accurate? 'cause they have the greatest skin in the game, they have the biggest penalty. If you don't do an accurate tax return, it's tax fraud. You could theoretically be arrested, sued. There's a lot of teeth in that mistake.

So as a result, really, the tax returns are the most accurate set of books between the three, is the tax returns. And that's exactly why most sellers will not give you their tax returns, they'll come up with all kinds of excuses, privacy, and they're afraid you're nuts and you might turn them in to the IRS. But the bottom line is it's because the numbers don't match. It's also a given the numbers will go down progressively between those three sets of books; highest supposed net income, there are promises, second highest, profit and loss statements, third highest, their tax returns. And that's just a given. That's just a part of life, just a part of by a self-storage property. So what do you do when they don't align?

Well, when they don't align, clearly, what you do is you go to mom and pop and you say, "Wait a minute, these numbers do not match what you told me, and my value was very much different than what you're telling me now." And there's real teeth in that argument, because clearly, if the NOI is 20% lower than what they promised you, well, then the price needs to be 20% lower as well. So often, having them not align is simply a trigger for you to try and get a price reduction. Or, if they won't do a price reduction, well, then the other option would be to demand them to carry the paper, carry the financing, because... Tell them that the bank isn't gonna do this deal. These things don't align. The bank will be spooked. So if I can't use a bank, if I can't get a bank loan, you'll have to carry the paper, you'll have to be the bank. And on top of that, you'll have to be the bank because since your numbers are lower than what you promised, the only way this deal will work, if you use a lower than average interest rate. So often, when the numbers don't align, you can actually use that as a tool, a tool for progress, a tool for change, a tool to make more money. Because the first reaction when those things don't align should immediately be moral outrage, and you hit them up with the fact they're gonna have to lower the price and/or carry the financing. Preferably both.

Now, the real trick to all this is that there's really a fourth set of books. They have those three sets of books, but you as the buyer, you should have your fourth because you go through their P and L and you re-craft it based on what you think you can attain. You say, "Well, this guy does a terrible job of marketing, he's not even online. If I build an online presence, if I get five star reviews, I bet I can boost this occupancy from 50% to 75%." Okay, that might be your assumption on growth in revenue, and then you look at it, you say, "Oh, you know what? This guy just hammered his money on nothing. He's spending way too much money on paving, there's all kinds of ways I can cut these costs." And if you're a smart operator and you have the right deal, that fourth set of books is even better than what mom and pop promised you. So now with this fourth set that you've created, suddenly, this deal looks a whole lot better than it did even at the best case scenario with mom and pop.

And if you use the tool of their promises not aligning with the P and L, not aligning with the tax return, and get them to lower the price and carry the paper, and then you spring forth internally, never told them about it, the fourth set of books, which meant it really wasn't a bad deal as originally promised, that's when you're gonna hit possibly your most profitability. Now, it's also important to note in this equation that the mom and pop seller that will be the most susceptible to having these three sets of books not aligned is gonna be your traditional more mom and pop. Big corporate owners with computerized records, it's very unusual for them to make any errors and things may well align. But that's not really where the money is in self-storage anymore, right?

All those urban multi-story self-storage facilities right now are barely surviving, if they even will. With interest rates doubled, cap rates doubled, most of them are under water, just a matter of time before it all shakes out and all comes tumbling down. But if you go to the suburban and exurban markets out of town, more rural areas where you can deal directly with moms and pops, that's where you're gonna find the better deals, and that's where you're gonna find these options to take advantage of their multi sets of books with your own set of books and forge the best deals of all. This is Frank Rolfe, The Self Storage University Podcast. Hope you enjoyed this. Talk to you again soon.