What are the red flags in an offering memorandum?

The offering memorandum red flag checklist

Work through these against the actual documents, not against the summary. Check each one off as you clear it on your deal.

• 01CriticalThe financial summary leads with proforma NOI

  What it looks like in the OMThe financial summary opens with a column labeled proforma, stabilized, or year one, and that is the column carried onto the pricing page. Actual trailing performance sits further back, in smaller type, or as a single annual line with no monthly detail. The projection usually bundles several optimistic assumptions at once: every unit renovated, rents at the top of the comp set, vacancy at 5 percent, and expenses held flat while rents climb.

  How to test itFind the actual NOI and set it beside the proforma NOI. If the document never states an actual NOI, that absence is the finding. Then ask what specific capital spend and how many months of downtime produce the projection, because a renovation proforma without a capital budget and a lease-up schedule is a wish, not a plan.

  Dollar impactIn the 24-unit worked example the seller package reports $177,000 of NOI and the verified ledger supports $168,000. At a 6.00 percent cap that is $2,950,000 against $2,800,000: a $150,000 price gap produced by a $9,000 accounting difference.

• 02CriticalThe headline cap rate is computed on projections

  What it looks like in the OMThe cover says 6.00 percent cap. The footnote, when there is one, says the cap rate is calculated on year one projected net operating income. Nothing in the document is technically false, but the yield being advertised is a yield the buyer has to create rather than one the property currently produces.

  How to test itRecompute the cap rate yourself: verified trailing NOI divided by the asking price. Do that before reading the seller's number so you are not anchored to it. If the two differ by more than a few basis points, the difference is the amount of unperformed work being sold to you as an existing return.

  Dollar impact$177,000 of proforma NOI at a 6.00 percent cap prices the deal at $2,950,000. Measured against the verified $168,000, that same price is a 5.69 percent cap. The buyer pays a 6 cap price for a 5.7 cap property.

• 03CriticalNo 12-month statement, only an annual summary

  What it looks like in the OMThe financials section shows an annual summary, an in-place column, or a trailing three months annualized, but no twelve column statement. Sometimes the language is explicit: full financials available on execution of a confidentiality agreement. Sometimes the T-12 is present but two months are absent, or one month appears twice under different labels.

  How to test itCount the calendar months. You need twelve distinct ones, each with income and expense detail. Then tie the sum of the twelve columns back to the annual figure quoted in the offering memorandum. Any month that is missing, estimated, or annualized from a shorter period is unreported until the seller produces it.

  RTOM detectorMissing months (critical): RTOM flags any statement containing fewer than 12 distinct calendar months, and the listing cannot publish until the seller acknowledges the gap in writing.

  Dollar impactEvery adjustment in the worked example lives in a specific month: the $12,000 payout in March, the $21,000 repair in March, the rent step-up across October through December. An annual summary shows none of them, and together they account for the full $150,000 price gap.

• 04CriticalRents step up in the three months before the listing

  What it looks like in the OMThe rent roll shows in-place rents well above what the T-12 collected, and the increase is concentrated in the most recent months. The offering memorandum frames this as momentum: recent leases signed at the new rate, market is moving. The pricing then rests on the new rents rather than the collected ones.

  How to test itAverage the last three months of collected rent and compare it against the prior nine. Then demand lease-level evidence: start dates, new versus renewal rates, concession schedules, and delinquency. A lift built on signed twelve month leases is durable. A lift built on month-to-month bumps, concessions burned off right before the listing, or face rents that never collected is not.

  RTOM detectorPre-list rent lift (critical): RTOM flags a trailing three month effective rent more than 10 percent above the prior nine month average, and blocks the listing from publishing until the seller writes a disclosure explaining the cause.

  Dollar impactIn the worked example the trailing three months average $32,500 against $29,000 for the prior nine, a 12.1 percent lift. Annualized, the T-3 implies $390,000 of rent against the $358,500 actually collected. Capitalizing that $31,500 of unproven revenue at a 6 percent cap adds about $525,000 of price.

• 05CriticalOperating expenses that are too good to be true

  What it looks like in the OMThe expense schedule totals well under a third of income and the offering memorandum presents it as evidence of an efficiently run asset. Look at what is not there: no property tax line, no insurance line, no management fee because the owner self-manages, or repairs pushed onto a capital schedule that never appears in the package.

  How to test itDivide total operating expenses by effective gross income. Then check the largest lines against primary documents rather than the category totals: the assessor's actual bill for taxes, the declaration page for insurance, and a market management fee whether or not the current owner pays one.

  RTOM detectorExpense ratio too low (critical): RTOM flags total operating expenses below 30 percent of income. Multifamily typically runs 35 to 50 percent of effective gross income, so a ratio under 30 percent usually means categories are missing rather than that the building is unusually cheap to run.

  Dollar impactThe worked example books no management fee because the owner self-manages. Adding a market fee of about $15,000 a year removes roughly $250,000 of value at a 6 percent cap, and that is one missing line out of nine.

• 06CriticalA negative NOI month smoothed away by the annual figure

  What it looks like in the OMThe annual NOI looks acceptable, so nobody asks about the monthly path. Inside it, one or two months ran below zero: an insurance premium paid in a single installment, a tax payment, a mass turnover, or a stretch of collections failure. Reported annually, the month disappears.

  How to test itRead the NOI row across all twelve months before you read the total. Any negative month needs a written explanation and a source document. Some are benign timing, such as an annual premium booked in one month instead of accrued. Some are the first visible symptom of an operating problem that has not finished playing out.

  RTOM detectorNegative NOI months (critical): RTOM flags any single month with NOI below zero, and the seller must disclose and explain it before the listing can go active.

  Dollar impactThe verified $168,000 averages $14,000 of NOI a month. One month at zero instead of $14,000 is about $233,000 of value at a 6 percent cap, and it is invisible in an annual summary.

• 07CostlyOne-time income capitalized as if it recurs

  What it looks like in the OMOther income runs higher than the property's mix of pet rent, parking, and utility reimbursement would explain, and the excess sits in a single month. The usual culprits are an insurance claim payout, a lease termination fee, a utility true-up, or a legal settlement. The offering memorandum shows the annual total, so the lumpiness disappears and the pricing capitalizes it as recurring.

  How to test itRead other income month by month, never as a year total. Any month that breaks the pattern needs a source document. Then ask for the itemized breakdown of the bucket, because line-level durability differs: pet rent generally persists, a claim payout never repeats, and utility reimbursement can vanish when the billing arrangement changes.

  RTOM detectorOpaque other income (flagged): RTOM flags "other income" at 5 percent or more of total income when there is no itemized breakdown, so a buyer sees inside the bucket before capitalizing it.

  Dollar impactThe $12,000 insurance claim payout in the worked example, capitalized at a 6 percent cap, is roughly $200,000 of phantom price paid for money that arrives once.

• 08CostlyA single expense month hidden inside the annual total

  What it looks like in the OMOne month of repairs, legal, or turnover cost dwarfs the other eleven, and the annual total absorbs it. This flag cuts both ways. Sometimes the spike is a genuine operating cost the seller would like averaged away. Sometimes it is a capital item that should come out of operating expenses entirely, which moves NOI up.

  How to test itCompare each month against the median of the other eleven. When a month stands out, ask for the invoice rather than the explanation. A roof, a re-pipe, or a parking lot is capital. A string of turnover costs on the same three units is operating, and it is telling you something about the tenant base you will inherit.

  RTOM detectorExpense spike (flagged): RTOM flags any month of operating expenses more than 3x the median of the other months.

  Dollar impactThe worked example carries a $21,000 repair month against a $3,000 median. Reclassifying the $18,000 re-pipe as capital raises NOI by $18,000, worth roughly $300,000 at a 6 percent cap, before the same normalization adds back a $15,000 market management fee that offsets most of it. This adjustment runs in the seller's favor, which is exactly why the work has to be done line by line instead of assumed.

• 09CostlyOccupancy sliding while the summary says stabilized

  What it looks like in the OMThe cover reports a single occupancy figure, usually physical and usually as of the most flattering date. The trend behind it is not shown. An asset at 94 percent that stood at 97 percent three months ago is a very different deal from one climbing toward 94.

  How to test itCompute economic occupancy month by month: collected rent divided by scheduled rent from the rent roll. Physical occupancy counts heads, and a unit with a tenant who does not pay is occupied and worthless at the same time. Three consecutive months of decline is a trend, not noise, and it should change your vacancy assumption rather than just your negotiating tone.

  RTOM detectorOccupancy decline (flagged): RTOM flags economic occupancy falling for 3 consecutive months.

  Dollar impactThe worked example collects $358,500 against $403,200 of in-place scheduled rent, an 11.1 percent gap. One additional point of economic occupancy loss is about $4,000 of income, roughly $67,000 of value at a 6 percent cap.

• 10CostlyThe seller's property tax bill carried into your first year

  What it looks like in the OMThe expense schedule shows the tax line as it stands today, under an assessment that reflects the seller's basis and history, not yours. Nothing in the document flags that a sale often resets the bill: some states reassess on transfer, and even in nondisclosure states such as Texas, appraisal districts tend to move assessments toward market value in the years after a trade. The offering memorandum is accurate as history and misleading as a forecast.

  How to test itPull the parcel record from the county appraisal district and compare the current assessed value against your purchase price. Apply the local rate to the likely reassessed value, then rebuild year one expenses with that number. This belongs in your forward underwriting, not in a correction to the historical statement, and the two should stay separate in your model.

  Dollar impactTaxes are the largest single lever in most multifamily expense schedules. At a 6 percent cap, every $10,000 of additional annual tax removes roughly $167,000 of value, because each recurring dollar of NOI is worth about $16.70 of price.

• 11CommonSale comps selected by outcome

  What it looks like in the OMThe comp set supports the asking price a little too neatly. Look at what the comps share with each other rather than with the subject: newer vintage, a stronger submarket, post-renovation pricing, a unit count large enough to earn institutional pricing, or a sale date from a materially different rate environment. Rent comps get the same treatment, with the subject's unrenovated units priced against a competitor's renovated ones.

  How to test itRebuild the set yourself on likeness: year built, unit count, unit mix, submarket, condition, and sale date. Then ask what was excluded and why. The single most useful question is what closed nearby that is not on this page. A comp set that omits every trade below the asking price is not evidence, it is a selection.

  Dollar impactComps set the cap rate, and the cap rate moves value harder than NOI does. On the verified $168,000, a quarter point of cap rate is worth roughly $121,700, which is most of the $150,000 gap this whole checklist produced.

• 12CommonThree or four expense buckets doing the work of nine

  What it looks like in the OMThe expense schedule reads payroll, repairs, other. Or worse, a single administrative and operating line. Coarse categorization is sometimes sloppy bookkeeping and sometimes deliberate, but the effect is identical: no line item can be tied to a primary document, so nothing in the schedule is verifiable.

  How to test itCount distinct expense categories. Then ask for a general ledger export rather than a re-cut summary, because a reformatted summary is the same data in new buckets. With the ledger you can tie taxes to the assessor, insurance to the declaration page, and utilities to the actual bills.

  RTOM detectorThin categorization (flagged): RTOM flags fewer than 4 distinct expense categories. The industry norm is 6 or more: administrative, marketing, payroll, repairs and maintenance, landscaping, utilities, insurance, taxes, and management.

  Dollar impactTwo of the worked example's adjustments hide inside coarse buckets: a $12,000 one-time income item and an $18,000 misclassified repair. Together they swing NOI by $30,000 in opposite directions, about $500,000 of value movement at a 6 percent cap.

Frequently asked questions

What is an offering memorandum?

An offering memorandum, usually called an OM, is the marketing package a broker or seller distributes to solicit offers on a commercial property. It typically contains an executive summary, property and unit-mix detail, photos, a market and submarket overview, sale and rent comparables, and a financial summary with pricing. It is prepared by the sell side to support a price, which makes it advocacy rather than disclosure.

Can you trust the cap rate in an offering memorandum?

Not without recomputing it. The headline cap rate is frequently calculated on year one projected NOI rather than on trailing actuals, so it describes a yield the buyer must create instead of one the property produces today. Divide the verified trailing NOI by the asking price yourself. On the 24-unit example, $177,000 of proforma NOI supports a 6.00 percent cap at $2,950,000, while the verified $168,000 makes that same price a 5.69 percent cap.

What is the difference between an offering memorandum and a T-12?

The offering memorandum is the sales narrative; the T-12 is the ledger. The OM is authored to present the property favorably and mixes historical figures with projections, comps, and market commentary. The T-12 is a twelve column statement of what the property actually collected and spent, month by month, produced from the accounting system. When the two disagree, the T-12 governs.

What should you request beyond the offering memorandum?

Request the full T-12 with all twelve months shown separately, the current rent roll with lease start and end dates, the trailing general ledger, the most recent property tax bill from the county, the insurance declaration page, twelve months of utility bills, and a capital expenditure history. Those documents let you verify the largest lines rather than trusting the OM's category totals.

Why do offering memorandums use proforma numbers?

Because the seller is pricing the property on the upside a buyer could capture, and there is no rule requiring an OM to lead with actuals. Proforma columns are legitimate as a description of a business plan. They become a red flag when the cap rate, the asking price, or the returns table is built on them while the trailing actuals are summarized, buried, or withheld until after a confidentiality agreement is signed.