The seller's numbers are lying to you. Except they're not, technically, and that's the part that makes an offering memorandum so dangerous.
I pulled a real deal one of my accelerator members was looking at, changed the names and moved a few figures around, and rebuilt it live. The offering memorandum said 7.25% cap rate. Rebuilt honestly, it's a 4.56% cap rate. And every single number the seller put on that page was accurate.
That gap isn't fraud. It's what's absent. The offering memorandum gives you data points, and it is your job as the buyer to do something with them. Nobody is coming to fill in the blanks for you.
In This Article
What an Offering Memorandum Actually Is
What It Costs to Go Get That Income
What the Rebuilt Deal Looks Like
The Same Building, Two Sets of Books
7.25%
Cap rate on the cover of the offering memorandum
4.56%
Cap rate once you rebuild the numbers honestly
$53,720
NOI that evaporates between the two
What an Offering Memorandum Actually Is (And Isn’t)
Most investors open an offering memorandum and go straight to the cap rate on the cover. That's fair enough. Cap rates let you compare deals side by side fast, so it's become the number everybody leads with.
Then they check the expense ratio, which is operating expenses as a share of revenue. I'm generally aiming for 30% to 35%. Anything above 35% tells me the property isn't being run efficiently.
And here's the part people miss: anything below 30% tells me the same thing. You might think a lower expense ratio is strictly better. It isn't. There's a floor of maintenance you have to spend every year, and cutting under it just converts operating expense into capital expense later. Service the HVAC once a year instead of quarterly and yes, your expense ratio drops. That unit also lasts five years instead of twelve.
Then there's the phrase stabilized proforma. All that means is somebody made up numbers to show you what the building could look like. It isn't what the building does. If the proforma cap rate is 8% but it depends on rents 15% above market, that's not a projection, it's a wish.
The deal I worked through is 78% leased and priced like it's full. That happens constantly. Sellers want you to pay tomorrow's price today for work they haven't done. I don't do it. Unless there's upside I can see that the seller clearly can't, I pass.
Offering memorandums aren't usually fabricated. They're selectively assembled. It's the commercial version of a residential listing calling a tiny house "cozy" and a badly designed one "quaint." Nothing in there is a lie exactly. It just isn't the whole picture. The fix is to stop auditing their document and start rebuilding it as your own underwriting.
Line One: A Rent Nobody Has Ever Paid
This deal has two empty suites, about 4,000 square feet. The offering memorandum prices them at $14 a foot.
Every executed lease in that building is at $10 a foot.
So why would I get $14 for this space? Especially when it has been sitting on the market for 14 months and nobody has taken it at that number. There's no reason to accept a seller's word on what space will rent for when they have demonstrably failed to rent it.
The market is voting. If a seller is asking $14 and leasing nothing while everything occupied sits at $10, then $10 is your market rate. The only thing that would change my mind is recent executed leases at the asking number.
Which sets up the come-to-Jesus moment on price. He wants to be paid for $14 rent. I'll pay for $10 rent, because $10 is what he's proven.
Line Two: The Tax Bill You Inherit
People forget this one constantly, and it is guaranteed to bite.
This seller has owned the building since 2009. His current tax bill is $21,000 a year, assessed on a valuation that's a decade and a half stale. Reassessed at the price I'm actually paying, that bill becomes $38,000.
Never underwrite a deal on the seller's property taxes. Death and taxes are the only two things you're assured of, and I can assure you the taxes are going up.
$17,000 a year doesn't sound like much. Over a five-year hold it's close to $100,000 that nobody accounted for, and it can be the entire difference between a two-times equity multiple and breaking even.
One caveat worth knowing: reassessment rules vary by municipality. Some reassess immediately on sale, some every two or three years, some annually, and a few states don't reassess at sale at all. Look up your own assessed value ratio and mill rate rather than guessing. The Deal Analyzer will calculate the new bill from your purchase price and local millage, so you don't have to invent a number.
Line Three: The Three Lines Nobody Enters
Vacancy, property management, and reserves. Sellers leave these out because they aren't the seller's problem. They're yours.
Vacancy
I don't care if a building is 100% occupied today. I put a 5% to 7% vacancy rate on everything. It doesn't matter if it's a single tenant net lease Starbucks with 15 years left. It gets 5%.
Two reasons. First, no building is 100% occupied over the long run, even if it is in a snapshot. Accruing 5% a year means that when you eventually eat three or six months of true vacancy, it washes out. Second, your bank is going to apply a vacancy factor whether you do or not, and discount your loan accordingly. You may as well underwrite it honestly on the front end.
Property Management
This deal carries about 4%, roughly $7,000 a year. The mistake I see is a seller who self-manages handing off to a buyer who also plans to self-manage, so nobody ever books the expense.
Congratulations, you've bought yourself a job. And you still have to account for the cost. What happens if you get hit by a bus tomorrow? Your family or your partners have to hire a third-party manager, and the proforma you handed them no longer works.
I underwrite market rate for everything. Management, leasing, construction. Even when a partner is doing the work. They got the job because they're qualified, not in exchange for a discount, because if I ever have to fire them the numbers still have to hold. Call two or three local managers and find out what it actually costs, then read up on what commercial property management involves before you decide to do it yourself.
Reserves
Cash you set aside monthly for the thing that always comes up. I use 25 cents per square foot per year, which on this building is three or four thousand dollars.
You're rarely buying a brand new building. The roof, the HVAC, and the plumbing were all there before you were, and you don't know how they were built or treated. If nothing goes wrong, great, you have a pile of cash waiting for you at the end. That's a much better problem than the alternative. Real due diligence tells you how big that pile needs to be.
Line Four: What It Costs to Go Get That Income
The seller books the income from that vacant space as if it appears for free. It doesn't.
Tenant improvements. Call it $60,000 for the 4,000 vacant square feet. That's $15 a foot, and honestly $15 gets you paint, carpet, and maybe some ceiling tile. You're spending $10 to $15 a foot regardless if you want a quality tenant. Tenants expect you to invest in them. I want them investing in themselves too, so I don't turnkey it, but there's a market rate here. My guide to tenant improvement allowances has the current ranges by property type.
Leasing commissions. $8,000 on this one, 4% on a five-year deal, due at signing. Could you lease it yourself? Sure, the same way you could represent yourself in court. There's a real learning curve in sourcing tenants, touring correctly, marketing, and knowing what's market to negotiate. For $8,000, hire somebody who does this every day.
Downtime. This space has already been on the market 14 months. Even marketed properly, assume another nine months to get a lease signed.
That's at least $68,000 to chase income the seller has already booked into his asking price.
What the Rebuilt Deal Actually Looks Like
Maple Grove Commons. 18,400 square feet, built 1998, $2 million asking price. Six tenants all at $10 a foot plus one vacant suite. I financed it at 30% down, 7% interest, 25-year amortization on a five-year term, 1.5% closing costs, 1% origination, exiting in year five at a 7.5% cap.
Run on the seller's numbers, it looks like a deal. Average debt service coverage of 1.45. A 12% IRR, which is under my 15% target but not embarrassing. A 13.5% annualized cash-on-cash, which is good. A 1.68x equity multiple against the 2.0x I want. Total cash to close of $644,000.
Then I changed five things, and I didn't invent a single one of them. Vacant space to $10 a foot instead of $14. Added leasing commissions. Property taxes to $38,000. A 5% baseline vacancy rate. A 4% management fee. Reserves at 25 cents a foot.
Same Building, After the Rebuild
0.98
Debt service coverage, down from 1.45
-26%
Projected IRR, down from +12%
0.22x
Equity multiple, down from 1.68x
A 0.98 debt service coverage ratio means the property no longer carries its own debt. Annualized cash-on-cash is negative 15.6%. A 0.22 equity multiple means you get 22 cents back for every dollar you put in. I wasn't a math major, but that math is not good.
Cash to close went up another $69,227, because the model now demands an interest carry reserve. Look at the cash flow tab and you can see why: property cash flow is negative every single year of the hold.
All I did was underwrite what the seller is actually collecting instead of what he hopes somebody will collect someday. If you want the full method rather than just this example, start with how to analyze commercial real estate deals, and use the cap rate guide to sanity-check any number on a cover page.
What You Can Negotiate, and What You Just Eat
Here's the caveat I want to leave you with, because not every one of these adjustments is a lever against the seller.
Some of it is genuinely negotiable. The vacant space priced at a rent nobody pays is a price conversation, because you're being asked to pay for income that doesn't exist. Property management belongs in the numbers because every buyer carries that cost, so it's fair to argue the real NOI.
Some of it just lands on you. You cannot walk in and say the NOI isn't really $145,000 because your property taxes are going up, so credit me the difference until this hits a true 7.25% cap. They'll tell you to pound sand, and honestly they're right. Their taxes went up when they bought it too.
Knowing which is which is most of the skill. Fight over what's actually in dispute. Price the rest into what you're willing to pay.
One Related Question Worth Asking
Somebody on the livestream asked how you tell if a submarket is overbuilt. Look at absorption, meaning how long space actually sits. If nice new retail is coming online and just sitting there with nothing leasing, that market doesn't have the demand the deliveries assumed. Check how much is being built, how much is currently available, and how long it's been available.
Key Takeaways
The offering memorandum isn’t lying. It’s incomplete. Every number can be technically accurate and the cap rate on the cover can still be off by nearly three points.
Rebuild it, don’t audit it. The seller hands you data points. Underwriting is your job, and nobody is coming to fill in the blanks.
Trust executed leases, not asking rents. If every signed lease is $10 a foot and the vacant suite has sat 14 months at $14, your market rent is $10.
Reassess the property taxes at your price. On this deal that’s $21,000 becoming $38,000, or roughly $100,000 across a five-year hold.
Always book vacancy, management, and reserves. 5-7% vacancy even on a net-leased Starbucks, market-rate management even if you self-manage, and 25 cents a foot in reserves.
Price the cost of capturing vacant income. Tenant improvements, leasing commissions, and downtime came to $68,000 on 4,000 square feet.
Know which adjustments are negotiable. Phantom rent is a price conversation. Your new tax bill is not.
This article is adapted from an Office Hours livestream on the Tyler Cauble YouTube channel, where I take apart real deals on camera every Tuesday at 8:30 a.m. Central. You can rebuild your own offering memorandums for free in the Deal Analyzer, or get coaching on your actual deals inside the CRE Accelerator.
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