The profit and loss statement (P&L) is a critical document when applying for a real estate investment loan. Pay special attention to the variables listed below in on the profit and loss statements of your properties, your business, and your future projections in order to give loan officers a reason to offer you a loan with favorable terms that empower your future acquisitions to become maximally profitable (read more about home equity loans vs. HELOCs). Here, we will explain three groups of elements on your profit and loss statement that actually matter to lenders:
- Gross rental income, operating expenses, and operating income.
- Land and structure depreciation.
- Taxes and P&L reporting.
Gross Rental Income, Operating Expenses, and Operating Income
It is important to include in your P&L gross rental income, operating expenses, and operating income.
- Gross Rental Income. The total amount of revenue the property owner collects from tenants.
- Operating Expenses. The total expenses of owning the property.
- Operating Income. The funds allocated to fund the operating expenses of the property.
Land Appreciation and Structure Depreciation
Appreciation refers to the property’s increase in value over the lifetime of its utility. Variables that influence appreciation include the development of the municipality in which it resides, the job market and economy of the local area, the school districts and infrastructure, tax rates, municipal politics, and even larger issues such as inflation, the cost of lumber (incentivizing home buying over new home construction), and the stock market.
The national average appreciation rate of property in the United States is 3-5%. The majority of this appreciation resides in the appreciation of the land, since the structure usually depreciates over time. When determining the cap rate of the property, as well as the debt service coverage ratio, it is necessary to remove capital expenses, interest on the loan, as well as depreciation.
Taxes and P&L Reporting
Along with your P&L, it is important to include previous Schedule E reports from your tax returns. The IRS explains:
Use Schedule E (Form 1040) to report income or loss from rental real estate, royalties, partnerships, S corporations, estates, trusts, and residual interests in real estate mortgage investment conduits (REMICs).
The Schedule E form will certify your P&L statements align with your official filings with the IRS, further solidifying your credibility with the lender (read more about tax returns in the loan process).
Give special attention to these variables in your profit and loss reporting so that you are equipped to command the most favorable terms for your mortgage. Schedule a consultation with one of our loan experts to build a profitable loan strategy for your 1031 Exchange.