GAAP, CCA, Capital Expenses vs Operating expenses...say what? What language is that and what does it have to do with commercial real estate investing? Well, some of you probably recognize this as accounting lingo; and it has everything to do with commercial real estate investing....well, at least with successful commercial real estate investing.

In my last discussion on successful commercial real estate investing, I did a general overview of points of importance to commercial real estate investors. Let's delve a little more into detail today. What better place to start than with financial considerations? And what better financial place to start than GAAP?

GAAP stands for Generally Accepted Accounting Principles. GAAP is (are?) a set of standard procedures for accounting for income, expenses, assets and liabilities. Without a standard, it would be impossible to know a company's true income. Without standard procedures, it would be impossible to compare that company's income to another company's. It would be impossible to value a company and to compare it's value. The same applies in commercial real estate. One must be able to know a property's true income and true value, and to be able to compare these to other properties in the hopes of making a wise investment decision.

While we don't exactly follow GAAP in commercial real estate investment analysis, we do follow certain standards and they are fairly closely linked to GAAP. One problem - most owners of commercial real estate don't quite follow standard procedures when doing their accounting. There are two problems this creates. First problem, some owners add in as many expenses as possible to keep their taxable income low, which keeps their taxes low. While this certainly does keep their taxes low (at least until a Canada Customs and Revenue audit), the value of investment properties is tightly linked to their ability to produce income. It's difficult to justify a higher price for a property than the income suggests.

The second problem is, you guessed it, owners adding in too few expenses in the last few years before they know they are going to sell a property in an attempt to increase the income and support a higher price. this is usually in the form of minimal maintenance. The problem with this is that the buyer who believed the income statements and paid the higher price finds that they actually achieve lower income for years because they have high expenses as they have to pay for extra maintenance the previous owner neglected.

Okay, this is probably enough boring information for one blog entry. In the next installment, we will discuss how we re-create a more standard set of financial statements, and more importantly, the latent opportunities for the savvy real estate investor to take advantage of financial statement analysis.