Investors – or just about anyone who’s interested in real estate for that matter – will often come across the term due diligence when they are set to acquire a residential or commercial property.
Going beyond legalese, due diligence is basically a term used to describe a set of processes formalizing the sale and turnover of a residential or commercial property. If you are set to acquire a multifamily complex of some 15, 50 or 200 units, it’s essential to do your part of the due diligence before you are able to enjoy the cash flow generated by these assets.
Sure enough, the due diligence part comes off as the most tedious and time-consuming step in any real estate transaction. Sometimes, it’s easy to say, “Oh man, there’s a lot to do. How about let’s skip some steps and get straight to sealing the deal?” Oh, how I wish it would have been that simple! There are strict laws governing the sale of properties, and failing to handle all the necessary paperwork can put you at the receiving end of a legal complaint. This puts your reputation at risk, and not only will multifamily sellers see you under a negative light, but it will also affect future acquisitions. Will a mortgage lender approve your application for a loan if they know you have had failed to do your due diligence for a previous transaction? Obviously not.
Another reason why due diligence is so important is that it secures your interests. It allows you to ensure that the transaction is worth your time and money. If the seller fails to deliver their part of the due diligence (such as securing repairs, as negotiated, matching of rents with the bank deposits, proper leases in place, etc.), you are in the position to walk away from the deal.
As an investor, you have the responsibility of doing your part of the due diligence by providing the needed documents and doing the necessary steps. It’s hectic, but you don’t really have any choice on this.
All you need to do is to apply the right approaches when it comes to handling each step. I hope these tips will help you overcome the stress when conducting due diligence.
It’s always important to have the property assessed before conducting due diligence. Before reaching a closed deal, it is essential to have the property inspected by a professional assessor. The task involves examining the overall condition of the property and making sure the community provides easy access to basic services such as education, emergency response, and healthcare. In multifamily, the lender will send their assessors to accomplish it.
As much as possible, never conduct a spark check where you inspect only a “sample” of the total units you are going to purchase. Apparently, examining only 30 units out of 100 doesn’t provide a thorough picture of the property’s condition. You need to do an in-depth assessment of all units. Failing to do so will result in you getting a bad deal. If you are a multifamily syndicator, you need to show your investors the full inspection report before closing the purchase. This has helped my two acquisition companies the most. After going through 100% of the units, we were able to write out a “Repair Letter” to the seller with proof of our findings about 10 days into the due diligence process. It’s important not to wait until the 27th Day of the 30-day due diligence period. You need to have plenty of time to negotiate an agreeable Repair Credit at the closing of the sale.
It is of utmost importance that we check all the leases in place and their accuracy and make sure legal forms are duly signed by the residents of the complex. We also like to plot out the lease expirations dates on a monthly graph, to see if there are too many leases that expire in one particular month. Staggering the expiration dates is ideal for reducing risks in low occupancy.
After signing a contract with a seller, it’s important that you collect the proper finances for conducting due diligence. Known as a due diligence amount, it consists of the expenses you need to conduct the necessary processes on your part during the 45-day period (or whatever time frame specified by State law). The amount will vary depending on the contractor you are hiring to conduct inspections and surveys on the property. As a syndicator, my company is able to spend the upfront fees and then get reimbursed as the funds are collected in the Offering LLC account towards the closing date.
Does the market perform well? Does it promise a good return on your investment? It’s important to spend ample time researching the specifics of the local market. Make sure to look at the demographic data including job growth and purchasing power as well as the median rent in the area. You can work with local brokers or search online for comparable prices. You also need to look at the property taxes and access to basic community services.
What other important tips to follow in conducting due diligence? Let’s talk about it in the comments below.