Due Diligence can be very fun and at the same time can be very stressful and difficult. Due diligence is a very important part of the transaction. This is much more involved than a single family home or small multi-family and should be treated as such. You are going for a treasure hunt and your goal is to un-cover hidden gems or find the ugly blemishes.
In your Purchase contract you put in writing that the seller would provide you with all the financial statements needed for you to completely verify your underwriting. Some important things not to leave out include profit and loss statements for at least 2 years, 6 months+ of bank statements, certified rent roll (matching with bank statement), tenant leases, Security deposit account statement, Background checks for the current tenants, Service agreements (Pool, laundry, cable, etc), surveys of the property & utility bills. Please be sure to give yourself at least 30 days for due diligence. I always try for 45 days and for the period to start after I receive all of the documents that I listed above.
The first part of the due diligence can be done from the comfort of your own home or office. You will be reading through leases, bank statements, P&L statements, rent rolls, etc to verify your initial findings. You will also want to call the city to be sure there are no code violations, zoning violations or rental licensing issues as well as liens. I would also call the fire department and police departments to see if they have issues. In this phase you will also contact the service contract providers to talk with them about the property and any issues as well as about the contract.
The second part is the part that will cost the most amount of money, so I would complete the financial audit, etc first and then do the physical inspection of the property. During this phase you should hire a building inspector, pest inspector, sewer inspector, environmental specialist and potentially some contractors depending on the condition of the buildings.
You will need to walk every single unit! Yes, even if it is 500 units or more, you need to walk all of them or hire someone to do so. Some sellers and brokers will try to get you to do a survey, where the let you into a “random” amount of units. Do this and you are sure to skip the units with flood damage, vacancies or other crazy skeletons hiding. You will want your property management company and on site staff to be walking the property with you as well.
For the property inspector, I would have them randomly join you in 10% or so of the units and then also look at the mechanicals, common areas and exterior condition. Be sure they go on the roof or hire someone to do so. You will also want someone to scope the sewer lines and inspect the plumbing.
Here are some major things to look for:
- Plumbing: Condition and type. If you buy a building with galvanized piping and cast iron waste, then plan on replacing it all within 10 years. I would budget 50% of that up front.
- Electrical: Insurance provider may deny your building if there are fuses or if they are off brands. You may also have issues with knob and tube and aluminum wiring. Also, be sure GFCI’s are present in the baths and kitchens and smoke detectors and CO detectors are present.
- Roof: Look for aging roofs, especially ones with patches
- Condition of the heating and cooling: The units last 15-20 years. Much more that that and they will need to be replaced. Find out information about the units and if it is a large central piece of equipment, bring in an expert to look at it.
- Condition of exterior trim and siding/brick: Look for rotting areas, water intrusion, cracking etc.
- Foundation: Check for cracks, bulging and water intrusion
- Landscaping: Check for drainage away from buildings, large trees close to foundations or over roofs
- Driveway/parking: Potholes, striping, etc.
Believe it or not, some sellers will try to hide these things. The more eyes that you can get on the building and the grounds, the better. If you can find the issues before you purchase, then you can plan and prepare for them. Most businesses that fail, fail because of money issues and you will have a money issue, if you don’t understand the financials and/or the work that needs to be completed
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To your success!