The due-diligence or inspection period is a very important time when purchasing a property. The period allows you to access to the property onsite and makes records available so you are able to verify the information and perception you have about the property you’re about to purchase.
Before purchasing a property, it’s critical that you take the necessary actions so that you can make an informed decision on whether the condition, operations and financial picture of the property are as you were made to believe.
The information discovered during this period will allow you to either move forward with closing the sale, terminate the sale or request concessions from the seller.
Below are 4 critical areas to consider when performing your due-diligence.
1. Income documentation
During the due-diligence period, you should update financial statements (also known as an income or loss statements), rent roll, copies of leases and estoppels. On multi-family properties, lenders typically require at least 2 years of profit or loss statements that they will use in their underwriting of the loan, so request at least 2 years or more if the seller has them.
On larger multi-family properties, getting copies of leases can be a massive administrative task – imagine the work for a 100 units or larger apartment complex. In these situations, you’ll want an updated rent roll to perform an onsite audit of the leases. You should also request any other information that involves other sources of income such as laundry income contracts, storage income, vending machines, etc.
Some properties may also bill back utilities to the tenants, so you’ll want to review any documentation that shows how that gets charged back to the tenants and how much is received on a monthly average. Carefully review these documents for any fluctuations or differences when compared to any original information received as this will give you the ability to request a credit if the income numbers are less than previously suggested.
2. Expense documentation
You should also request copies of receipts or contracts for fixed cost such as taxes, insurance, contracted services such as property management, pest control and landscaping and other variable cost receipts such as utilities, maintenance repairs, materials, etc. Also, be conscious of how utility costs fluctuate over the seasons as you may be purchasing the property during the low usage season.
You should also request an employee list and any employee agreements or rent credits given to onsite personnel. On larger multi-family properties, it’s not uncommon for onsite personnel to receive a free apartment as part of their compensation or a credit on their rent.
Any increase in expenses compared to what was originally disclosed may allow you to request a credit from the seller.
3. Building condition and inspections
During the physical inspection, it’s a good time to assemble your team. You should consider hiring an inspector and/or general contractor to check the building for any potential structure issues or problems that are not easily visible, such as roof problems or plumbing. You may need to hire a roof or plumber contractor to check those specific systems and your general inspector or contractor may suggest you do so in their report.
You should also consider getting any available copies of any 3rd party reports such as termite and environmental reports. It’s a good idea to get copies of any permits recorded at the county recorder’s office as well as any certificates of occupancy if required by local government and business licenses for a specific property.
You should also be aware of any adverse conditions not previously known that may impact your cost of repairs and can be used as a reason for the seller to allow you a repair credit. For example, some areas may be designated flood zones and it’s good to check that as it will increase your insurance costs.
4. Personal property/inventory list
Lastly, you should request a list of any personal property or inventory that will be included with the sale of the property. These items may include things such as stoves, washers, dryers and any other appliances.
Items such as tools, supplies and materials can be useful for any future repairs or make-ready expenses. If there’s any vending machines or coin-operated laundry that produce income for the property, you should verify if they’re included in the sale.
The due-diligence period is your opportunity to get a clear idea of what you’re getting into when buying a property.
Using a checklist can be useful and you can also do a search online to produce some forms that may be helpful. Different properties in different areas will have their unique set of circumstances and doing your due-diligence research will help you discover possible pitfalls.
Omar Ruiz is the founder of LeRu Investments, a private for profit real estate investment company and LeRu Management Services, a property management company. He has been in business for more than 10 years where he serves as a real estate investor and property/asset manager and has a Bachelor’s degree in business and training in reduction practices for lead paint and mold. Omar was also the co-organizer of the Real Estate Investors Network in Long Beach.
Photo by: Christopher Kelly.