The due diligence process for an apartment building is much more involved and complicated in comparison to that of a single-family residence or smaller multifamily building. For the latter, you will likely only require an inspection report and an appraisal report in order to close. If you are experienced, you’ll perform your own financial audit, comparing the leases and rent rolls with the historical financials.
When you scale up to hundreds of units, the increase in potential risk points is such that you’ll need additional reports before deciding whether or not to move forward with the deal. In fact, during the process of due diligence for apartment real estate, you’ll want to obtain and analyze the results of these 10 reports:
- Financial Audit Report
- Rent roll/Lease Expiration Dates
- Internal Property Condition Assessment
- Market Condition Report
- Lease Audit
- Unit Walk Report
- Site Survey
- Property Condition Assessment
- Environmental Site Assessment
Before closing on a multifamily asset it is wise to assess whether the asset is performing up to the pro-forma financials that the owner provided in the beginning. The easiest way to obtain this information to make sure you are being told the truth is to ask for 1-3 yrs P&L Statements or Schedule E forms that they report to the IRS for taxes every year.
This is the most basic information that the owner can provide you and should be attached along with the P&L statement (s). This will tell you want the current rent is per unit and when the lease expires. Now, I know you’re probably wondering.. Doesn’t this seem kind of invasive? I mean, who would tell me how much money they are making on something? The truth is, the only people that will provide this info are motivated sellers and that is the only people you want to be dealing with in the first place. There is no point in heckling an unmotivated seller to give you information you need to buy something they don’t want to sell, it is a waste of time.
The internal property condition assessment is an inspection report that provides you with the overall condition of the property. This portion of the real estate due diligence process is conducted by a licensed contractor or inspector of your choosing. You will most likely be provided with a list and images of problem areas observed by the contractors, recommendations for repairs, opinions on costs to address deferred maintenance, and whether or not further inspections are required.
These results will help you confirm or make adjustments to your repair and rehab assumptions and screen out deals that have maintenance issues outside your investment criteria.
Knowing the market and your product is the most fundamental necessity of investing in any asset. There are several points to consider in your market analysis survey, starting with the demographics of the area. Is the population growing in 1, 3, and 5 mile radius? What are the vacancy rates for other similar assets in the area? What are current market rents and what are the average growth rates over the past 1-3 years? Also, how does that compare to the specific asset you are purchasing. Understanding what drives the demand for your asset along with knowing the expectation of the supply of it in the near future is vital to your bottomline.
The lease audit is a systematic examination of the leases, including the stated income and expense figures, billing methodology, and lease language. Typically, this audit will be conducted by your property management company, if you have one. Estoppel agreements are ways to make sure the tenants are paying what the owner says they are paying. You should always ask for a copy of the current lease agreements to analyze the structure of the lease and landlord responsibility.
I know it seems laborious to walk every, single, unit in your complex but you can imagine even if you haven’t purchased a multifamily property before, it would be wise to have every unit inspected individually. The interior condition of the units are just as important as the exterior. Although, you may blow a large sum of money on capital expenditures if 60% of the HVACs go out or the entire roof needs replacement, minor interior repairs/replacements can and will eat up a significant portion of your operating expenses. Therefore it is imperative to manage the expected expiration for the flooring, appliances, or any other updates that may be needed to realize value with your building and remain competitive.
A site survey shows the boundaries of the property, indicating the lot size, and is a key component of your due diligence for real estate. It also includes a written description of the property. The report resembles a map.
There are a lot of third party services that can conduct a site survey. A quick Google search of “site survey + (city name) will do the trick.
The property condition assessment is the same as the internal property condition assessment, except this one is created by a third party selected by the lender. So, you’ll have two PCAs from two different contractors, which should cover all your bases.
The environmental site survey is an assessment that identifies potential or existing environmental contamination liabilities. This report is required and is conducted by a third-party provider selected by the lender.
The analysis typically addresses both the underlying land and the physical improvements on the property.
When completing due diligence for real estate, the appraisal is a report that determines the value of the property based on market capitalization rate and net operating income. This report will also be created by a third-party provider selected by the lender. Hopefully, the appraisal value comes back equal to or, even better, exceeding the contract price.