When you find a property that you like, either from a sales agent or through your own efforts, you will need to conduct thorough due diligence. Conducting due diligence investigation on a commercial real estate transaction can be time consuming and expensive. But not conducting a due diligence investigation properly can ruin a deal.
Here is the checklist / steps you need to take:
1. Letter of Intent (LOI). This is a letter that describes what you are willing to do regarding the price and terms.
2. Purchase agreement. You should ask your real estate attorney to make one for you. Set the due diligence schedule at 60 days: “In this agreement, all referenced days will be interpreted as business days.” Having this gives you a good time frame to do your research. Try this, offer more than the asking price in exchange for the down payment. Split initial payment. Half at the close of the other half 30 days -12 months (the longer the better). However, request interest payments only for the first 12-24 months. When negotiating a down payment, ask the seller to keep 200k, but he agrees to only keep 100k, say “if you have 150k, I will pay 6% for the first three years, 7% for the next three years, and 8% for the next three years. term of the loan. When trying to put in the minimum of pocket money to close a deal, try “cross collateralization,” this is when the mortgagee allows you to transfer your mortgage from one property to another. You must have substantial equity in another property to possible or you can distribute the mortgage among several properties.
3. Financing. Select mortgage lenders / professionals. Submit Lender Requirements (which will vary from lender to lender). Set closing date.
4. If you have private money partners to help you finance the property, send them the details of the deal.
5. Get comps from apartments sold in the area that are similar. Check what is the average rent per unit in the area. A property management company in the area should help (especially if you will be using them in the future).
6. Rental income. Get the most current “rental list”. A rental listing is an inventory / documentation that shows what the rentals are and what was collected per unit. Rentals must match operating statuses. Get a letter from the seller with all tenants (verification) attached to the current lease. The letter should state that the attached lease is true, accurate, and that no other agreements have been made between the tenant and the landlord (some entity can try to pull one out quick and have your cousin sign a lease for $ 100! a month!). The letter should detail the lease and when the last payment was made.
7. Audit leases, deposits, lease expiration dates, landlord disputes, concessions with other tenants (like getting half the rent to clean the property).
8. Projections / pro-forma of 5 years of ownership.
9. Vacancy. Historical and current.
10. Ancillary income (money that comes in other than rent). Analyze this income and see if it comes in consistently.
11. Laundry contracts. When do they expire? Who are you with? Last time renewed? What are the divisions between owners and providers?
12. Cable / satellite TV. When do they expire? Who are you with? Last time renewed? What are the divisions between owners and providers?
13. Operating expenses. Get the vendor list and copies of all service contracts. Review these contracts. Get copies of last year’s insurance claims, get vendors list of pending litigation (if any), environmental issues.
14. Review the advertising contracts of the owners, all advertising costs included in the proforma. Price what it will be for having a leasing brochure (if self-managing), resident retention programs.
15. Cost of payroll. # of staff (office and maintenance). Check salaries, bonuses, rental incentives. One number you can have to help you manage the property is to have 1 person (office and maintenance) for every 50 units.
16. Administrative expenses. Review: equipment leases, postage costs, phone and internet charges, snacks, supplies, legal business permits (evictions and “pay or quit”) and cleanup.
17. Property management costs. Who is the company? Check your property records. It is the rate in proforma form. Are their differences? Pest control costs and other miscellaneous costs.
18. Cost of the landscape. Review the contract. Discuss what the property looks like with them doing the cleaning. Check the irrigation system. Get quotes for landscape improvements.
19. Property Tax Adjustment – Find out what the new tax amount will be before you buy. Go to court and talk to the tax applicant, asking what information you need to review the building taxes. If they can lower it, ask if they can make it retroactive.
20. Security expenses. Investigate crime reports. Ask the police if any incidents have been reported in the apartment building. Include the cost of security in the proforma. Try to get a door and have patrol security (making rounds).
21. Billing cost of construction. Look at the turnover rate and the cost per unit. Look for unusual turnover expenses (refrigerators, stoves, etc.).
22. Maintenance and repair expenses. Look at previous work orders. Review previous work.
23. Public services. Gas, water, electricity, garbage, others. See if the building can be “submeasured.” This is where tenants pay their own utility bill.
24. Property taxes. Get copies of tax bills for two years. Look at annex “E”, this is where they report to the government what they have done with the property, compare this with what they want for the property.
25. Property insurance. Get an insurance offer along with floods, earthquakes.
26. Reserves review past capital expenditures. Identify common items of concern and budget by having reserves per unit per year.
27. Title problems. Select the title company. Get a preliminary title. Analyze the title. Determine who pays you and the seller for the title. Title fee must be included in financing. Learn about transfer taxes now and what they could be when you sell. Any cost of documentation? What are the escrow fees? These costs must be in the contract / agreement. Is a survey needed for ALTA? Zoning and parking compliance verified?
28. Inspections. Physical inspections of grounds and units, electrical wiring, plumbing, balconies, view as many units as possible, HVAC, stair, elevators, roof, landscaping, asphalt condition, lighting, garage, exterior paint, pool, revised capital expenditures, copies of occupancy certificates, swimming pool operating permits, repair and maintenance records, recurring plumbing problems, list all estimated deferred maintenance capital expenditures, estimates should resemble third party reports, garage condition, condition of washer and dryer, fire code sprinklers, determine if it complies with the American Disabilities Act. Try videotaping the property to show as evidence if necessary.
More about inspections
Report to Inspectors – Make sure you understand everything they have reported. Ask about the consequences of any potential problems. Have each of them read the results of the others who also reported. Ask them after reading the other reports if there is something they would like to re-inspect or something in their report that they need to change / modify or something they think the other inspectors should re-inspect based on what they found. Remind them that they are a team.
When you find problems
o Check the extent of the problem
o Determine if there is a dollar amount to fix the problem.
o Go over the problems with the seller: ask if they knew about the problem, if they have investigated how much it would cost to fix it, if any tenants have complained about the problem, if so, what did the landlord do about those complaints?
o Submit an addendum to the contract stating that the seller agrees to fix the problems, or reduce the down payment or price, or both.
29. Last Task – Make sure all numbers are correct. Have a CPA review. Have an exit strategy: refinance or sell and when.
30. Closing – Closing rental record received and reviewed. Have the pro rata reviewed and agreed The purchase price in the contract is correct. Seller’s credits are credits. Correct closing cost. Payment of points reviewed and approved. Approved legal cost.
