September 28, 2022
If you’re syndicating in a multifamily deal, you want to be in a position to make an informed decision that will increase your chances of successfully raising capital and making money for your passive investors. Understanding the due diligence process is one of the most critical steps toward making that happen.
The first two weeks are crucial for success because this is when you find out whether the property is worth the price you are paying. There are six essential due diligence steps for a multifamily deal that you will want to take in these first two weeks, and if you fail to complete any of these, it could be fatal for your deal. Continue reading to find out more.
There are several types of multifamily purchase and sale agreements/ contracts. The most common are:
1. Realtor Associations. For example, in North Texas, NTCAR & TAR are some of the most used contracts.
2. National Brokerage Contract. Marcus & Millichap is an excellent example of a national brokerage contract. A lot of national brokerage houses have standardized contracts.
3. Seller attorney drafted. The seller’s attorney prepares those contracts without using any standard forms. If this is your case, you need your attorney to review the agreement.
Whatever the contract type, I strongly recommend that your attorney reviews the agreement. Also, you can ask your attorney to draft a contract for you.
The most common addendums that we find in PSAs (Purchase & Sale Agreements) pertain to the financing.
Other important addendums include:
You might be wondering about the seller’s disclosure. Seller’s disclosure is only necessary for single-family properties. Multifamily properties, including fourplexes and duplexes, do not require seller’s disclosure. As a result, you will often notice the seller crossing out any of the seller’s representations in standardized multifamily contracts related to the property’s condition.
Therefore, it is your responsibility as a buyer to examine the property and conduct your due diligence thoroughly.
Inspection period. In the other article about making an offer for a multifamily deal, we mentioned that we recommend a rule of thumb of 21 days. Here is an example of how due diligence period looks like in a multifamily LOI:
Once you execute your PSA, it is assumed that you have conducted your inspections. However, depending on the situation, you can negotiate anywhere between 14 to 25 days. Sometimes market conditions dictate a shorter period. Remember that the timing is critical. If you have 14 days – you have 14 days. Here is an example of title, survey, and property materials review from an actual multifamily PSA:
However, if the deadline falls on a holiday or a weekend, it is pushed to the next business day. If you can’t meet the contract timeline due to an emergency or a force-majeure, you need to speak to your broker and negotiate to change the deadline. In different types of contracts, you will see a feasibility period. Remember that the feasibility period and inspection period are interchangeable terms.
Independent consideration dollar amount. Any contract should have independent consideration, the non-refundable earnest money or how much it costs you to put the deal under a contract and do the due diligence. Whether you buy this deal or not, the seller keeps this amount. It can be anywhere from $0 to a couple of thousand USD. It all depends on your negotiations.
Delivery of the seller’s information. Such as which seller documents will be delivered and the timeline for you to receive them. This is a crucial contract term, and the seller must deliver those documents at the closing.
Anyway, the seller should have prepared all these items when they put their property for sale. You can notice if the seller doesn’t have their act together and does not manage their property professionally if they cannot pull this information within seven days.
The goal of the market analysis is to build a projection & business plan that is as accurate as possible. The market analysis consists of the following:
In one of our previous articles, we spoke about the importance of defining your multifamily property criteria before locating the property. When defining criteria, you will have to conduct high-level market research using online tools, such as:
You need to look for the following information:
Once you located the property and have done a high-level multifamily financial analysis, you will need to go through the following steps before making an offer for your deal:
This level of market analysis needs to be done when your offer is verbally accepted and before signing the contract. If you couldn’t complete it during that time, you have to conduct it during your due diligence period.
The steps you need to take are
Market analysis has to be the 2nd part of your business plan after your Executive Summary.
During your first week, you have to schedule all of the inspections:
To help you with this process, here is an actual due diligence checklist for one of the multifamily properties we’ve recently acquired:
Remember that you need to guide the contractors when doing inspections of the property. Most of the time, they are just looking for deferred maintenance. However, you need to tell them to look for value add improvements as well. Unless you tell them what to do, they won’t tell you how to improve the property value.
For example, if you plan on doing unit upgrades, you need to be specific about what a unit upgrade means for you. Are you going to put in new flooring? New appliances? New countertops? Or will you resurface the existing countertops? Giving your contractors specific information on what upgrades you plan to do will help you get more thorough info about the property and the bids for these improvements.
Think about the landscaping and if you are going to change it. Do you want to change the property’s paint and exterior? Are you going to change the signage? Then you need to have a sign company and your exterior contractor come to the property and provide you with bids.
It’s crucial to schedule all these different inspections and contractors in synergy. Because you would not want to end up in a situation where you’ve inspected 20% of the units with a foundation contractor and then check another 10-15% with an electrician.
If you want to add things to the property that aren’t there, you need to include this in your due diligence and get bids. The end purpose of due diligence is to confirm that the property matches your expectations.
Therefore, if your rehab budget, including capital improvements and value-add improvements, is $500,000 and after your due diligence is still in the $500,000 range, the property matches your initial expectations.
Once your contractors complete inspections, you should receive a condition assessment with the costs of repairs. Here is an example from an actual condition assessment of the roof:
And the same thing for the foundation works:
A lease audit consists of going through all the lease files and ensuring that they are complete and consistent. Then you have to complete the leases to the rent roll. Remember that lease is a legal document, so if the numbers on the rent roll are different from the lease, you need to take the lease number as the correct one. In many cases, wrong numbers on the rent roll can be caused by human error.
The next step is to compare the rent roll to the P&L. They should match up closely. Following this, you need to walk all the units (you can walk 50-60 a day, so you should be able to complete a 300-unit property within a week) and compare the number of actual vacant units to the number on the rent roll.
One of the essential parts of the multifamily deal’s due diligence is reviewing the seller’s documents. Therefore, in addition to the rent roll and leases you require for the lease audit, you should request:
It includes office equipment, coffee machines, etc. It is important that you know what the seller is taking with them when they leave the property. This is what this inventory looks like as an exhibit to a PSA.
For example, the trash contract, cable contract, etc. Some contracts have a 3-year term (like the electrical contract), and you may not be able to terminate or change them. Therefore, you need to include them in your financial calculations. Laundry contracts can be as long as ten years.
As a part of your due diligence, contact the city to request all of their previous inspection reports for the past 12-24 months.
All of this due diligence needs to be done in the first week or two. Because if you find something odd, a major item that prevents you from moving forward, or realizes that the property is not what you expected (doesn’t match your criteria) – you can walk away easily before applying for loans. Once you’ve determined that the property is a solid deal and fits your criteria, you can proceed with loan applications.