Due diligence in commercial real estate involves making sure that the real estate can be used for the purpose for which you intend and validation of the represented property operating income. The due diligence process involves many aspects including financial and physical review. For example, If you are purchasing a piece of property you plan to develop for multifamily usage, due diligence would involve making sure the property is zoned for commercial use. If the property is located near a dry cleaner, it would be prudent to have a professional provide an environmental report including soil testing for possible contaminates.
For existing properties, I also would recommend the use of a qualified inspector prior to the purchase of any commercial investment property, especially multifamily investments. If you are purchasing a multifamily property that has deferred maintenance, it would be wise to locate an inspector that specializes in apartments. Please ensure to request a report that details repair items and estimated repair cost. This can serve as supporting documentation for your request for seller concessions. Due diligence also requires the buyer to examine a survey and ensure that any easements are included as part of the deed or lease. When purchasing a multifamily property, you will want to make sure the legal description on the survey matches the legal description on the title insurance commitment.
The title insurance commitment is issued by the title company that will most likely be facilitating the settlement of the property. They will search the property for liens or encumbrances that will prevent transfer of title for the specified property, status of tax payments and verification of seller’s authority to sell the property. These services can also be performed by an attorney experienced with commercial real estate due diligence.
Real estate financial due diligence involves the investigation or audit of the financials of a real estate property. This is a fundamental process that requires some ability to understand the primary profitability drivers related with a multifamily property. This process is critical to determining whether the potential investment meets established investment thresholds and objectives. At a minimum, most investors prequalify investment candidate based on predetermined cap rates, debt coverage service ratios and cash-on-cash returns. Conducting financial due diligence for a multifamily property can be tedious, but the effort brings immeasurable value to the overall due diligence process.
All decisions regarding the underwriting of a multifamily property requires a complete comprehension of key market and financial drivers. In order to determine the true economic health, keen investors analyze the property’s actual numbers as compared to the property’s proforma data. Remember, you are purchasing the property based on the current operating income with any upside based on future net operating income improvement should show on your balance sheet and not the previous owner. Based on my financial experience, this is part of the due diligence process that I tend to enjoy the most. At a minimum, you will want to request the prior three years operating statement, YTD operating statement, balance sheet and last 12 months rent rolls.
In addition to environmental reports, survey and title commitment, physical due diligence require you to inspect the property, so to determine any required cosmetic or major deferred maintenance improvements. One major area that many investors overlook relates to utilities and sewer connections. This can be a major cost consisting of both financial and time to coordinate with local city officials. Don’t forget to ask the seller to contribute to the cost via repair credits or price reductions. Multifamily investing can be profitable with some basic knowledge of national trends and the local real estate market.
Creig Stephens is a retirement strategist specializing in helping the self-employed who fear they lack sufficient capital from their operations to funds their ideal retirement lifestyle. His diverse financial background and education, allows him to extract cash-flows from hidden business value to help grow small business retirement accounts.
He is managing partner for Crowne Equity Partners, LLC a firm specializing in B to C class multifamily apartments located in emerging markets. He provides the strategic vision and analytical skills to underwrite undervalued properties that provide significant returns for CEP’s private partners.
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