What Is Good Due Diligence?

Effective due diligence is information collected prior to purchasing a property that accomplishes the following:

1. Results in changes to the business plan resulting more rapid increase  in revenue.
2. Results in changes to the business plan resulting in greater final revenue than was anticipated.
3. Results in changes that assure the project is fully funded for capital improvements and operations.
4. Results in changes to  the operation and marketing plan finally reducing on going operational costs.
5. Results in information that improve the appraised value on an “as is” and “as improved basis”.
6. Results in information that will prevent a non-performing purchase.

As an investor, you should be measuring your projects against these issues and determining changes to your due diligence plans to meet these goals

Photos

Due diligence is a great time to capture a photo perspective of the property.  Photos should accomplish a number of items:

1. The best faces of the property will give a good start for the property website later.  These photos may be where you begin before you are able to capture professional staged photos of views and residents later on.
2. Photos should capture each critical view of the units, the buildings, the grounds, amenities, nearby shopping, neighborhoods, nearby sites.
3. Photos should provide critical information for planning improvements, staging the office and a myriad of other items.

Photos are one of the critical items for showing the property to investors, to lenders, to staff and support contractors as you develop initial operations and business plans.

General Guide to Multifamily Investment Due Diligence

Successful multifamily investment requires careful consideration of a range of areas supported by carefully prepared information, research, and analysis for these areas. This is known as the due diligence process. A well executed due diligence assures appropriate funding, strengthens the total financial plan and therefore potential returns, and finally leads the way to completing a successful investment.

This article does not seek to provide all the necessary steps to effective due dilingence. The point of this article is to highlight in as a great of detail as possible what each of the due diligence areas are and the importance or purpose of the particular area.

Due diligence can be divided into some key general areas:

1. Sales contract negotiation and details,
2. Financial needs including the appraisal, debt & equity structure, budgeting, and distribution & exit plans,
3. Operational expense needs,
4. Physical infrastructure needs and inspection including associated reports,
5. Legal and title requirements,
6. Market factors,
7. Management and staffing,
8. Operating agreement / investors contract,
9. Resident issues and analysis

Each of these areas is multifaceted bringing information demands, investment opportunity, and risk management requirements. We will explore each of these in limited detail below as a foundational comprehensive look at the due diligence discipline required evaluating multifamily projects for investment or acquisition.

The sales contract is not normally considered a due diligence item by most investors. Nevertheless, we recommend reviewing the contract specifically focusing on:

1. Items to be provided during due diligence,
2. Requirements to maintain occupancy, revenue, and quality of residents in place and being added,
3. Requirements to allow ongoing inspection by the purchaser,
4. Requirements to correct day-to-day maintenance,
5. Processes should an insurance company repair occur during the contract period as well as guidelines for value adjustments should units be lost to acts of God or other insurance addressing repairs,
6. Requirements regarding background and credit check of the existing residents and new residents added while under contract, and
7. Pre existing liabilities

The sales contract should have specific financial considerations protecting the integrity of the investment post closing.

Financial requirements will include past utilities costs, recent property improvements, dates of roof replacement, dates of paving and sealing, a review of the appraisal, project budget, historical income and expense statements, and project pro forma financials. Additionally, the investment should be supported by a fixed investment management, exit, lending, and banking service plan.

Operationally and physically, the keys inspection areas are type of electrical wiring, HVAC, roofs, termite inspection, metering, trash, age of appliances, acreage, unit by unit inspection, building inspection, grounds inspection, paving and sidewalks inspection, amenities facility inspections and punch list development, development of and review of environmental and property condition reports. This should include photos showing the best of the property for marketing, investor development, and lender support purposes. Also, photos should capture and record major structural and physical issues.

The operating agreement should be reviewed for budgeting, capital expenditure management, sales and acquisition rules, status with state and local authorities, occupancy certificates if applicable, status of tax payments, survey encroachments, survey parcels, and other legal guiding documents and forms.

The market and submarket studies are critical elements for due diligence. The study should result in a detailed marketing plan that flows down to a set of actions designed to:

• Improve customer satisfaction,
• Improve retention,
• Drive traffic,
• Close leases,
• Increase revenue

Developing the marketing plan and market information includes collecting the following:

1. Economic trends,
2. Major employers,
3. Economic demographics including per capita income, industrial employment breakdowns, etc,
4. Lists of local businesses, shopping and restaurants of interest to residents,
5. Lists of local churches and religious groups of interest to residents,
6. Lists of clubs, schools, government facilities, colleges, universities, points of interests,
7. Ethnic, racial, education, and age demographics,
8. Comparable rents and amenities,
9. Comparable sales,
10. Housing inventory, price, and rental information

Additionally, the marketing information should include photos of nearby shopping, schools, points of interests, signage, comparable properties, etc. These photos combined with the other information will be a part of the larger plan for the investment, part of property websites, ILS website info, etc.

Today marketing should include a clear and detailed management plan for online marketing plans.

The Company should have an articulated proven plan for screening and managing resident issues from initial contact, to day-to-day operations, and finally to eviction or moveout.

The management company must demonstrate proven accounting, reporting, leasing, property maintenance, improvement management, resident screening, resident management, expense management, and investor reporting capability. Also, the management company should a clear concrete resume of skills, education, and experience relevant to delivering all of the above items. Further, the management company should have articulated plans for acquiring and maintaining management skills needed to support the investment.

Finally, the investor should spend enough time with the principals to assure comfort and trust regarding communication and management capacity to assure the success of the investment.

In summary, the above article provides a general outline of the major due diligence issues. While in no way, conclusive and totally comprehensive this article can serve as a good starting point for an effective due diligence process.