What Is Real Estate Due Diligence And Why Is It So Important When Buying An Apartment Community

If you're new to real estate investing you may have heard the term ‘due diligence’ used but not completely understand what it meant. Real estate due diligence is a finite period of time in where the buyer conducts research to disclose all the facts and conditions of a multifamily asset before closing on the transaction with the seller.

Due diligence is the most critical step a buyer or investor should take during the acquisition process because it determines whether a property is worth what it claims to be worth and will identify any ‘red flags’ about the property that may cause the buyer to back out on the deal.

Although a property may appear to be in fine condition on the outside, there may be reasons why it should not be purchased at all or why it should be purchased for less than the asking price.

The buyer should never rely solely on the information provided by a seller as they may leave out critical details, risks, pending litigation, liens or other legal issues that could prevent the buyer from acquiring the property.  In some cases, the omission of this information could be intentional, in other cases it could be that the seller doesn’t know that some of these issues exist.  In either scenario, the buyer needs to do intense research to uncover any potential pitfalls about the property prior to purchasing.

Adequate real estate due diligence also assists the buyer in making a better investment decision. Due diligence could, for example, reveal structural issues that could be costly to repair, as well as delinquent taxes, utility bills, and other debts that the vendor had refused to pay.  Knowing this information upfront allows the buyer to adjust their underwriting accordingly to ensure it can provide investors good returns on their investment.

How the Real Estate Due Diligence Process Works

A typical due diligence period in an apartment syndication ranges from 2-4 weeks, beginning when a buyer files a Letter of Intent (LOI) and the property is put under contract. 

There are several stages of real estate due diligence, some of which is conducted by way of online research about the property, checking the city government website for information about utilities and zoning regulations and reviewing tax information on the county assessors site to name a few.  This ‘digital due diligence’ can be conducted from the comfort of the buyer’s office by searching websites or reviewing electronic documents provided by the seller.

Physical due diligence requires the buyer and any other third parties such as inspectors or contractors to visit the property.  This stage of due diligence requires coordination with the seller to obtain access to the property and many, if not all, of the apartments for inspection. Walking the property and units can be very telling about the condition of the asset and uncover a lot of information to aid the buyer in their final purchase decision and underwriting.

Real Estate Due Diligence Checklist

The goal of the due diligence process is to uncover any potential legal, environmental, safety or financial issues that impact the ability to purchase the property and achieve the project’s business plan. Discovering a major issue during real estate due diligence gives the buyer the opportunity to renegotiate the purchase contract terms and conditions or possibly even walk away from the sale.

Each sponsor team has its own due diligence checklist, so while this is representative of the most common due diligence items completed, it’s not an exhaustive list.

1.     Current Rent roll: setting forth the rates, security deposit, lease terms, concessions, unit type, beginning date, expiration date. Include payment history for each tenant for the last 6 months, including any late payments collected and how much the tenant owes. Identify any existing evictions in progress.

2.     Last 12 months expenses (also called a T12)

3.     Security deposits held for each tenant

4.     What evictions are currently in progress

5.     Copies of all leases and rental applications

6.     Copies of all utility statements from the past year OR authorization to contact water and electrical company to get actual usage statements

7.     Copies of service contracts showing term of the contract, the monthly cost for services, work performed, and termination penalty for:

•          Pest Control

•          Trash Removal

•          Landscaping

•          Janitorial Service

•          Parking Lot Sweeping

•          Snow Removal

•          Security

•          Laundry equipment lease

8.     Copies of the last two years' profit and loss statements or summary of expenses

9.     Electrical Expenses

10.  Water

11.  Operating bank statements for the last two years

12.  Copy of Schedule E from last two years tax returns

13.  List of all improvements/repairs made in the last five years (or at least in the last 12 months)

14.  Copy of current management agreement or employment agreement with Property Manager

15.  Copies of all insurance policies and insurance company contact info

16.  Copies of last two years’ property tax bills

17.  As-built surveys showing any improvements to the property

18.  Owner’s Title insurance files

19.  All noted trust deeds and other documents relating to title and liens or debts against the subject property, title insurance commitment

20.  Mortgage document or letter from the current lender(s) showing the current balances and terms of the mortgages

21.  A written inventory of all furnishings and other personal property in, on, or commonly in use for the regular operation and maintenance of the subject property. Identify the personal property that will not transfer to new owner

22.  Copies of all warranties for appliances, equipment, utilities, roof, paving, pool, etc.

23.  Inspection documents for the last two years from HUD, USDA, THDA, or other housing-related agencies

24.  Recently sold comps of neighboring properties

Conclusion

Real estate due diligence refers to a thorough examination of a property or real estate asset. It brings together all the knowledge and facts that a buyer should have prior to making a purchase. It is carried out by gathering all relevant information on the property and cross-referencing it against the buyer’s assumptions when putting the asset under contract.

Real estate due diligence is the most critical stage during a real estate acquisition.  Information overlooked or not uncovered about the asset could lead to legal, title, environmental or zoning issues that could affect the team’s ability to close on the property.  It can also have a significant impact on the projected returns for investors if expenses or income sources are not properly verified by the sponsor team.

If you’re curious how our team conducts real estate due diligence schedule a call today or fill out our investor form and we will reach out to discuss.