Commercial Real Estate

Buy With Confidence: A Brief Guide to Due Diligence for Apartments

Expertise: Mortgages & Creative Financing, Business Management, Landlording & Rental Properties, Commercial Real Estate, Real Estate Deal Analysis & Advice, Real Estate Investing Basics, Personal Development
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They say you make your money when you buy. Well, the flip side of that is you also lose your money when you buy if you do it wrong. This is why due diligence is so important; it prevents you from making such mistakes. And when it comes to apartments and larger properties, it’s all the more important because more money is at stake.

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I have unfortunately witnessed many projects go south as budgets ballooned, and deals that at one time appeared to be great fall apart and become money pits more often than I would like to recount. Given that among those I’ve witnessed, a few have been ones we have purchased, it makes it all the more unfortunate. Luckily, these headaches can be avoided or at least mitigated with proper due diligence.

First of all, it’s important to know that larger apartments and commercial properties are usually purchased on a 60-day contract versus the average 30-day contract involved with the purchase of houses and small multifamily or commercial properties. The normal inspection period until your earnest money goes hard and is no longer refundable is 30 days, whereas it is usually 10 or 15 days with houses. Of course, all of this is subject to negotiation, but it’s critical to finish your due diligence before the inspection period ends in order to get your earnest money back if something turns out be wrong with the property.

A Brief Guide to Due Diligence for Apartments

Walk Every Unit!!!

Yes, three exclamation marks are necessary. Many sellers and even some real estate agents will tell you it’s OK to walk every second or third unit. Ignore this “advice” with extreme prejudice. If you only view every other unit, do you think the seller will show you the best or the worst units? How many hidden problems are you leaving behind closed doors, only to find out later once the property is in your name? It is critical to know the condition of each unit, even if there are 100 of them. It’s a painfully long process, but no one ever said real estate was easy (or at least no one every truthfully said that real estate was easy). Often, words like “new furnaces” or “new appliances” only apply to a very small number of the units.

Related: How to Purchase Apartment Buildings Without ANY of Your Own Money

During these walkthroughs, you should be taking a careful inventory of the work that needs to be done and compare that to the estimate you had when you made the offer (and yes, you should have a rough estimate of necessary repairs when you make an offer). Is there a major difference? Are the units in much worse shape than the few you saw beforehand? If so, that might mean you need to re-trade (renegotiate the price after the property is under contract). Re-trading is perfectly normal, so don’t be afraid to do it. That being said, don’t plan on it going in or make a habit of it or do it capriciously; otherwise, you will get a bad reputation and agents will steer their sellers away from you.

You should also pay a lot of attention to the tenants. Do they treat their units well, or do they treat them like a rental car? Feel free to ask them questions too, such as:

  • How do they like the apartment?
  • Do you have any consistent maintenance problems?
  • Does it get really cold in the winter or hot in the summer because of these old windows/window A/C units/old heating system?
  • Is it quiet here or pretty loud?

If it’s a large building, check the Google rankings to get an idea of tenant complaints. You can also ask a few what they pay in rent and what their deposit is. You want to verify what you see on the rent roll is actually true.

With regards to inspections, I recommend getting an inspection of the roof, the foundation if any major cracks or movement are apparent and at least a few electrical panels (to make sure they aren’t Federal Pacific panels or any other brand that has been recalled). It’s also not a bad idea to get a pest and dry rot inspection. And finally, I would recommend scoping the sewer line unless the property is relatively new. The old clay tile sewer lines break down quickly, and replacing a sewer line is not cheap. You can probably get a plumber to scope the line for $150 to $200.

You should have a licensed property inspector review anything else you have questions or are unsure about. If you are relatively new, it’s worth spending extra here, but you do not necessarily need an inspector to go through each unit like you did. Instead, you can have them view a couple units and then line out the specific items you want them inspect.

And go ahead and start bidding out the work with the contractors and vendors of your choice.

Leave No Financial Unturned

Please, for the love of everything good in this world, never take a seller’s financials for granted — especially the pro forma, which is basically just an uneducated and grossly optimistic guess. Often the pro forma’s are drastically better than the property’s operating history which leads one to wonder why the seller couldn’t reach the performance their pro forma takes for granted. In all likelihood, the seller couldn’t reach it because it’s not a real possibility.

Analyze the operating statement carefully, and review each lease to make sure it matches the rent roll. You’ll need proof of deposits (such as bank statements) so you know that the money is actually being collected. Also make sure you look for tenant delinquency and don’t just assume every leased unit is paying rent. You want the economic occupancy number, not the physical occupancy. Tenants who aren’t paying rent are actually worse than vacant units because you usually have to incur the cost of evicting them. Request utility bills and contracts to make sure they are in line with the operating statement. Double check the taxes with the county, and price out the insurance with your preferred carrier or even better, get a couple quotes.

You want to review the operating statement very carefully. But especially make not of two major things:

  1. Bad Debts
  2. Misallocated CAPEX

With regard to bad debt, if they are using accrual accounting, make sure that uncollected debts have been charged off so you can see the total delinquency. Sometimes properties will carry tons of bad debt without charging it off, and thereby the books look much better than they are. Make sure you are crystal clear on who is behind and by how much. New owners often have to kick out a lot of tenants, especially if the property is a bit dilapidated.

Related: The Step-by-Step Guide to Making Offers on Apartment Buildings

With regards to CAPEX (capital expenditures), some owners throw things in CAPEX (i.e. not in operating expenses so they don’t count on the property’s operating statement) that don’t really belong there so the net operating income looks better. A common example of this is turnover expenses. Replacing carpet in an apartment unit is really an operating expense, or at least a recurring capital expense, which should go above the line (be on the operating statement) — yet many sellers put such expenses in CAPEX. Make sure to get an inventory of their CAPEX expenses when analyzing properties and put in “recurring CAPEX” as a line item in your analysis (usually about $250/unit per year for things like roofs or furnaces going out).

Phase One, Appraisal and Survey

Any bank loan will require an appraisal and a Phase One Environmental Site Assessment (for larger properties). Sometimes they will require a Phase Two and/or a property survey. The Phase One is vital either way. It is an environmental study, and you absolutely don’t want to buy an apartment sitting on top of a toxic waste dump. The EPA does not look particularly kindly upon such things, and the cleanup can be ridiculously costly.

It’s hard to do too much due diligence. The mistake is almost always in the opposite direction. So never skimp on it. Due diligence could be the difference between solvency and insolvency, especially with larger apartments and commercial properties.

What would you add to my list? Have you ever purchased an apartment building before, and if so, what due diligence items did you find most essential? 

Leave your comments below!

Andrew Syrios has been investing in real estate for over a decade and is a partner with Stewardship Investments, LLC along with his brother Phillip and father Bill. Stewardship Investments focuses on the BRRRR strategy—buying, rehabbing and renting out houses and apartments throughout the Kansas City area. Today, they have over 300 properties and just under 500 units. Stewardship Properties on the whole has just under 1,000 units in six states. Andrew received a Bachelor's degree in Business Administration from the University of Oregon with honors and his Masters in Entrepreneurial Real Estate from the University of Missouri in Kansas City. He has also obtained his CCIM designation (Certified Commercial Investment Member). Andrew has been a writer for BiggerPockets on real estate and business management since 2015. He has also contributed to Think Realty Magazine, REI Club, Elite Daily, Thought Catalog, The Data Driven Investor and Alley Watch.

    Trevor Nazzaro
    Replied over 4 years ago
    Very good article. I have bought several large apartment complexes (300+ units) and I have found the roof inspection to be most critical (and saved us a lot of money). The roof inspection turned up little wrong with the roof itself but since our inspector was a “water-proofing” consultant he noticed something wrong with the balconies at the property – none of the scuppers were sealed! This led to another somewhat invasive inspection where we peeled back the siding and found out that most of the framing and OSB was completely rotted away. Nonetheless we dropped the deal!
    Paul Timmins Specialist from Rockland, MA
    Replied over 4 years ago
    Andrew Excellent job. I would add that the due diligence clock does not start until you have received all the requested documents. This will avoid a later occurring surprise. Paul
    Andrew Syrios Residential Real Estate Investor from Kansas City, Missouri
    Replied over 4 years ago
    That’s definitely a good point Paul. I will make sure to add that to my list, thanks!
    Cydni Anderson Real Estate Agent from Long Beach, California
    Replied over 4 years ago
    Thank you for laying this out so completely. This is a useful list for someone like me, just getting started.
    Kou Moua Accountant from Clovis, Ca
    Replied over 4 years ago
    Thank you for the article. It definitely touches on many areas that may be missed out. Keep them coming. The knowledge empowers better decisions.
    Ken P. from Northville, Michigan
    Replied over 4 years ago
    Andrew, thank you for the very helpful article. It is beneficial not just to someone looking to purchase their first apartment complex, but to someone like me who is someday going to be selling some my apartments. My knowing ahead of time what potential buyers will be looking for allows me to prepare and save documentation now so that everything will be ready when it’s time to sell. When we bought, there were minimal records available from the previous owner, so we relied heavily on the physical inspection and knowing what comparable units in the area could be rented for. We don’t want to put any potential buyer in the same situation that we were in.
    Johnny Julian Investor from Cincinnati, Ohio
    Replied over 4 years ago
    Very informative I learned so much off this thanks
    Joe Trinsey from Anaheim, California
    Replied over 3 years ago
    This is an older article, but I just read it. It was really helpful. In particular, the part about looking into operating expenditures being written off as CapEx. I had never thought of that before. I will be on the lookout for this now.
    Don Alberts from Frankfort, Illinois
    Replied over 3 years ago
    Thanks for the info. Nice article. Don
    Justin Doyle from Louisville, Kentucky
    Replied over 3 years ago
    Very informative thanks for the article.
    Brooks Armstrong Investor from Kenora, ontario
    Replied over 3 years ago
    I am starting a rental portfolio in the US am I better to staying with multies or SFH to fix and rent .
    Andrew Syrios Residential Real Estate Investor from Kansas City, Missouri
    Replied over 3 years ago
    I’m of the opinion that you go where the opportunity is. We focus more on houses but we purchase apartments as well when they become available. You want to focus on a niche, but I don’t think that niche needs to exclude houses or apartments unless you are focusing say on large apartments in which case, houses may be more of a distraction than anything.
    Michael Tucker Investor from Bowie, MD
    Replied over 3 years ago
    Great Post! Andrew, is there a related post of questions to ask when initially screening an APT deal? I found one I’d like to check out but have no idea where to start.
    Jack Knochel Investor from Huntersville, North Carolina
    Replied about 3 years ago
    Hey Andrew, great article and I’ll be reading plenty more since we just locked up our first 10 unit today! It might not be 300 or even 100 but its our first big one to add to 5 rentals we already have. Its a bank foreclosure so getting all the info from them and the MISmanagement company isn’t as smooth as we’d like but we are feeling pretty good with our numbers and after the next week or inspections and all we should know if we are off on anything.
    Jack Knochel Investor from Huntersville, North Carolina
    Replied about 3 years ago
    Hey Andrew, great article and I’ll be reading plenty more since we just locked up our first 10 unit today! It might not be 300 or even 100 but its our first big one to add to 5 rentals we already have. Its a bank foreclosure so getting all the info from them and the MISmanagement company isn’t as smooth as we’d like but we are feeling pretty good with our numbers and after the next week or inspections and all we should know if we are off on anything. Reply Report comment
    Jim Walker Real Estate Agent from Roseville, California
    Replied about 3 years ago
    Good post, Andrew. My clients and I enjoyed this. The reverse can also be true when Capex are expensed as routine OPEX – maintenance and repairs. Owners do that sometimes when preparing their taxes so as to avoid spreading the deduction over an IRS depreciation schedule. They could usually achieve the same result utilizing section 179IRC and keep the accounting cleaner. But if everyone did that, forensic accounting would not be so much fun. You asked for additional due diligence tips. Here is another interesting link my client sent me.
    Florentina Ronquillo
    Replied 11 months ago
    Great article.
    Bob Starlin Rental Property Investor from Missouri Nebraska, Iowa
    Replied 10 months ago
    I realize this article is a little older. But thank you for it anyway. It is/was very helpful in crystallizing what I have been trying to put together in my notes.
    Andrew Syrios Residential Real Estate Investor from Kansas City, Missouri
    Replied 10 months ago
    Absolutely Bob, glad you found it helpful!