Confused about Deal Flow

7 Replies

Hello,

I am a new to the area of real estate and one of the biggest problems stopping me from investing is that I do not understand the general flow "the deal". I'm specifically interested in this from the perspective of acquiring apartment buildings in Washington state.


As I understand it, the flow occurs something like this:

Acquire Lead

Letter of Intent
Acquire Finacials (P&Ls)

Negotiate Offer
Under Contract
Due Dilligence (Rent Rolls, Structure, Title, etc)
Escrow
Management Reorg

The part I'm confused about is Due Diligence is likely where the treasure trove of info is going to be, but by the time I reveal that information, I'm already under contract. If I find something unfavorable to the seller how do I get out of the contract and negotiate a better price?

I feel very uncomfortable making an offer without that due dilligence info, but as I understand it, that comes after the contract is executed.

Hello @Matthew Fiebig  ,

I am a Realtor in Las Vegas and I do not know about Washington state contracts. However, the contracts should be similar so I will explain the process here.

The Las Vegas purchase contract has a period of time called the due-diligence period. I typically set the period to be 10 days with single family homes and 20 days with most multi-unit properties. During the due-diligence period the buyer can terminate the contract for any reason and get their earnest money back. You need to have similar verbiage in your purchase contract. If not, then you have the wrong contract. Below is the actual verbiage from the Las Vegas contract.

"Due Diligence Period: Buyer shall have ____ calendar days from Acceptance to complete Buyer's Due Diligence. Buyer shall ensure that all inspections and certifications are initiated in a timely manner as to complete the Due Diligence in the time outlined herein. (If utilities are not supplied by the deadline referenced herein or if the disclosures not delivered to Buyer by the deadline referenced herein, then Buyer's Due Diligence Period will be extended by the same number of calendar days that Seller delayed supplying the utilities or delivering the disclosures, whichever is longer.) During this period Buyer shall have the exclusive right at Buyer's discretion to cancel this Agreement. In the event of such cancellation, unless otherwise agreed herein, the EMD will be refunded to Buyer. If Buyer provides Seller with notice of objections, the Due Diligence Period will be extended by the same number of calendar days that it takes Seller to respond in writing to Buyer's objections. If Buyer fails to cancel this Agreement within the Due Diligence Period (as it may be extended), Buyer will be deemed to have waived the right to cancel under this section."

A few thoughts on due-diligence of multi-unit properties:

• Add verbiage to the contract that the due-diligence period starts upon I have access, utilities are on, I have copies of all lease agreements and access to their record of rent deposits.
• Never believe anyone’s books. Not infrequently they have generated some just for the sale.
• Make a point to talk to all tenants. What you want to ask are things like: are there any maintenance issues of which you are aware. Are you planning to renew you lease? If not, why? How much are you paying per month? Are there any changes you would like to see to the building?
• Have an qualified inspector go over each unit and the building in detail. Pay special attention to the roof and drainage. Check the water pressure. I find a lot of (expensive) deferred maintenance issues on the multi-unit properties here so be careful.

Keep in mind that multi-family properties have different characteristics than single family properties. For example, multi-family properties are generally only purchased by investors. Investors determine the value of a property based almost exclusively on its rate of return (or cap rate). If rents don't rise then the property value does not rise. So, unlike single family properties, multi-family property appreciation is largely based on rising rents. This means that if you are in a market where rents have been (and are likely to remain) flat, you need to consider a multi-family property only for cash flow; not for appreciation.

Multi-family advantages:

• Lower rental risk. A single-family property is either 100% occupied or 100% vacant. With a multi-family property if one unit is vacant you still receive a portion of the rent. With multi-family properties, vacancy risk is distributed across multiple units.
• Per unit cost is much lower with multi-family than single-family homes.
• Multi-family properties with four units or less (currently) qualify for standard 20% down investor loans. This is very attractive. My understanding is that more than 4 units may require commercial financing which is a more complex and expensive financing option.

Single-family home advantages:

• In Las Vegas, tenants in single family homes tend to move less frequently than the single people who are the dominate renters of multi-family properties. I believe this is because people who rent single family homes tend to be families with children. Parents want to provide stability for their children and thus do not want to move them to another school district.
• When it comes the time to sell, you have two potential buying groups with single family homes: investors and home owners. You could be in a market where rents are not increasing (so CAP rate valued properties do not increase in value) but the prices of single family homes are increasing. Or, you could be in a market where rents are increasing but property values are static.
• Financing is usually easier with a single family home investment loan.

Other multi-family vs. single-family considerations:

• In Las Vegas, multi-family seems to appeal to a different market segment than single-family. Because of the different market segments, the vacancy rate can be very different between the two. For example, currently the vacancy rate for multi-family properties is about 15%. For single family homes it is closer to 5%.

Matthew, I hope the above helps. Do not hesitate to post questions or drop me an email if I can help.

Best Wishes,

Eric gave you a good answer. I would like to add I always have the seller sign the IRS form allowing me to review the tax return schedule for the property. Very rarely does a seller inflate his tax return income for a property.  I did run into a case where the seller was using his apartments and a few laundromats to launder cash.

@Eric Fernwood  , thank you for the reply.

So basically what you're saying here, is that the initial offer is based off of whatever financials I can get our of the seller (P&L, rent roll, sched E) which represents the highest offer. Then I have an escape clause which is executed when when due diligence is completed and finds better leveraging material.

Instead of a linear flow like I was thinking it looks something more like:

Acquire Lead

Letter of Intent

Acquire Finacials (P&Ls)

  > Negotiate Offer
|    Under Contract
<   Due Dilligence (Rent Rolls, Structure, Title, etc)
  Escrow
Management Reorg

What sort of information besides Financials should I be requesting from the owner/broker during that first touch? What is left deffered to due diligence?


@Brian P. at what point should I be getting that info. Due dilligence?

Hello @Matthew Fiebig ,

Before I talk about the deal process have you verified that apartments are the right choice in your area? Before you seriously consider anything I recommend you take a step back and take a wider view. Is the geographic area you are considering a good investment area? If it is a good area, are apartments the best type of property? Do not get caught up in some "technique"; every market is different and you need to look at the bigger picture before you zero in on anything. See this thread for the process that I would follow to identify the best area(s) and type(s) of properties to invest - http://www.biggerpockets.com/forums/12/topics/153168...

Ask a few local property managers whether apartment buildings rent well, you will usually get an honest answer. The reason the property manager will answer honestly is that the last thing they want is another unrentable property. So, if you ask them what to buy they will be happy to tell you what type, configuration, location and rent range do best. They will also be able to tell you what the apartment you are considering should rent for if it is in market ready condition. Matthew, all we do is investment real estate and we never consider buying a property unless the property manager agrees.

Let's assume that all the property managers tell you that the apartment is a good investment. They will also be able to tell you that in market ready condition the units will rent (making the following up) for $600/Mo. for two bedrooms and $400/Mo. for one bedrooms. Also, that it should take about 45 days to rent a market ready apartment.

With this information you now have a very good understanding of the financial potential of the property. Based on this you can then calculate what the property is worth to you and this is the amount you should offer. When I first started out in real estate investing in Houston (many years ago) I followed this process. I made a lot of offers. Some people got angry, some people laughed but some accepted my offers. I made very good money from my Houston properties.

If your offer is accepted the due-diligence starts immediately after the contract is executed. During the due-diligence period you need to get the property manager, inspector and anyone else you need into the property. You also need to get the leases and have your property manager review them. @Brian P.   made an excellent point about getting the tax schedule for the property as well as the documents I mentioned in my last post. Once the inspections and document review is complete you need to look at the numbers again. Unless the numbers look good and the property manager agrees, cancel the contract.

Matthew, I hope the above helps to clarify the process.

@Eric Fernwood I'm back from reading your two posts. My first question is how you find these local property managers in the first place. I can think of a couple ideas, like phone book, contacting the local REIA, google search. Are there any other methods that you would suggest? Also what would be the best way to validate the information that they give you. "Trust but verify" right?

Hello @Matthew Fiebig ,

Use Google to search for property managers. For example, according to your profile you live in Edgewood, Washington. I Googled "Edgewood Washington property management" and got several pages of hits. Click here to see the search results. I next tried "Las Vegas Nevada property management" and got similar results. So, that is how I would get a list of property managers. (Phone book? I have not seen a phone book in years.) After you look through a few property manager websites you will start to have an idea about their services and possibly even their fees and such. Choose 4 or 5 that look interesting to call. Tell the property manager that you are new to investing and you are looking for a property manager to work with.

Before you start making calls, develop a list of 10 to 15 questions. This is important: ask each property manager the same questions and compare the answers. You will quickly know who is providing facts and who is providing fiction. This is your method of validating what they tell you. I have a list of property manager interview questions. Drop me an email (or anyone else who would like a copy) and I will send you the list. The list includes a lot of questions, far more than you will be able to ask in a 20 to 30 minutes initial interview.

So the process is:

1. Develop a list of 10 to 15 questions designed to understand the property manager's focus (specific area, commercial, industrial, etc.), number of properties under management and the type, configuration, location and rent range that do best. I would choose mid sized property managers. They will have enough properties under management to know the market but small enough to be interested in a new client (you).
2. Google the name of the city/state plus the words "property management" of the area you are considering to get an initial list of property managers.
3. Look through their websites and see what types of properties (commercial, only high-rise, etc.) they primarily manage. You want property managers that focus on the type of property you are considering.
4. Look at their geographical coverage, they may not cover the specific area where you are considering.
5. Read their "corporate profile" and listen for the "ring of truth". I looked through a few of the property manager websites and some were puffing and I would discount them.
6. When you have a short list of 5 to 10, prioritize them and, starting with the lowest (not top) call and set up a phone appointment. Tell them you are new in real estate and are looking for a property manager to work with. Make notes of their answers. After you go through 2 or 3 you will have a pretty good idea of what is happening in that area and the type, configuration, location and rent range which do best. Remember that you are not just looking for "facts", you are trying to determine if this is an individual you can trust with your money.

Matthew, I hope this helps. Feel free to ask if you have more questions.

@Eric Fernwood  - Are you sure about the 20% down for 2-4 units?  I have been recently approved by a credit union and national bank and both was 25% down for 2-4 units.  Both lenders say this is a new, recently changed from 20%.  If you know of a institution lending at 20% down for 2-4 unit properties i would LOVE to know about it!

Bill Schrimpf, Real Estate Agent in NV (#11844)

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