Due Diligence: What is a new commercial investor likely to miss?

12 Replies

Good day everyone, I hope you had a wonderful weekend.

A thought has been running through my mind lately as I have been trying to digest as much information as I can find regarding the due diligence process for commercial multi-family units.

I am an engineer by background, and as my wife would point out, by nature I couldn't be anything else. I have to triple check all the T's for crosses and I's for dots before I will even consider thinking about moving to the next step.

I think she is embellishing a little.

Anyway, the thought that has been bothering me is that I am having trouble finding a "checklist" of due diligence items to watch for. Some obvious things are of course obvious enough even for me to see without having a giant red sign with blinking lights on it. But, I am wondering has anyone put together a basic or advanced checklist for people to get started with? I expect there are some in the "for sale - join my investing course for $2000 to $50000" packages, but I would think there has to be something out there to get started with that doesn't require 3000 hours of reading to piece-meal from 3000 topics.

At any rate, more importantly than that, for all of you heavy hitters and longtime investors that have seen it all before, what would you tell yourself to watch out for, if you could go back and tell yourself when you were just getting started to be watchful for?

I know never to trust or believe a sellers proforma or a brokers assurances that "this is a great deal"... unless you are the seller and it is your proforma of course *cough*, but what would you say are the hairiest items that people tend to miss?

Any idea?

Thanks for your indulgence.
Bob

@Bob Starlin Due diligence is one of the least-talked about topics because it is not as sexy as other areas. You are smart for not getting suckered into courses that offer little or no insight apart from the usual marketing platitudes. 

An excellent book on due diligence: Brian Hennessey - The Due Diligence Handbook For Commercial Real Estate: A Proven System To Save Time, Money, Headaches And Create Value When Buying Commercial Real Estate

It's reasonably in-depth but a lot of this stuff one learns from experience. This is also product and market-driven so there is no "one size fits all" way of doing it. 

@Omar Khan Sir, your response is immensely appreciated. Thank you so much for taking the time to respond. I will look into that today. I was actually looking at this book on Amazon the other day, but there are so many books from so many people that all seem to be the same nonsense, I tend to shy away from "best seller" lists until some people actually recommend them.

Thank you again.

@Bob Starlin No worries, hope it adds value. 

As a quantitative person, I empathize with your approach about wanting to get everything right. But part of this game is following the Pareto Principle and building in a margin of safety for the big-ticket items. 

If you take too long the deal will never be yours, but if you hurry into it then... you know how that story goes :)

Hard to find a balance. That's why we keep learning.

1. Do the numbers match up? From what the realtor or owner tells you?

2. what do house close to this one cost? 

3. How long were similar homes in the neighborhood for sale?

4. what will the property cash flow (be conservative 50% of rental income should be used for miscellaneous)

5. Do you have the cash if it is empty, also know as carrying cost?

6. what utilities are you responsible for?

7. PM or self managed?

8. Other issues like how old is the furnace? the roof? electric? plumbing?

9. what is the property zoned?

10. do you feel you read enough stuff?  Just kidding..... I know you need to read some stuff but let me ask you as an engineer this how many engineering books did you read before you did your first project?  My bet is that you did something small during your first class.  Now I know that was just your gateway to the bigger projects but think did you do good on that project?  now fast forward to getting your degree in engineering..... how many books on engineering were required to read front to back and understand and KNOW everything?  Since getting your degree have you come across a problem/situation that you didn't study? Do you see where I am going? 

Tag me if you have any further questions so I can try to answer them. 

Have fun and happy real estat-ing!

@Michele B. Thank you, Michele, for your response.

Thank you for your thorough and well thought out response, it is much appreciated.
Please let me try and clarify a little. I am not completely new to real estate. I have bought, held and sold over 20 SFH and duplex units in my previous real estate "life" as it were.

I realize that analysis paralysis can be very real, even more so for someone like myself that needs to see numbers that I find attractive and reasonable. 

My post wasn't so much about the obvious things to look for, those are covered everywhere, and I don't mind digging for those things as needed. My post was more along the lines of things that might not be so obvious other than 50% for expenses, and check mechanicals for serviceable age remaining. Things that maybe people have been bitten by or better yet, almost bitten by but they managed to avoid... that kind of thing.

And the last part of your statement is really what I was getting at, to paraphrase, what sort of situations have people seen that they weren't expecting to find that may have been a problem.

Does that make it clearer?

Thank you again for your response, it is much appreciated and I will contact you with questions if I may. Thank you for the offer, that is very kind of you.

I wish I had known you while I was still investing in Michigan. :D

Bob

Originally posted by @Bob Starlin :

@Michele B. Thank you, Michele, for your response.

Thank you for your thorough and well thought out response, it is much appreciated.
Please let me try and clarify a little. I am not completely new to real estate. I have bought, held and sold over 20 SFH and duplex units in my previous real estate "life" as it were.

I realize that analysis paralysis can be very real, even more so for someone like myself that needs to see numbers that I find attractive and reasonable. 

My post wasn't so much about the obvious things to look for, those are covered everywhere, and I don't mind digging for those things as needed. My post was more along the lines of things that might not be so obvious other than 50% for expenses, and check mechanicals for serviceable age remaining. Things that maybe people have been bitten by or better yet, almost bitten by but they managed to avoid... that kind of thing.

And the last part of your statement is really what I was getting at, to paraphrase, what sort of situations have people seen that they weren't expecting to find that may have been a problem.

Does that make it clearer?

Thank you again for your response, it is much appreciated and I will contact you with questions if I may. Thank you for the offer, that is very kind of you.

I wish I had known you while I was still investing in Michigan. :D

Bob

 I am sorry I had misread your question. (Now I feel stupid)  Guess I should learn to read.   

I now understand you were looking for the things that normal due diligence might miss.

I had a person who bought a property that was in a larger town and there was the air space above the house that was sold so that no one could block another building or sign.  They did not know this and they bought the building and started to add on going to another story and they found out they had to tear it down because someone sold the space rights to someone else. 

I had another buyer who bought a house to live in for themselves and they were so excited they got it for a steal.  Moved in and about 3 months later found out that their was a highway coming through and the property was considered under emanate domain for the city/state and they were buying the properties at a reduced rate.  My friend lost about 5 k. plus moving again.

I have also run into problems with liens that the owners didn't know about. So they get to a couple days before the closing and they find the lien.  Most times people don't know about them and in most cases they are small.  I had one that with paying off the bank and the lien the seller was in the negative as in they had to pay cash up front to get out completely.  

I hope those cute little stories make me sound smarter than the first set of answers I gave.  

Have a great day....and remember tag me with any questions. 

@Bob Starlin When Mark Twain said 'Good decisions comes from experience and experience comes from bad decisions' he must have been thinking about investing in MF-we will never know for sure. I would say at the beginning play it safe-walk before you run etc. In the beginning stay away from complexity-auctions, land contracts, FSBO etc. Do a conventional deal with a realtor at both ends-yours and the sellers. Get a CPA if you don't already have one, and a REI attorney should you need one. Follow all the rules, Rent roll, leases and T12. Get an inspection by an inspector, etc. Join your state LL association and network. Spend time reading and posting on BP, webinars, etc. Why don't you create that 'check list' you mentioned that makes you feel comfortable. While you are at it be clear about what your goals and objectives are for doing MF in the first place-and no, I want to quit my day job is not good enough! All the best!

@Michele B.
Outstanding! Now that airspace contingency is something that I would never have thought of. LOL. Excellent. Thank you

And you didn't sound foolish. they were excellent points and seriously appreciated. It was just a different answer for a different question :D

Thank you again.

Bob

@Bjorn Ahlblad
Thank you, sir, for taking the time to respond. All that is excellent information for a new investor to follow.

Do you have anything in particular that you wish you could warn yourself to watch for during due diligence? Something like a "gotcha" that most beginner books and newbie lists don't cover?

Thank you again for all the good information you posted in there.

Bob

Hi Bob,

When purchasing apartments/multifamily, there are 10 main reports you want to obtain during the due diligence phase (between contract and close):

  1. Financial document audit
  2. Internal property condition assessment
  3. Market survey
  4. Lease audit
  5. Unit walk report
  6. Site survey
  7. Property condition assessment
  8. environmental site assessment
  9. Appraisal
  10. Green report

Much more involved than due diligence on a SFR.

@Theo Hicks
Thank you, sir, for that excellent list.

Just in keeping with the thread, is there anything that you have found in your travels and deals, that you wish you had known about when you were just starting out that perhaps wasn't easily found or referenced somewhere? Anything jump at you in a deal from the weeds that might have been a tragedy?

Just a morbid curiosity on my part.

Thank you!
Bob 

I'd say that you want to learn as much about the property as possible before going under contract, especially the big-ticket exterior items (i.e. roof, HVAC, parking lot, clubhouse, siding, etc.). The less surprises the better. Touring the property is a must! Do not trust the listing broker's sales package when determining the interior and exterior renovations budgets.