Multifamily Syndicator · Greater Los Angeles Area · Member since 2015 · 399 posts · 261 votes
Hi everyone,
I am currently doing due diligence on a MF property and have come across several leases that do not match the rent roll. All of the leases that do not match are all on month to month at this point. The seller is not providing me with any other information other than telling me they pay more than the lease states and its what's on the rent roll. This is a smaller property so every dollar counts and 10 of the 42 do not match. Does anyone have experience or advice for me on this? Is this typical or should I being going back to the seller and asking for a retrade? (which is never my intent). The difference in valuation is about 6% of the purchase price or $95k.
@Kyle Mitchell I think this is an opportunity to get Estoppel Certificates for each tenant. The certificates will also tell you about security deposits and last months rent paid or not. Money that would be owed to you at closing. All the best!
A little over a year ago,I bought a property that I SHOULD have pressed harder on. For me it was a 1031 exchange and I was purchasing 3 properties at once. What a handful. I reluctantly took one of the rent rolls as gospel for that property as I had many other details to concentrate on. After purchase It was clear that the rent roll was inflated. I'd definitely should pressed harder for clarification or proof of such differences between rent roll and leases. Either through banking statements or something. Press harder. There shouldn't be anything to hide if the rent roll is accurate and well intended. If it has been fudged, only a diligent buyer will know and if that information has been fudged, what else has been?
Definitely check. It is possible that they have been there long enough that the amount on the lease is outdated and the rents have increased while they are on month to month.
@Kyle Mitchell I think this is an opportunity to get Estoppel Certificates for each tenant. The certificates will also tell you about security deposits and last months rent paid or not. Money that would be owed to you at closing. All the best!
As part of the due diligence I have done in the past it wasnt unusual for me to talk with the current tenants about the property, current management and rents. I would be making some phone calls. Aside from the possibility of a skewed rent roll (which is likely) having month to month tenants occupying 25% of the property poses a bigger potential risk.
Obviously I can't speak for your state laws but here in VA month to month tenants can leave at any time without incurring any penalties. This creates an obvious problem should you decide to raise rents. I would check on your state laws regarding periodic tenancy.
I am currently doing due diligence on a MF property and have come across several leases that do not match the rent roll. All of the leases that do not match are all on month to month at this point. The seller is not providing me with any other information other than telling me they pay more than the lease states and its what's on the rent roll. This is a smaller property so every dollar counts and 10 of the 42 do not match. Does anyone have experience or advice for me on this? Is this typical or should I being going back to the seller and asking for a retrade? (which is never my intent). The difference in valuation is about 6% of the purchase price or $95k.
Thanks,
Kyle
Bank statements is what separates the sellers sales pitch and reality.
Don't take the rent rolls as the truth. I got burned on it once and never will again. It won't sink me but it dropped my CoC return by 4%. Not cool at all
Esstopal letters are mandatory in every purchase offer. It makes little difference what the lease says or th eowner says. Without esstopal letters it is all hrearsay.
Likely rent roll is inflated or there is payment plan agreement in place (some tenants missed 1-2 months rent, seller work out payment plan with them so tenants pay extra per months to catch up). These type of extra payment will go away after you take over - no obligation by tenants to pay more than what is on the lease. You have to assume lease agreements is the real rent roll, not seller's words. I agree best to get Estoppel for those mismatch tenants.
@Kyle Mitchell I would agree with @Bjorn Ahlblad that you need to get Estoppel Certificates and I would do it not only for the 10 tenants in question. Make sure the seller is ok with it.
@Kyle Mitchell this is common and the simple explanation is that there was a rent increase after the lease term expired. For month-to-month tenants, we just send a rent increase letter instead of signing a new lease. We file a copy of the letter with the lease document.
As others mentioned, if you get an estoppel signed by the tenants, it is verification of the rent amount they are now paying. Some sellers push back on this because they view it as a hassle.
For a property with 42 units, I would ask for a copy of their income and expense statement. Either a CPA certified summary or a copy of their tax forms for the last two years. This type of statement will show you total actual rents collected for the year. Usually it is less than the rent roll, because of rent increases, vacancy and uncollected rent. This will give you a real income number, which is more important than a rent roll.
Thanks @Joe Splitrock The problem is the seller in not willing to provide me with any of that documentation which makes me think that those rent increases on the month to month are not accurate. The PM company has no records of the letters either....
@Kyle Mitchell This reminds me of a few business brokering deals I've been involved in. When the seller of the business isn't willing to submit supporting documentation like banks statements showing claimed deposits and invoices supporting the expenses that the business would require to operate at that level, I walk away.
About 7 years ago, I was going to buy a business that was a competitor to one I owned. A little forensic accounting showed that on $500K in claimed sales, there was about $70K I couldn't account for. The seller said it was from a "confidential part of the business" that he wouldn't discuss until after the sale.
No dice.
Another operator bought it and was out of business within the year.
I was first going to ask why you don't have a 3rd party conducting the DD, since they would have procedures in place for this. But then I read that this is a 42-unit.
First, it doesn't matter. You are buying this thing to re-position it, I would hope, therefore if you have to evict them early that's not a bad thing. You'll just renovate the units quicker and bring them back on line at higher rents.
Secondly, they are month-to-month, so I don't see why you're sweating.
Lastly, though, why in the world do you care what the valuation of in-place revenue is? You don't actually buy on capitalized value, do you?
@Kyle Mitchell I agree with @Ben Leybovich that it really doesn't matter. They are all month to month, so you could just enforce the higher rent with 30 day notice.
The more important question is what is fair market rent of the units as-is and what is the value after rehab? It really matters less what he is getting for rent today and more what you will be able to get for rent tomorrow.
Glad you went and pulled leases, a lot of investors out there find the rent roll with the OM and underwrite it like its the true income you will be producing to date. I find a majority of rent-rolls wrong, essential to use in preliminary underwriting though. These lease is the lease and i would never go by the fact that there is more rent being paid than what is written on there. Why would that ever be the case?
All in all i think @Ben Leybovich advice is solid. Unless this mis-valuation REALLY takes you off course of your business plan.