Multifamily Investing Due Diligence Do’s and Don’ts

Multifamily Investing Due Diligence Do’s and Don’ts

With historically high rents fueling the apartment market, sellers are once again demanding top dollar and buyers have become increasingly aggressive in their pursuit of available inventory. During this process, the prevalence of defective construction in the apartment industry over the past several decades should not be overlooked.

Amateurs and professionals alike have purchased properties that were economic disasters because they were fraught with undetected construction defects. As a consequence, conducting thorough “due diligence” investigations are essential in avoiding the substantial repair and maintenance costs that can result from latent construction defects.

Understanding Apartment Construction

As owners and operators know, apartments are hybrid commercial/residential projects that have a history of problems unique to their classification. Making sure that a buyer, or a buyer’s inspection company, understands these problems, and where and how they manifest in apartment construction, can make or break a due diligence investigation.

Even reputable commercial inspection companies focus their due diligence investigations on interior systems, such as mechanical and plumbing systems, and generic sources of water intrusion common to all construction (roofs and windows). It’s doubtful, however, that these inspectors will discern hidden points of water intrusion such as handrails, deck edges, and stair stringers. Thus, it’s important the investigator be aware of not only how and where water penetrates, but how evidence of that water penetration—even when hidden behind finish materials like concrete and stucco—manifests itself on the finished surfaces of the building.

Forensic investigators who provide support to attorneys can be an excellent resource for buyers, too, during the due diligence process. They can, for example, review a building’s architectural plans for common architectural details that can allow water intrusion. They can also walk a project and identify areas that have a high probability of leaking, without conducting destructive and costly testing. If destructive testing is necessary, the forensic investigator can perform the testing and provide estimates the buyer can then use in soliciting bids for the repair work. The investigator’s findings can also help the buyer evaluate the economics of the purchase and renegotiate the sale price, if desired.

Understanding the Construction Team

An apartment building’s original construction documents are commonly made available as part of the due diligence process and should contain design drawings, subcontracts, and prime contracts, at the very least. These files can answer many questions you, as a buyer, may have, including the following:

First, ask whether the builder built the property for the builder’s own profit. Some extremely reputable developers occasionally function as their own general contractors. This is a red flag that should trigger caution, because the economics of development can be in conflict with the time and cost requirements of contractors. When developers act as their own general contractors, there’s an increased probability that quality control will suffer for the sake of maintaining the development pro forma and schedule. This is particularly true if the developer didn’t “hold” the asset for a significant amount of time after it was built.

Second, ask about the design professionals who worked on the job. Different firms have different reputations. Some architectural firms are better at generating plans that are more subcontractor–user-friendly than other firms. If the plans are too complicated, it’s common for subcontractors to ignore them.

Third, ask about the subcontractors who were retained to perform the construction work. Among the major trades, such as framing, waterproofing, sheet metal, and lightweight concrete, how many of those subs are still in business? What was their reputation when they worked on the project?

Trade contractors tend to use the same means and methods on every project they work on, often despite the requirements of their contract documents. It would astound the common consumer to learn how frequently trade contractors ignore essential contract drawings and specifications. As a consequence, a builder’s habits tend to carry over from project to project, good and bad. Attorneys and inspectors who work with apartment owners in your region should know who they are.

Understanding the Maintenance History

Because purchase and sale agreements commonly have limited representations and warranties, buyers should seek to gain as much “actual knowledge” about the function of the project as possible. Maintenance records are often the most important records for ascertaining this information, yet they are commonly ignored.

Patterns in maintenance records can provide valuable insight into which, if any, of the building’s systems aren’t performing. For example, is there a history of complaints of water coming through door thresholds or windows? Are there particular units with multiple maintenance requests for mold abatement? Is there a correlation between maintenance requests in a particular place (such as on a certain floor, or facing one particular orientation)? The problem may lie not with the tenants but with the system itself.

Talk to the maintenance personnel. What do they think works well and not so well at the property? On one occasion, a client of ours was horrified to learn that a team of painters did nothing but caulk and paint siding, because of installation errors in the building envelope. The buyer never bothered interviewing any members of the maintenance staff, some of whom freely volunteered to lawyers in subsequent litigation that the project was referred to as the Golden Gate Bridge because the asset was perpetually being painted.

Understanding Claims Preservation

Besides the building, its construction team, and the maintenance staff, there are three important legal theories apartment buyers should be aware of prior to closing escrow on a property.

Ten-year defective-construction limit. There is an absolute bar against suing a builder for defective construction more than 10 years after the project was completed. As a consequence, when a purchaser fails to identify defective construction in older properties, there can be no recovery against the builder to help offset repair costs, making thorough and effective due diligence inspections all the more important.

Three-year potential claims limit. For projects less than 10 years old, claims for construction defects can nonetheless become time barred if not pursued within three years of when an owner knew or should have known that the defect existed. Moreover, when a buyer purchases a piece of real property, the buyer is charged with the knowledge of the prior owner. Thus, if a prior owner discovers or should have discovered defective workmanship, the statute-of-limitations period commences as to that owner and all future owners.

Limits of transference. The right to sue for defective construction is a personal property right that does not automatically transfer with the sale of the real property. To the contrary, if a seller is aware of defective construction prior to the close of escrow and does not specifically transfer the legal right to sue for that defective construction (through a document called an “assignment of choses in action”), the right remains the personal property of the seller, and the buyer will have no recourse against the builder.

By conducting a thorough review of the project file, maintenance materials, and any prior sales documents, an apartment buyer should be able to determine whether the seller discovered or should have discovered any defects at the property. However, as a matter of course, purchasers of property less than 10 years old should demand that assignments of choses of action be included in the closing documents.

Good due diligence requires patience, hard work, and professionals who possess the expertise to correctly advise their clients. A proper investigation yields a thorough understanding of the building’s construction and maintenance history as well as the available rights to be conveyed.

Multifamily and Apartment Refinance, Rehab or Acquisition Lending

Multifamily and Apartment Refinance, Rehab or Acquisition Lending

Bridge, hard money or CMBS funding available for Multifamily, Apartment refinance, rehab or acquisition

When it comes to refinancing, rehabbing or acquiring multifamily and apartment properties, often times the difference between a good investment and a great investment is the cost of financing.

Winston Rowe & Associates understands this and that’s why they have developed a comprehensive mix of highly customized multifamily and apartment refinancing and acquisition programs to help maximize your return based on the individual needs and requirements of you and your apartment building investment.

Winston Rowe & Associates apartment and multifamily funding solutions are offered at competitive rates, so owners and investors can spend less on interest and fees and turn an even bigger profit from their investment in an apartment building or complex.

Apartment & Multifamily Financing Solutions:

No upfront or advance fees

Loans available nationwide

Loan amounts start at $250,000 – no upper limit.

Up to 30-year amortization

For purchases, refinances and cash-out

Quick closings with complete file

How To Buy And Finance Apartment Buildings

How To Buy And Finance Apartment Buildings 

Apartment Building investing is the preferred investment strategy for those investors who want an additional source of monthly income along with slow but steady appreciation in the value of their portfolio.

Buying an apartment building is a long, sometimes complicated, process. It’s important for you to gather as much information as you can before you make the decision to buy.

Applying for a mortgage to finance an apartment building is not at all similar to applying for a home mortgage. Apartment complexes with four or more units are commercial properties, and loans for them have different underwriting rules.

Here’s how to make a great investment in an apartment building.

Verify the accuracy of your assumptions; it’s critical that you have a realistic idea of what the value is, and what the income and expenses will be, accuracy of the information is everything

Don’t trust any numbers you hear from the seller, the real estate agent or anyone else representing the seller, use a third party firm that specializes in conducting a professional due diligence investigation.

Winston Rowe & Associates provides this service with no upfront fees to their clients.

They will make sure you’re working with reliable data from the seller and their agents.

A professional due diligence investigation will get to the hard evidence from using business analysis metrics to find out what those numbers have been in the past and what they may be in the future.

The Metrics of Apartment Investing:

Gross Rent Multiplier (GRM):

Gross rent multiplier is a rough measure of the value of an investment property that is obtained by dividing the property’s sale price by its gross annual rental income. GRM is used in valuing commercial real estate.

Utilizing the GRM you can accurately determine the value of the commercial real estate prior to ordering an appraisal. Additionally, the GRM can also verify or discredit an existing appraisal.

Net Operating Income (NOI):

Net operating income (NOI) is used in the real estate market to determine the revenue that a property generates less operating expenses. NOI also determines a property’s capitalization rate, or rate of return.

Occupancy:

The occupancy rate is the number of units filled divided by the total number of units.  For instance, if there are 95 units occupied out of a 100-unit apartment complex the occupancy rate is 95%.

Vacancy:

Some investors prefer to use the vacancy rate instead of the occupancy rate.  The vacancy factor is just the reciprocal of the vacancy.  For instance, in the example above if there were 5 empty units out of a 100-unit apartment complex the vacancy factor would be 5%.

Absorption:

The absorption rate is the rate at which available apartment units are rented in a specific real estate market during a given time period. It is calculated by dividing the total number of available apartment units by the average number of sales per month. The figure shows how many months it will take to exhaust the supply of apartment units on the market.

Capital Expenditure (CapEx):

Capital expenditure, or CapEx, are funds used by a company to acquire or upgrade physical assets such as everything from repairing a roof to building, to purchasing a piece of equipment like water heaters, air conditioners, or new plumbing.

Cash Reserves:

This is very important to every potential lender; it’s the amount of cash that you set aside when running a business. A business that is not properly capitalized can fail in a very short period of time.

Internal Rate of Return (IRR):

Internal rate of return (IRR) is a metric used in capital budgeting measuring the profitability of potential investments. Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.

Loan-to-Value (LTV):

Loan-to-value ratio (LTV ratio) is a lending risk assessment ratio that financial institutions and others lenders examine before approving a mortgage. Typically, assessments with high LTV ratios are generally seen as higher risk and, therefore, if the mortgage is approved, the loan generally costs the borrower more to borrow.

Debt Service Coverage (DSC):

The formula for DSC is Net Operating Income divided by the total debt service.

Typically, lenders want to see at least a 1.10 DSC.  This means that for every $1.00 of debt service, the property is producing $1.10 of cash-flow to service that debt.

Capitalization Rates (Cap Rate):

The capitalization rate is the rate of return on a real estate investment property based on the income that the property is expected to generate. The capitalization rate is used to estimate the investor’s potential return on his or her investment.

Even though this metric is simple, most real estate brokers manipulate this number (usually by using forecasted income numbers rather than the actual numbers).  Always take a stated cap-rate with a grain of salt and do your own math.

Due Diligence Review & Investigation:

Winston Rowe & Associates commercial real estate due diligence services range from initial deal review for accurate and reliable analysis to help support your important real estate decisions, then presentation and placement to their extensive network of capital sources.

Without the usual upfront or advance fees that are typical in the industry.

Whether you are looking to finance a small apartment building, a complex with hundreds of units, or a co-operative looking for an underlying mortgage, Winston Rowe & Associates can help you find the optimal financing solution to meet your individual needs.