DEAR MONTY: About six months ago, three longtime friends and I decided to make some real estate investments together. Our investment goals are similar; we are each high-income professionals, share similar risk tolerance and see real estate as a long-term investment opportunity. Now, we have identified a 60-unit apartment building we are interested in pursuing. We have the standard list of due diligence items, but wonder if there are some “out-of-the-box” due diligence tactics to make certain we do not make a mistake. Can you help? — Nathan G.
A: Hello Nathan, and thank for your question. Buying, owning and selling investment real estate is always a series of calculated risks. “Make certain” are strong words. No matter your methods, you cannot know everything the seller knows. Over and above the standard due diligence list, buyers have ways to discover more about a property that either encourages or discourages them.
It is always difficult to understand the motivation of the seller because many sellers do not share their core beliefs, or some may even mislead or miscommunicate their ideas to create an image of trust. As callous as this statement is, I believe it to be true in many cases. To balance that statement, self-interest is to be expected.
Business ethics is a subject that is not black and white. It involves various shades of gray depending on the person with whom you are talking. Choose carefully which tactics to employ with which transaction. Some sellers might not take kindly to a given tactic, while others may well have done something similar, or further out-of-the-box, themselves.
I have never witnessed any one buyer applying all of these tactics on a single property. This is a career compilation of tactics I have seen. Here are nine questions you may want to answer before buying.
9 Out-of-the-Box Due Diligence Questions About Apartments
1. Determine where the tenants are employed. This data will be on the rental application, but not on the rent roll. If 25 of the tenants are with the same company, and a move to Mexico is announced 30 days after the sale closes, your vacancy rate could skyrocket.
2. Visit with multiple tenants who have moved out of the apartments. You can determine this by comparing year-to-year rent rolls. Look for patterns in the reason they moved out. Getting closer to work is one thing; moving away from drug dealers is a different story.
3. Get the financials both annually and monthly. Look for patterns in vacancy swings. If you find one, learn what creates it every year. When you hear the answer, trust it – but verify.
4. Visit the apartment property unescorted on multiple occasions. Visit in early morning, mid-day, late afternoon and midnight. You will learn something about your potential tenants and how the building functions. Do tenants congregate in appropriate places? Are there vehicles with stale damage? Is the parking lot well lit? Do you feel safe? It can be surprising what you learn going unannounced.
5. Check with the local police department. Tell them you are considering buying the apartment building and ask if you could do anything to help them in the neighborhood. You will learn if the building has a reputation. The best thing that can happen on that visit is they will have trouble placing the property.
6. Locate the single-family homes closest to the apartment property and canvas them. Go to multiple homes, possibly a half–dozen. Some owners may be timid, while other will talk your ear off. The goal is to learn what the neighborhood thinks of the property and how the building operates.
7. Determine the turnover rate by apartment unit. Is the average occupancy per unit six months or six years? If it is six months and the building operates on a six-month lease, why are they not renewing? Serial leasing is expensive.
8. Identify the apartment handyman or maintenance person. Take note of the vendors who perform service for the building. Interview some of these folks. Ask them if there are any situations in the building they would change. It could take a number of calls before you hit the jackpot.
9. Find the closest neighborhood tavern or bar. Stop in for a drink and introduce yourself to the bartender. You want to talk with a bartender who has been there for years and knows the neighborhood. He or she may have something to say that is beneficial to you.
Make these visits or calls yourself. Split them up between the four partners. If you do not have the time or inclination, hire someone who understands the apartment business. These tips will undoubtedly add value to your ability to make a good decision.
Note: One great investigative tip – Ask the landlord owner why he is selling. Any response should tell you tons.