Due Diligence 101 with Rich Trepanier
How would you describe multifamily due diligence?
Rich: Due diligence on a multifamily property is the equivalent of a home inspection when you buy a residential property.
When does a GC like Gage get involved in due diligence?
Rich: From time to time, customers will reach out to us early in the process when they have a property of interest and a letter of intent and are at the point when they are generating a contract.
Once the potential buyers and the community owners have negotiated their contract, a letter of intent is drawn up and the format of the price and some of the terms of the deal will be in this letter.
Once there is negotiated contract, there is a set of time usually within 30 days to complete due diligence on the property. There is financial due diligence and physical due diligence. Financial due diligence is going through all of the accounting, all of the leases, to make sure everything the owner is reporting in their income statement is correct. Physical due diligence is touring the property and that's where a general contractor like Gage Multifamily is brought into the process.
How does Gage assist with due diligence?
Rich: We will establish a scope of work for inspection depending on where the customer wants us to focus our time and effort and we will establish reporting requirements.
We also present them with some budgets based on the findings from due diligence and they can use our budgets for the CAPEX renovation plans or they could use our budgets as documentation to retrade with the current owner.
What is retrade?
Rich: Retrade means going back to the current owner and negotiating to get more money off the price of the property, similar to finalizing the purchase price during the residential home inspection process.
What are some elements of the physical inspection?
Rich: Generally, we will physically review each system - HVAC, plumbing, and electrical, and provide documentation about the age and condition of each system. We will confirm whether they have copper wiring or aluminum wiring. We will review appliances and provide an estimated age for all appliances. We will determine the quality of finishes of each unit, and if there is any damage to flooring or sheetrock.
When you submit an LOI, you have probably only seen a small handful of units. You can tour the exterior of the property but if you are submitting an offer on a multifamily property, you don't tour all 120 units at that time. You tour each unit during due diligence, so we recommend that you physically tour every unit on the property to confirm that what is being represented by the broker and owner is correct.
We will complete an exterior walk of carpentry and paint, we will identify areas of deficiency and itemize those areas in the report.
Due diligence is there to ensure that what is represented by the owner is correct. You still complete the due diligence process on a class A community because you want to get photos and video or each unit you want to have the documentation so when you go and turn each unit you have a scope or work easily.
The older the asset the more you want to be involved with due diligence.
The key point is from a GC standpoint is we preach is to be thorough about the process, walk the units, walk the exterior, so you are not surprised after taking ownership of the community. Financial due diligence is just as important as physical.
When have due diligence inspections saved an investor?
Rich: Here's a perfect example. A customer came to us and they were considering a 1970s asset that had corrugated metal pan concrete floor balconies. We inspected the property and identified that those galvanized pans were rotting away causing a potential structural issue. We identified the damage to the owner and we presented a cost estimate of the repairs. In this example, the buyer was able to go back to the existing owner to decrease and upon closing of the prop, and the repairs commenced just after the acquisition.
For instance, not getting a roof inspection is an expensive mistake. But financial due diligence is equally if not more important. Yes, it might be a sticker shock moment to get lateral lines inspected. But that $2000 can be worth it for retrade during the contract phase.
We always recommend getting a camera inspection done on sewer lateral lines out to the street to check for any bellies in the pipe or if there are any roots through the line or breakage that can cause potential damage or eventual backups into the community.
Why is Austin a hot market for vintage multifamily?
Rich: Austin is affordable. We live in a city where some of the workforce housing communities in Austin are still affordable, and they allow residents to live at a reasonable rate. With vintage, there is still meat on the bone for investors. Somebody can come in and buy a 1980s asset and increase the rent and net operating income by doing interior renovation and exterior renovations - perhaps adding amenities.
In Austin, vintage multifamily assets are trading about $140-200k/door, so what these value-add investors are trying to achieve is a rent bump. The goal here is to achieve a rent bump; increase the NOI, and the overall value of the property. Value-add opportunities like these allow you to increase your cash flow by increasing the rents in the community.
The Class A properties in Austin are now trading at 300k/door. When you buy a Class A property, there's not much you need to do; it's beautiful usually as-is. You may make some tweaks to the leasing office or you might want to change the exterior paint. But generally, it's an appreciation play you hold the investment, hoping it gains value.
What is your best advice for a smooth multifamily acquisition?
Rich: It's a time-intensive process. It's key to establish your team early.
Identify your property manager before your letter of intent - they will walk the interiors for you pm will assist with the financial due diligence. Determine your General Contractor before due diligence so you can move quickly on the physical inspections.