The Capital Stack
When it comes to new property acquisitions, completing thorough due diligence is crucial for the long-term success of the property. The due diligence phase immediately follows the completion of the purchase agreement and typically lasts 30-60 days. It is during this period that the purchaser of a property can tour units, complete inspections, finalize their financing, and much more. This week’s article will feature the due diligence items we routinely complete before purchasing a property.
We always obtain and review…
- P&L statements: We issue offers based on our review of a T12 (Trailing 12 months P&L). Once the offer is accepted, we assess three years of Profit and Loss (P&L) statements. While we initially review a T12, analyzing the financial data from the past three years helps us identify any anomalies and gain a clearer understanding of the property’s long-term operational performance.
- T12 updated monthly: Given that the closing process typically spans 45-90 days, it’s crucial for us to consistently receive updated financials. This ensures that the property maintains its financial condition from the time our offer was accepted to the closing date. Some sellers may mistakenly believe they can alter their operations once the property is under contract; we aim to prevent any disruptions to normal operations.
- The seller’s operations budget: We request the seller’s budget for the current and upcoming year to gain insight into their planned operational expenses. Because they hold current ownership, they should have a solid understanding of future operations, allowing us to compare and align their projections with our budget numbers.
- Rent roll updated monthly: Similar to the T12, this allows us to monitor ongoing operations throughout the due diligence phase.
- An occupancy report for the past 24 months: We always cross-reference this data with the Profit and Loss statement to assess collections and identify potential red flags.
- The delinquency, evictions, and collections report (24 months): Similar to the occupancy report, these reports help us understand the recent operational performance of the property and compare it with our expectations.
- A list of personal property: Any ‘non-real estate’ items owned by the seller and used in the normal operations of the property. These could include items such as a snowblower, maintenance vehicle, and others of a similar nature. If an item is used in typical operations, we want to ensure it stays with the property so as not to disrupt normal operations upon closing.
- The capital improvement schedule: This document outlines major repairs undertaken by the seller in the last 5 years. This information is crucial for our understanding of the property’s maintenance history.
- Utility bills: We compare these with the P&L numbers to ensure accuracy and to accurately prepare our budgets.
- Bank Statement/Tax Returns: Certain P&L statements may have omitted or altered items, so we request bank statements or tax returns as proof of income. This allows us to verify the accuracy of the P&Ls by reviewing the actual money transactions coming in and out.
- Plans, surveys, and drawings: We review these documents to identify any potential issues with the property that may not be visually apparent.
- The leases: We verify that each lease aligns with the rent roll this helps ensure an accurate transfer from the seller to us.
- Tax bills & appeal documentation: We want to get a full scope of recent property taxes and if they were disputed.
- Insurance loss runs: These reports will show us if there have been any major claims on the property that could affect our insurance rates and/or alert us of any damages or repairs that weren’t reported.
- Title insurance: We review this document to ensure the property has a clean title.
- Inspections and reports: We always review inspections and reports, particularly those related to asbestos, environmental concerns, engineering assessments, appraisals, or any other third-party evaluations. This is crucial to confirm the absence of major red flags.
- Building codes etc: We inquire about building code violations, liens, lawsuits, and any other historical legal matters associated with the building. This helps us gather historical information and identify potential future issues.
- Marketing media, photos, and floor plans: We consistently review the marketing media, photos, and floor plans used by the current ownership. This allows us to compare their marketing materials with our expectations for marketing the property to potential tenants. Bad marketing is a big factor in owners not attracting tenants at full market rent.
- The Vendor List: During interviews with vendors, we verify pricing and gather insights into their experiences with the property. Vendors can often provide valuable information, especially regarding specific areas like plumbing, electrical, landscaping, etc., which may not be as readily known by the owner. Additionally, we need to review any contracts that we might be assuming responsibility for at closing.
- Licenses & permits: We want to be sure the property is legally operating within the terms of the municipality.
- Maintenance records: We review maintenance records to obtain a full scope of all previous maintenance requests. This process is crucial for identifying any recurring issues or patterns.
While this list doesn’t cover everything, and each due diligence period is tailored to the specific characteristics of the property, it includes many of the items we routinely review before finalizing the purchase of any property. The due diligence process is always slightly changing, allowing us to address unique aspects of each property, and ensuring a thorough and informed decision-making process.
Major Market News
Detroit Rental Market
An article by Rent Cafe reviews the landscape of the rental market. According to the article, ‘renting is the new buying as home prices are still high.’ The article ranks the month’s top ten cities for rental activity and places Detroit at number three, rising three spots from last month. According to the article, there was a triple amount of online traffic for Detroit listings compared to last November.
Source: RentCafe. (2023, Nov 20th) November Rental Activity Report: Minneapolis Is Most In-Demand City, Two California Destinations Join the List. https://www.rentcafe.com/blog/rental-market/market-snapshots/rentcafe-rental-activity-report/
Tips and Tricks
T12: A T12, or Trailing 12, is a financial document that provides a summary of a property’s income and expenses over the past 12 months. It is often used to assess the property’s financial performance, providing insights into its revenue, operating costs, and net operating income. Investors and potential buyers analyze the T12 to evaluate the property’s profitability and make informed decisions during the due diligence process.
P&L Statements: Also known as income statements, are financial documents that summarize a company’s revenues, costs, and expenses over a specific period, typically quarterly or annually. The P&L statement provides a snapshot of a business’s financial performance by showing the net profit or loss resulting from the difference between total revenues and total expenses. It is a crucial tool for assessing a company’s profitability and overall financial health.