Investing in multifamily housing and apartments requires extra investigation, sometimes called due diligence by attorneys, for investors who want to be certain they do not make a mistake. This extra investigation and these questions are beyond what a real estate investor may do normally for a typical commercial real estate investment. As a real estate investor, once you go beyond multifamily rentals such as duplexes or fourplexes, you enter the commercial real estate area. Here are 9 out-of-the-box questions you should be asking, or at least consider asking, before you purchase that multifamily or apartment building.
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 as investors. Can you help?
ANSWER: 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. Choose carefully which tactics to employ. 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.
No. 1 – The rent roll is not enough
Where do the tenants work? 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.
No. 2 – Visit with former tenants
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. But moving away from drug dealers is a different story.
No. 3 – Investors should look for patterns in the vacancy swing
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.
No. 4 – Visit the apartments in the morning- and in case you don’t see them also “good day, good evening and good night”
The quote from the Truman show applies when you want to find out what is really going on with the apartment building. Visit the 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.
No. 5 – Talk with the local police about the apartments
Check with the local police department. Tell them you are considering buying the 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.
No. 6 – Research single-family homes near the apartments
Locate the single-family homes closest to the 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.
No. 7 – What is the average occupancy per unit?
Determine the turnover rate by 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.
No. 8 – Talk to whoever is actually doing the maintenance for the apartments
Identify the 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.
No. 9 – Visit the neighborhood bar near the apartments and introduce yourself to the bartender
That’s right. That is really what I said. 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.
Investors remember these due diligence tips
- Make these visits or calls yourself
- Split them up between the four investors or 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.
- Monty’s special tip for investors – Ask the landlord owner why he is selling? Any response should tell you tons.
Remember these are the special out-of-the-box investigation or due diligence questions you want to ask. There are many other standard ones recommended that you should also consider, but these are my special ones from my years and experience in the business. So remember:
- Where do the tenants work?
- Talk to former tenants
- Review the vacancy swings
- Visit morning, evening and night
- Talk to the police
- Check single-family homes nearby
- Study the turnover rate
- Talk to the maintenance folks
- Visit the local bartender
Richard Montgomery gives no-nonsense real estate advice to readers’ most pressing questions. He is a real estate industry veteran who has championed industry reform for over a quarter century. You can ask him questions at www.DearMonty.com. Reprinted with permission of theRental Housing Association of Washington.