The Due Diligence process is the art of inspecting the asset prior to signing the contract to purchase the property.
In this article we are going to speak about the “EXTRAS” that should be included in the Due Diligence process and the reason why you should demand this as part of your program.
Depending upon the size of the property always ask for at least a five (5) day Due Diligence process for onsite information. Of course you will have numerous other days for gathering the rest of the supporting documentation.
Inspection of Your Apartments
It goes without saying that you should inspect every apartment including all occupied apartments when performing this important task. A checklist should be created prior to inspection and you should make sure that you receive all requested documents in order to make a conscious decision.
There are all sorts of Due Diligence checklists out there but I have yet to find one that includes two very important extras that will help you once you own the asset.
So let’s discuss what these two extras are and why are they so valuable?
1. FILE AUDIT: I am sure that you know you should conduct a complete file audit and it goes without saying that your checklist should have categories indicating what you find in the resident files.
So let’s look closer at the file audit and view what makes this a successful tool in understanding your possible resident base. Always make sure that you create your spreadsheet prior to starting the audit. Include resident’s name, residents address, how many people live in this apartment, the lease holder, the second lease holder, occupants and the children. As you take each lease holder make sure you have a category where they work and how much do they earn. How long have they been employed in this company. You want date of birth, social security number, driver’s license or identification number, income and place of employment. Once you have this information now you want to list the children and their ages. Finally you want to list any type of notices that are in the file such as Insufficient Funds returns and any resident negative notices and finally a comment column.
(When I perform a Due Diligence, I break it down to how many children live on site as well as how many are male and female and age category such as how many are under four and then 10 and how many are under 16 etc. You should be able to generate a report that will break down the children. Do not worry how large the spreadsheet is as it is the key to a successful file audit.)
The lease is the next document in the file that is very important and here is something special you should pay close attention to and that is to write down from the actual lease what is the actual security deposit payment made and if any other deposit such as pet deposit etc. record that on your spreadsheet. Do not hesitate to request ALL files when performing a file audit and really study them. Allow enough time to check all the information and then you can compare it to your computer printouts so that you have a definitive comparison of supporting documentation.
(I can tell you that recording the actual deposit amounts listed on the lease ALWAYS seem to have some variation and it becomes a real strong testament to the actual deposits paid. The last three Due Diligence’s I have completed have proven to be a huge problem because the computer printout is less than accurate. If the deposits do not match accurately then the current owner will be held accountable when you have a resident vacate and you have to refund their deposit or deduct for damages the deposit total must match. The lease is the contract and in a court of law the figures listed for deposits paid will stand up regardless of computer printouts. Be absolutely sure that the figures are correct. The only confirmed document that is valid is the lease agreed to by all parties. Make sure that the deposit figures are correct and that the dates match for the lease terms.)
A. VENDOR FILES
The vendor files are another source of information that will supply a two part source of information. First of all, your checklist must have the vendor names, address, telephone number, invoice number and what exactly does the vendor do for this property.
Once you have this checklist set up, it is important to highlight any capital work that has been done by this vendor or anything that relates to a high dollar value. One of the reasons is that it will validate any documentation you receive for work completed on the property via computer printouts. (This is a valuable resource and it is your only chance to compare the computer printouts to the actual work and view the invoices for work completed. Once the Due Diligence is completed you cannot ask to see any documentation after this period is closed so be aware that you have this opportunity and do not blow it!) Never hesitate to ask for the actual invoices for work reported during Due Diligence. It is your right and it is the only way to validate that what is reported on the computer printouts is actually what was completed.
B. WORK ORDER FILES
One of the best secrets is to ask to see the work order files as this is a very revealing tool that will help you with your analysis of the property. Look at the last six (6) months of service request to see the type of work orders that are being completed. Do you have many plumbing request that have to do with stopped up toilets and tubs which could reveal a problem with the lines, a possible tree limb problem or it could be an issue that reveals itself that a resident maybe using the toilet for a trash container and stopping it up. Do you have many complaints for leaks or mold problems? What about pest control problems? All of these work orders tell a story that you cannot get from computer printouts. Pay attention as this is your only chance to get a true photo of this property.
Look for major work orders that may spell a problem such as roof leaks, foundation problems or any other major problems that could be discovered and revealed with work orders
2. UNIT INSPECTION REPORT: Now is the time to really inspect EVERY apartment in the complex. You do not want to just view a percentage but the whole property. The reason for this inspection is very important. You want to make sure that you do not have any “down” units that have not been revealed. Trust is a very good characteristic in many social atmospheres but when performing Due Diligence inspection you must have a view of actual and visual apartments.
You also want to see all common areas of the property and this means all closets, pool room, maintenance shop, laundry room and storage areas. Another important feature is the keys and how they are set up. Do they have keys to every apartment? Do they have mailbox key to every mailbox? Are they set up on a key code system or Handy-Track System? Keys are a very big expense so you want to make sure that you do not have to incur this expense so demand that there is a key for every door!
One of the most important features when performing the unit inspection is to have your checklist in hand and use it for every inspection. Smoke Detectors, Carbon Monoxide Detectors, plumbing, electrical, inspection of ceilings, floors, windows and doors, window treatment, locks, keys, cabinets, and condition of the apartment. You want to look for sanitary conditions as well as if you have any hoarders who are a fire safety risk.
When performing an inspection of the unit although it is time consuming this one “EXTRA” is the second item that I know is a valuable step in the Due Diligence process. Recording of all serial numbers, model number and make of all appliances will pay a huge dividend during your inspection.
(I had a Due Diligence and recorded the appliances with all brand names with make, model etc. and the owner of the property had other locations close to this property. Once the Due Diligence was over and the property closed, we received a complaint of a refrigerator not working and the team discovered that the refrigerator had been changed and it was no longer the same refrigerator that was there one month earlier. Yes you guessed it –the owner had removed some of the better appliances and replaced them with older appliances. If we had not done this inspection we would have ended up with old appliances in some of the units and it could have been a costly problem.)
Appliances should be rated as to condition and this way you will have an idea when designing your budget for the future if the appliances are in need of replacement. Possible age, repairs recently from work order investigation and condition.
Capital Replacement Records
The one area that is worth its weight in gold is to have a binder that states all capital replacement items and usually this is done when you take over a property and create it from that point on but I believe it is a great starting point.
Just take an 8.5 x 11 sheet of paper and divide it in four sections. The first topic is
Type of Appliance, Name, Model, Serial number, cost and vendor. Now you must leave at least five lines under it so if this appliance needs to be moved for whatever reason, you would make sure that it is listed so as to keep track of this appliance.
The next section is Cabinets and you would list type of cabinet wood, the vendor and the cost. Next you would have Carpet and Vinyl Floors and you would state carpet or vinyl, the color, the vendor and cost and the final would be Tile Replacement where you would clarify where the tile was replaced and the cost and vendor. (You can also add other categories if you feel it is needed such as window and slider replacement possibly)
(My recommendation is to make a sheet for every apartment and place it in a binder and keep it as you start this investment. It will help you to keep track of all appliances and this is valuable as you operate the property. This is also a wonderful way to keep track of Capital Reimbursements and Replacements.)
Due Diligence is your key to investigating everything about this asset. It is a valuable way to discover what this property is all about. You must take the steps necessary to learn everything that you can find out with the tools presented.
Inspect everything possible to have a good picture of what this asset is all about. Do not accept computer printouts without gathering as much information to affirm what is printed. Ask questions and be satisfied with the answer and if you are concerned keep asking until you know the response is accurate.
When comparing the computer printouts to the lease make sure you ask about any differences in deposits and before you close on this property be sure to settle the amounts of deposits and do not accept any reasons unless it makes sense. The lease is the only place that the deposit amount is confirmed. I had a situation where there was a difference of over $1100 worth of deposits and we identified and settled the amount before the close!
INSPECT WHAT YOU EXPECT – never settle for less than the right documentation.
Patty Perdue, Owner of Properties Investment Solutions is a Property Operations Consultant with over 35 years of “Behind the Desk” experience including working with struggling assets all over the country and provides Onsite Training, Consulting and Due Diligence. Patty can be contacted via email at [email protected].