Real estate investor, developer and property manager. President and CEO of TM1 Properties.
Due diligence in acquiring a multifamily asset is sometimes more art than science. Ask any multifamily broker, and they will tell you the multitude of strategies regarding the processes of due diligence that different investors use. At a minimum, due diligence should include a financial review, lease audit, certificate of occupancy status check, contract review and property review, to name a few. As a general contractor-turned-multifamily investor, I find that most people miss eight things when evaluating the existing construction of a multifamily asset.
If you are an experienced investor, your typical property review process will include an evaluation of the roofs and foundations, cameraing of the sewer lines to locate problems, a walk of the units to determine make-ready costs and an inventory of deferred maintenance.
Here are other things that you should consider:
1. Aluminum wiring: From the mid-1960s through the ’70s, due to high copper prices, aluminum wiring was installed on new construction of multifamily buildings and residential homes. Typically, Fannie or Freddie will make you update these in order to get a loan. Sometimes, they won’t even tell you until you already have the loan and get your first inspection and then have to make the upgrades. My former construction company upgraded a 150-unit complex from aluminum wiring to copper, and that was an expensive fix for the owner.
2. Outlets: Before 1969, many residential units didn’t have grounding in the electrical outlets. This is easy to see because instead of a three-pronged outlet like you are used to seeing, the outlets will only be two-pronged. This will usually need to be updated to code.
3. Federal Pacific or FPE Stab-Lok breaker panels: These were installed from the 1950s to the 1980s and are potentially dangerous because if they fail, they can cause fires. If you have these panels, you will likely have to replace them by lender requirements. You should replace them anyway to protect your asset.
4. HVAC inventory: I have done much due diligence on multifamily complexes, and I have yet to see any seller have an accurate inventory of their HVAC systems. You must look at each of these. It is best to have an HVAC contractor walk the property with you to get an assessment. This is the biggest repair expense you will have, and you need a good estimate of the number you will be replacing in the first year. You need to know freon types, manufacturers, tonnage and the condition of the units. Typically they are split systems, but not always. Also, where are your condensers? Are they on the roof? You might want to build in the cost of buying a lift. Otherwise, you will be renting one every time you have to change out a condenser, doubling your cost.
5. Cast iron sewer lines: If your asset was built prior to 1975, you likely have cast iron pipes for sewer lines. Those are just a nightmare waiting to happen. They corrode over time, and you will not escape the wrath of them breaking. It’s not a matter of if they will break; it’s when. When cameraing the lines, your plumber can’t really tell what type of material the pipes are made of unless they see rust — and then it’s obvious. They are looking for possible areas that will cause clogs, such as tree roots, bellies (low areas) in the pipes, etc.
6. Water cut-offs on the property: When you are walking around, you need to look for water cut-off points already installed at each building. These are essential when making repairs so that you do not have to shut the water off to the entire property to make a simple repair to one unit. If there are none, plan to have some installed.
7. A drive-by at night: A part of your due diligence needs to be driving by the property at night. This will help you get a sense of how safe your property really is. You also can see how well or poorly lit the property is. One of the best things you can do to protect the property and your tenants is to light the place up at night. Thieves don’t like well-lit areas.
8. Balconies or upstairs porches: Any asset built more than 15 years ago was built with a structural code that was suspect. Typically, balconies or upstairs porches were cantilevered out with two-by-fours or two-by-sixes, which are not strong enough for the load they carry. The typical solution is to place four-by-four posts underneath to support them. If you don’t, you run the risk of someone getting hurt.
From my many years of experience, these are the things that I have learned to look for. Early on, I didn’t, and they came back to haunt me. The purpose of due diligence is to uncover all the problems with the property. It isn’t to convince yourself how great of a deal it is. Hire contractors and engineers, and don’t skimp. You make money in real estate when you buy, so make sure that you buy right.
Forbes Real Estate Council is an invitation-only community for executives in the real estate industry. Do I qualify?