Handling Due Diligence On A Multifamily Asset
Due diligence is the act of taking care to minimize risk and reap the rewards.
Let's suppose you have identified a multifamily property you want to purchase. Now that you have reviewed the basic information about the property, such as the date of construction, type and number of units, and the rent roll, you are wondering what next? This may be your first multifamily property, or perhaps it's your tenth. However, you still want to improve your due diligence.
These are the top 10 components of multifamily asset due diligence:
Evaluation of the competitive set.
Property tour in-person
Know your neighbors.
Visit competitive properties in person
Analysis of North, South, East, West
Conducting inspections and determining capital costs.
The building of a budget.
Potential for revenue growth
Assessing supply risks
Market stability or volatility?
Many people overlook the subtle aspects of due diligence. Sometimes it bites them, or it's a missed chance.
Evaluation Of The Competitive Set
It is essential to have a solid understanding of the area where the property is located. Your submarket. It is necessary to find assets in the submarket of your potential property built during the same period as you are and have a similar unit profile. These properties make up your building's competitive set. We'll be coming back to this term often throughout the process. Before you even consider visiting a property to determine if it is a good investment, the team should thoroughly analyze information on similar properties to the one we are considering buying.
After you have compiled your competitive list, you will want to analyze any data that you have about the comparable properties. Property owners and managers can share information within their competitive set. This means that the existing management team or current ownership team should be able to provide data about rental and occupancy rates and concession packages. In a slow market, concessions such as free rent or other incentives like gift cards are significant.
This is the same phase of due diligence that's done remotely as the desktop analysis. Don't be too relaxed, as we will soon be moving into the field for the next stage.
Property Tour In-Person
After you have completed your desktop analysis, it is time to visit the property in person. The building's common areas should be examined, including the hallways and lobby, as well as amenities like pools and fitness centers. It would help if you considered the general condition of common areas and their functionality and cleanliness. Consider the layout and organization of amenities within your property. Also, consider the benefits and drawbacks.
When looking at the units, consider the possibility of renting them. What is the profile of the units? Are they spacious? Are they equipped with nice appliances? What are the countertops' finishes? Are they equipped with a deck or other outdoor space? These are the elements of a rental unit that renters experience daily and they will decide how much they will pay.
Know Your Residents
You can then look at the property from the perspective of a renter. Then, park yourself in the lobby/leasing office to see who the residents are and how they use it. This gives you an idea of your resident base. The qualitative review should be followed up with data-driven analysis using information from the on-site teams about the income profiles of your residents. Management or existing ownership should provide information about residents' employment history and local employment drivers within the submarket.
Competitive Properties Tour In-person
After you have taken a tour of the property you are interested in purchasing, you can conduct an in-person inspection of your competitors. It would be best if you inspected these properties the same way you did your potential asset. This includes assessing amenities, common areas, and different unit types. Management personnel from competing properties will be open to giving you access to their buildings. He advised that it is best to be open and honest with your prospective investors. Tell them you are interested in investing in a property in the region and would like to tour the amenities and model units. After you have compared your competitive set, it is time to compare each building's strengths and challenges with your property.
Analysis Of North, South, And East
The final phase of an in-person assessment is when you return to your prospective property to complete what he calls the north, south, and west analysis. This is essentially a way to imagine yourself as a resident of the property. Begin at your property, drive around the property, and then walk around. This will allow you to feel what it is like to live at the property. Is it too far from the grocery shop? Is it convenient that the park is right across the street? Are the neighbors noisy? This can help you gain a better understanding of the quality virtues and weaknesses in the property.
Conducting Inspections And Determining Capital Costs
After the property has been toured in person and all local market and competitive set assessments have been completed, it is time to call in the experts. Third-party professionals will be needed to inspect the property. They will check elements like the age and condition of the mechanical components. Additionally, they will look for potential hazards such as flooding and drainage. Finally, an environmental report will be prepared to identify any contamination issues on the property or nearby.
These expert assessments, along with your analysis, will help you identify potential capital costs for the near term as well as the long time. These capital costs could be necessary repairs. Others may be for optional improvements that will increase the property's value and improve revenue. It is essential to determine if any upgrades could be made in the units and/or the amenities to enhance the resident experience and increase rental rates.
Building A Budget
You will need to know the ongoing operating costs for the property. This is where novice investors can make costly mistakes. Many people who are just starting out in business make the error of too much reliance on in-place expenses. Unfortunately, it's common for people to make this mistake.
They begin the process of acquiring a property without ever looking at existing operating expenses. Therefore, you don't need to look at historical performance data. Instead, create a budget from scratch and consider all aspects of the operation, including staff, to determine what budget is appropriate for the property.
Although this approach might seem intimidating to a new investor, it is actually quite simple. For example, investors can go out to get bids for service contracts for cleaning or landscaping. You can tell them everything you know, and many people will be willing to share it with you in the hopes of getting the business. You should also review the local labor costs to hire any staff required by the property and the utility expenses within the submarket.
After you have created your operating budget, it is time to compare it with the current budget for the property. As we go through the information, adjustments can be made to make the property more or less expensive.
Also, you should carefully review any existing service contracts. This can help to identify discrepancies between your budget and the current operating budget. To see the extent of their service, look at the agreements in place with these providers. For example, it might not be the best thing to do if they only cut the grass once a week and it is cheaper. You should also be familiar with the terms of any existing service contracts to ensure you can terminate any providers if you decide to change.
You should now have a final budget that includes both capital and operating costs. This will represent your vision for the property. This budget should be compared to the property's revenues. You will now have the asset's net operating revenue.
Potential For Revenue Growth
After determining the expected net operating income of the property based on its current revenue and budget, you can now decide if you believe there will be additional growth in that revenue in the future. To do this, you will need to compare the rents at your property to your competitors. Are the rents being charged at an appropriate level? Is there a way to increase those rents? He queried. Sometimes, rents can be increased by making improvements to the property or to the units. But other times, it's just an issue of where the rents are relative to the market.
The dynamics of your local market, and the possibility of new supply, will determine how your rent growth will look in the future. You might also be interested in...
Assessing Supply Threats
Based on the review of comparable properties, this stage of the process will give you a good understanding of the existing submarket competitors. You should also be aware of new multifamily buildings in the area that are currently being built or planned. These units could directly compete with yours. The additional supply of units could significantly impact your property's ability to increase revenue and reduce its value. This will provide a solid foundation for understanding the supply chain and, if you are in a larger market, it may be sufficient supply intelligence. You'll need to dig deeper if you are in a submarket where one or two projects could have a significant impact on your property.
You can go to your local city hall to review any requests for variances or construction permits. to uncover additional development activity. He advised that you can pretend to be a developer during the north-south, west, and west analysis. Then, consider where you would like to place the next one.
It is also essential to assess the attitude of the municipality towards submarket development. It could be risky if there is a lot of property available and the city permits construction to begin quickly. On the other hand, rents could drop rapidly in the future if there is too much inventory.
Market Stability Versus Volatility
You can identify the advantages of a stabilizing element if there is a particular characteristic that you are looking for in a property or a market. For example, is the capital of the state located in that city? Maybe there is an industry that congregates in that area -- such as tech companies in Austin or insurance firms located in Hartford. It could be a university in many cases. This is a great option, not just for student housing, but because they don't often pick up and move to another place. They don't seek to decrease their student enrollments or the corresponding staff numbers.
Volatility is a warning sign that could make us cautious about a market or property. Prospective buyers should look at historical market data to see what has happened in the past several years. Are rents rising dramatically, then dropping? Do you see the same thing with occupancy? Unfortunately, it's not possible to know why occupancy moved in this manner. This means that it is difficult to predict what might happen in the future.
It is essential to review all financial records of the property, especially concerning rental income. This is important for your protection as well as for identifying value-add opportunities. You should carefully examine the data to see the monthly revenue and identify patterns. For example, if you only look at the 12-month average revenue of the property for all units, you might not notice a decrease in revenue over the past two months or that your two-bedroom units have been priced too high relative to the market.
