In the previous article, we discussed the importance of performing due diligence when analyzing a deal. We included a due diligence checklist that listed all the items that need to be obtained and verified by the buyer. The first 4 items were:
In this article we are going to discuss:
Last two years tax returns
When a seller lists his property for sale, the first document that should be retrieved is his tax returns. If the seller is disorganized, then it may take a bit of pleading to get them delivered. Tax returns shed a lot of light on how the property is operating. A seller will always list every expense the property generates, but he may not disclose the total income of the property. You can check the expenses and the income on his tax return to the general ledger and see if they match. If the income does not match, as it often doesn’t, I would have the seller sign a document verifying the current rent roll collected. You may have to check every lease and add the total rent roll to calculate gross income. Our motto is “trust but verify”.
Current Year Budget
Most successful apartment operators fund a capital expenditure account every month to utilize for large repairs, such as roofs, driveways, or appliance upgrades. We establish a budget at the beginning of the year to tackle these large expenses, so that the partners will not be surprised when the account becomes depleted. Failing to plan is planning to fail.
During the due diligence, check to see if any sizable repairs have been accomplished in the past two years. Follow up by asking to see if the owners have created a current budget for any upcoming repairs. If the owners appear puzzled by the request, then rest assured they have no intention of performing any repairs. If a budget has been created, then it will give you an idea of the amount of deferred maintenance. You may even be able to use this budget as a reference to help negotiate a lower price.
Ask the seller for all current vendor contracts which include:
You are looking for the term of the contract, the cost, the work performed and the penalty for early termination.
The reason is twofold.
First of all, you may be locked into a contract with a vendor once you take over the property. You want to be certain that price and quality from each vendor is up to your standard before committing to them.
Secondly, check to see if there is a value play by saving money with another vendor. Owners often times continue to use vendors without shopping the price every year. You should always get bids every year from vendors to keep them honest with their pricing.
Request a list of all employees with current salaries. All current employees need to know that their job is secure once you assume ownership. You have to become familiar immediately with all employees, and that they will all have to be reviewed before you take over. It is much easier for you to retain current employees, but if you do find an employee that will not conform to your rules, then get rid of him without hesitation.
You will be able to tell if the property is being run efficiently by the number of employees the owner has staffed. For instance, we think an apartment complex needs one full time maintenance person for every 100 units and one leasing agent. If you notice 3 full time maintenance employees, then you may have another value play on your hands.
In the next article, we are going to discuss the next 4 items on our due diligence checklist.