due diligence - Posted by Duane

Posted by ryan on May 25, 2006 at 12:11:28:

Thank you

due diligence - Posted by Duane

Posted by Duane on May 25, 2006 at 02:40:24:

I’m currently in due diligence on a 60 unit low income apt bldg. Property was fully rehabbed in 05, and shortly filled up to 90% occupancy within few months. There were quality of tenants and initial management issues, resulting in some evictions a month ago. Currently occupancy is down to 70% which (appears) due to recent evictions due to poor screening/management;sellers and management company are of position they will fill these vacancies prior to closing. Sellers have provided 3 month 90% occupancy guarantee post closing. However, assuming sellers can only raise property to 80% level, there financial exposure is capped at approximately $15000 (based on scheduled rents) - where my financial risk is significantly higher if occupancy is below thresholds for a protracted period. Other properties in the area appear to be running anywhere from 75-95% occupancy.

Still with limited operating history, records and such a large transaction, I’m interested to know if proposing the following would be reasonable: apply a GRM to the lost annual rent for the vacant units below 90% threshold at closing, and used the resulting calculated amount as a reduction to sales price - verses sellers exposure being limited to 3 months rent on the excess vacancies. This seems particularly equitable to me since property is being valued mainly on projected income.

Any thoughts would be (very) much appreciated. Thanks in advance.

Re: due diligence - Posted by ray@lcorn

Posted by ray@lcorn on May 25, 2006 at 12:08:49:


Couple of thoughts…

First, understand I have a sharp bias against a seller staying involved in a property at all. I will almost always choose to negotiate price rather than any type of continued seller involvement.

Two reasons for that: one, it’s a given that the seller knows more about the property than I do, especially in tenant relations. Residential tenants are like small children, and will masterfully play one party against the other. Two, in this case you’ve already identified the problem as being mismanagement. Why would you want to make your investment success dependent on more of the same?

That said, I have done deals where the seller leases back some portion of the space. In a case like this I may accept some sort of master lease arrangement, payable direct to me (with draconian default penalties), with the payment due adjusted as units are leased. And I agree with Patrick that three months isn’t enough to really make a difference.

I would not allow the seller to place new tenants in the property under any circumstances, and would probably require part of the proceeds be escrowed as a guarantee of payment.

Last, you’re buying this valued on the projected income, which means you’re already paying the seller for the work you have to do. All the more reason for a cash escrow, or in the alternative, a revaluation based on actual income and be done with it.


Re: due diligence - Posted by Patrick S. Lawson

Posted by Patrick S. Lawson on May 25, 2006 at 11:28:17:

It’s a good idea but in practice it rarely works. I tried something similar with a seller about 6 months ago…it did not work.

Your best bet is to have a rent guarantee. Instead of 3 months I would ask for atleast 6 and try for a year.

Re: due diligence - Posted by Ryan

Posted by Ryan on May 25, 2006 at 06:17:57:

What is a GRM?

Re: due diligence - Posted by duane

Posted by duane on May 27, 2006 at 09:26:15:

Thanks Ray. The sellers are filling the properties during the interim period, while I am still in due diligence, so as they still own the property, they can continue to manage and review tenants accordingly. Also, this is a new management team, and the prior issues appear attributable to the old property managers that, along with the problem tenants were let go. I will seek to amend our purchase agreement to allow for a reduction in sales price. They want up to closing to fill the building to 90% - which again they hold that the current low level is due to quality of tenant issues whcih they chose to proactively address (eg., evict paying tenants to clean up property). To your point, I agree the 3 month guarantee is inadequate, and the purchase price should be adjusted. They want up through closing to fill the building, and then the 3 month gurantee period. Should any price adjustment be triggered at closing, since they have up to that date to fill the buildings. I guess we could agree to adjustment calculation in advance, and we as buyers could review all interim leases up through closing? Naturally, I will consult my attorney on amendments to the agreement, but any strategic advice or real world thoughts are very much appreciated. Thanks again!

Re: due diligence - Posted by duane

Posted by duane on May 27, 2006 at 09:29:19:

Patrick, can you elaborate further on why it did not work? Did you get this in to an agreement with the sellers? What was the specific problems with it? I will definitely seek a longer period as an alternative. Thanks again.

Re: due diligence - Posted by Patrick S. Lawson

Posted by Patrick S. Lawson on May 25, 2006 at 11:29:07:

GRM = Gross Rent Multiplier

Re: due diligence - Posted by Mike

Posted by Mike on May 29, 2006 at 10:00:58:

Now lets think about this. Do you think the seller is going to get QUALITY tenants in there for you? I would want to see copies of the tenants credit reports, eviction, and criminal backgrounds first off. Also, have considered making an offer based on the units that are already rented?

Re: due diligence - Posted by duane

Posted by duane on May 25, 2006 at 11:59:17:

grm = gross rent multiplier