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Due Diligence Check List for Commercial Real Estate
Posted by: | CommentsDue Diligence Process
Level 1
Financial
• Current rent rolls
• Operating and capital budget
• Operating statements YTD or 12 months running (certified)
• Discrepancies between rent roll and actual occupancy
• Unit mix or certified square footage
o Respective rents
• Existing financing or liens on property
• Check of value
o Cap rate
o Cost/Unit
o Cost/Sq Foot
o Gross Rent Multiplier
o Replacement Cost
• Understand staffing costs
o All current employees
• Name
• Job title and description
• Pay rate
o Benefits
General
• Physical confirmation of property conditions through site walkthrough
• View all vacant spaces to determine what capital would be required to induce a
new tenant
• View all common areas and base building areas
• Interview management team, leasing personnel, handyman (scope of work,
employee or contract labor, rate)
• Machinery/Equipment
o Office Equipment
o Maintenance Equipment
o Tools
o Vehicles
o Other
• Supplies
Physical
• Physical confirmation of property conditions through site walk through
• Property zoning classification
• View all base building areas, all floors, central plant, roof, exterior wall
• View all areas of building exterior and interior common areas
• Walk property line, photographs
• Night Inspection
o Security and lighting
• Review all architectural and engineering documents related to property
• Street size, congestion, condition, accessibility into property
• Biggest recurring maintenance problem
• Vacant sites on property (potential to expand existing property)
Level 2
Financial
• Add: Rent rolls, Operating Statements (certified), Capital Expenditures past 3
years
o Operating Income statements for past 3 years
o Balance sheet statements for past 3 years
o Tax returns for past 3 years
o Chart of accounts
o Accounts Receivable:
• Rents (Rate, due dates, history)
• Misc. Income sources
• Home sales, leases, rent/lease option, notes, contracts
• Bank accounts, deposits, other financial assets
o Accounts payable:
• Purchase orders
• Open/credit accounts
• Petty cash
• Notes payable
o Approved vendors
o Contracts
• Copies of every lease on rent roll
o Include names, addresses, current amount, deposits, rent history, estoppel
certificates, late fees, NSF, collection)
• Schedule for rent increases
• Estoppels from no less than 75% of tenants in commercial building, including
ALL tenants expiring or renewing in next 3 years and ALL tenants leasing over
10% of the building area
• Determine if any change in property taxes (Do taxes break out cost of land?)
• Pull original land purchase price on project
• Understand all transaction costs
o Real estate commission, if any
o Legal fees pursuant to transaction
o Accounting fees relative to financial statement review and pro forma
preparation
o Possible acquisition fee if an advisor’s services are utilized
o Title-related costs (insurance)
o Mortgage costs (points and closing fees)
o Appraisal
o Inspection
o Engineering reports/survey
o Environmental study
• Recalculate:
o Cap rate
o Cost/unit
o Cost/sq ft
o 1st year cash-on-cash
o 1st year total ROI
• Investigate financing possibilities
General
• Thorough understanding of the workings of the property under current setup
o Policies/procedures Manual
o Move in & move out procedures
o Existent files for residents, vendors, etc
o Emergency notebook
o Leases (written or verbal)
o Deposits/administrative fees
o Software used including maintenance and support
o Office supplies
o Forms/letterheads
• Interview all tenants on estoppel list to confirm information provided by seller
o Ask about problem areas—Management, physical property/structure, etc
• Delinquent units
• Confirm all information received against information developed through
investigation
• Develop a trust quotient with Seller
• Name and contact info for existing Insurance agent and coverage
o Copy of existing policy
o Workmen’s comp, liability, bond, hazard
• Local commercial agent
o What do apts sell for
o What are current rents
o What would comparable structure sell for
o Sales info for other groups in same area
o Average per capita of storage square footage
• Local residential agent
• Look into local advertising
o Current yellow pages cost
o Yellow book
• What percentage of competitors are in Yellow book
o Other avenues
• Local transactional real estate attorney
• Local Industry contacts i.e. Applicable associations
• Location of local:
o Post office
o Bank
o Schools
o Stores
o Employers
o Public Transportation
• Local rent survey, average rates for standard units
o Last 2 completed by Seller
o Over last 5-10 years if possible
o Check local newspapers for ads, etc.
o Local telephone directory and Yellow book for ads
o List of local competing retailers
o Evaluation Seller’s currently used ads, signage, brochures, etc.
o Chamber of Commerce packet
o Verify occupancy, rates fees charged, security systems
o Phone call and physical visit to each competing property (See
supplemental “Market Study” form)
• Pictures if permissible
• Interview managers
• Name of off-site management company
• Need copies of permits:
o All city and county permits
o Storm water management permit
o Consumption use permit
o Water supply permits
o Pool, Jacuzzi, etc.
• Learn about local laws
o Leases
o Evictions
o Regulation
o Licenses
Regulatory Agencies
• Board of health
o Copy of license
o Property records
o Pool and Jacuzzi reports
o Violation notices, if any
• Building department
o Talk with inspector
o Planning for other similar projects
o Ease of permitting
o Name of good roofer
o Name of good inspection company
o Building costs
o Name of good appraiser
o Certificates of occupancy
o Permits in force
o Local codes
o Known violations and records thereof
• Engineering Department
o Drainage information
o Local soil maps
o Proposed area improvements and related assessments
o Impact fees
o Utilities concerns
• Sewer, water, electrical and gas
• DER-EPA (Dept of Environmental regulation and environmental protection
agency)
o Wastewater treatment plant discharge permit
o Effluent testing results
o Flow records
o Treatment plant violations
o Domestic water supply permit
o Domestic water test results,
o Domestic water violations
o Domestic water flow records.
• City Planning—talk to senior planner
o Current new building permits for projects under development
o Path of development
o Floodplain maps
o Impact fees?
o Barriers to entry
o Ease of permitting
o Zoning in 4 mile radius
o Zoning in our area
o Special zoning?
• Map
o Thoughts of over-building of ________(student housing, self storage, etc)
• Tax assessors
o How much will property taxes be after sale
o How often do they reassess
o Name of good appraiser
• Better business bureau
• Chamber of commerce
o Growth statistics
o Boom bust economy
o Typical job types
o Projected growth areas
o Path of development
• Register of Deeds (or possibly a title company)
o Property ownership
o Eases and Encumbrances
o Legal description and acreage
Utilities
• Copies of meter record for both treatment plant and water supply wells
o Sewage treatment plant and water supply records
• Approvals for water sanitary collection system
• Approvals for domestic water distribution system
• Utilities Department
o Sewer and water rates
o Tap-in fees
o Impact fees
o Sewer and water capacity requirements
• Utilities commission
o Rules, regulation and status of utility
• Drainage district
• Name and contact info for gas and electric utility company
o Types of approved units
o Who owns and maintains
• Name and Contact info for telephone company
• Trash collection
• Name and contact info Cable television
o Who owns system
o Who maintains system
o Who invoices users
o Existence of a formal agreement between property and cable company
• Can it be renegotiated
Physical
• Professional contractor inspection
• Maintenance
o Evaluation
o Deferred maintenance items
o Obsolescence (how/why)
• Night Inspection
o Security and lighting
• Street plans with utilities identified
• Roof condition
• Boundary survey including all easements and encumberances
• Retrieve air quality samples
• Drainage type and adequacy
• Sewerage handling and adequacy
• Irrigation system
• Floodplain presence
• Vegetation and maintenance
• Environmental issues
• Inspect all maintenance records and interview supervisors in charge of critical
areas
• Receive copies of all documents related to mandatory inspections ADA/TDLR
compliance, ACM inspections, etc.
• Develop 5-10 year Capital plan for property, price projects, schedule out
o 2 Bids on cost of major improvements
o Cost for installing security, alarms, video
• Research any problems with elevators, other equipment
Fire/Life safety system status
• Type of building structure, any below grade levels, soil type
• Type of building cooling and heating systems
• Vertical transportation systems
• Type, age, and condition of roof (warranty)
• General assessment of leaks and exterior wall condition
• Elevators up to ASME A17.3 standards (Texas)
Red Flags
• Seller balks at providing records or access as committed in contract
• Stained ceiling tiles around the perimeter of the building (or shrinking
gaskets/joint failure)
• Dirty mechanical and electrical closets
• Poor maintenance and inspection records
• Financial records or estoppels not available
• Significant error in process or accounting
Wrap Mortgage ( A.k.a. Wrap-Around Mortgage): What is It?
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Jefferson Memorial was purchased on a Wrap.....okay okay...that is not true
Greetings from Washington D.C. (actually…not anymore…but when I wrote this…that’s where I was…as if you cared). Still my favorite metropolis (other than Cedar Crest, NM…of course).
Anyway….
With all that is happening with our economy, specifically, lenders not lending. Creative financing (owner financing) is showing up a lot more. Great for us…the investors.
In most cases, many of the “owner financing” deals have an existing mortgage in place. So…for a seller to sell his/her asset with seller financing, the seller may choose to sell via a Wrap Mortgage. What in the world is a Wrap Mortgage, a.k.a, a Wrap-Around Mortgage?
I have seen many definitions for a “Wrap Mortgage.” But for us, the investors, a “wrap” is basically taking the existing asset’s mortgage and wrapping it (hence the word “wrap”) with a brand new mortgage. In other words, a new legal document is created that refers to the existing mortgage (first position) but with the wrap mortgage now making the new owner liable. The beauty here is, the new owner is only liable to the seller. The “Seller” is still liable to the original lender.
****Note….A “true” Wrap is NOT an assumption….at least what I am defining here as a Wrap.
There is a lot more to this but the above is the general idea.
Many investors and sellers get a little jumpy when they find out there is a “Due on Sale” clause in the original mortgage when selling an asset creatively. A “Due On Sale Clause” is simply where the lender can call a loan due if certain points of the mortgage are compromised i.e., a “wrap mortgage.”
Have I ever experienced a lender initiate a “Due On Sale” clause? No. Have I heard of other investors have to deal with a lender exercising the “Due On Sale” clause? Yes…but only in a residential investment he or she bought on a wrap. But….that was the only one. Even in that instance, the lender worked with the investor on refinancing the asset. Go figure!
I have yet to experience or hear of it on a commercial deal specifically due to a “wrap mortgage” transaction. That is not to say that it does not happen. But my question is, will a lender excercise the Due on Sale clause on a performing note? I doubt it….but none-the-less it is a possible downside.
Just a few more thoughts regarding a Wrap:
1) the terms of first-position mortgage may or may not be reflected in the Wrap. Usually, the terms are negotiable with the first-position mortgage being the base line.
2) Legal instruments are used to put the Wrap in place, i.e., REC (Real Estate Contract). Usually, in a commercial transaction, the documents are a little more sophisticated (uhh…hmm…more complicated since attorneys are involved).
3) In some cases, an escrow company or attorney is used for the ongoing management of the transaction. In other words, a third party is usually used to make sure payments are collected from the new owner and payments are made to the first-position lender. This protects both parties.
Of course, there is a lot more detail involved but overall….I love buying assets with owner financing and a Wrap is a great tool.
Until next time…..rob
Real Estate: The Time To Buy?
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Hanging with friends and yes...real estate
Greetings from Washington D.C. Yes….I am still here.
Today I spent time with some friends who used to live in New Mexico and now live in the D.C. area. I also met up with an old high school friend. It was great to connect….but the realization of how I let time slip by since I last talked with my friends was fast hitting.
It had been twenty years since I saw my high school friend Israel. I hope it is not that long when I see him again.
But….I digress….
So….
There is a lot of talk that things are getting better with regards to the economic state of our great country. Well…I do not agree. We are getting ready to see another wave of sucker punches…but this time from the commercial real estate sector. Yes….it is true….commercial real estate is going to hit our economy hard. The question is…. how hard? With government money trying to soften the blow, it may not be as hard as I previously thought…BUT…with the government printing money at record levels, there will be a price to pay. The question is….when is that price going to be paid? My thought? …..soon.
High School buddy... Israel
None-the-less….lender’s books are filling up with Commercial REOs. Commercial assets at discounted prices are showing up by the truck loads….So….it is cherry picking time. BUT one huge problem. Lenders are not lending. Well….at least not without a heavy down payment. Up to 50% on some deals….especially retail…office….industrial. Apartments still fair better than other commercial real estate…but even that sector is feeling the pinch. Have you tried to fund a small apartment complex lately? Seems like only the 2M and above are getting funded these days and that is in only certain areas of the country.
But….there are a few solutions out there as funding gets tough. I am seeing more and more seller financing as well as reasonable terms on private money.
So…yes…it is a buyer’s market….but building those relationships outside of lending institutions will give you great buying power in one of the best times to buy commercial real estate.
Until next time……rob