Multifamily Due Diligence for Class C property investors can be the difference between paying extra attention prior to the sale, or paying dearly for unplanned capital improvements after the purchase.
Matt Hawley with Multifamily Inspection Services, provides some insight to help investors avoid costly, unplanned expenses.
Multifamily Due Diligence
The Due Diligence clock starts as soon as you have a signed Purchase and Sale Agreement. Typically, the seller will agree to 20 to 30 days for you to inspect the building for its physical condition. This is your chance to determine the condition of all systems, and determine what expenses you need to plan for or negotiate away prior to sale. NEVER, NEVER, NEVER skip inspecting each and every unit.
Value Add vs Capital Improvements
Most Class C investors hunt for a property they can make improvements to that translate to increased value. Management, rent increase, renovations, add dog park, RUBS, charge for storage, etc all translates to an increased NOI, and ultimately a higher value.
Unfortunately, capital improvements like a new roof, plumbing, electrical and HVAC systems don’t give a boost to the rents. These are bare essentials included in a place to live, and therefore will not improve the operational value of a property.
Therefore, it is important for any new investor to recognize the physical condition of the property prior to sale, so they can plan and budget accordingly for the updates needed to the systems.
Primary Building Systems
There are four primary building systems which are critical to the proper function of your multifamily property; Roof, Electrical, Plumbing, HVAC. For pictures and descriptions of each potential system, click here: What to Look For When Walking Older Properties.
A good roof keeps the water out and the inside dry and free from water damage. When inspecting the roof, look for any signs of improper installation. Inspect appearance, flashing, and the general condition of the roof.
Stains on a flat roof suggest pooling of water that can be problematic. If water is unable to properly drain from the roof, it will find seams and travel to places not intended causing potential damage on the inside of your building.
Get a professional roofing contractor to provide a condition report and determine the expected life left in the roof. When budgeting you should determine the cost of a roof replacement, and amortize this over expected life of a new roof and account for this amount to your annual capital replacement reserves.
Your electrical system can be the difference between affordable insurable or a non insurable property. For pictures of some problem systems,
There are multiple things to look for when inspecting a property:
- Electrical panels: Throughout time, there have been different electrical panels that have been used in construction that ultimately were determined to be problematic and potential fire hazards. Two specific panels are: Federal Pacific with Stab lok Breakers and Zinsco / Sylvania.
- Aluminum wiring: During a brief time in the 1970’s, the cost of aluminum was less than copper. This cost differentiation caused builders to use aluminum wiring. Over time it has come to be a potential fire hazard. The correction is to have the ends pigtailed to copper at every connection.
- Amperage to the unit; some insurance companies require a minimum of 100 amps to the individual unit. If the building units have less than 100 amps, you will need a written report from a licensed electrical contractor confirming the electrical system is in good working condition.
If any of these conditions are present, you will need to either budget for the correction, or negotiate the repair or cost of the repair form the seller.
- Type of drain pipe: If you have cast iron drain lines, have the lines scoped to determine the condition of the pipe has any corrosion, or has been compromised.
- Hot Water tanks; If they are all the same age, you need to plan for replacement.
- Supply lines; Polybutylene is a problem pipe that leaks and causes damage. Pipes are gray plastic with PB printed on the pipe. If you see any polybutylene, you need to get an estimate for replacement and reserve for this or negotiate the price of repair or a discount with the seller.
- Recognize the age of the system and get an estimate of how many years are left in the system.
- Is the system clean? Does it appear to be well maintained? Is the evaporator coil clean? Is the condenser clean? Is the condensation line clogged or is it able to drain properly?
- The AC units affect the air quality and can negatively affect your tenants health.
- Windows and doors; look for water intrusion.
- Settlement; look for for cracks in the foundation or slab floor of more than 1/8th inch difference in elevation
- Vegetation on the roof or against the building must be trimmed away.
- Spindle width on railings; should be no more than 4” between the post. Any larger opening and a toddler can fit between and potentially fall.
- Stains: look at the ceilings, and around the windows. These can be a clue to water issues.
- Electrical: are there any overloaded outlets? This can be a sign that the electrical system is not working properly and should be questioned.
- Shower walls: if you press on the walls and there is any give, it could be a sign of trouble.
- Cabinets: what is the condition? Do you need to plan on updating the cabinets?
BIGGEST RISK: Each week I ask my guest what is the Biggest Risk they see that real estate investors face.
Not properly doing your due diligence. If you have deal fever and don’t fully invest the time, money and effort into your the property due diligence, you will pay the price.
Stress test your rents for what if there is a change in occupancy, etc. Will you be able to hang onto your property?
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