Imagine you’ve found the perfect multifamily asset to invest in. The current owner tells you it’s fully occupied, reported rent is in the ballpark with the local market (or maybe a bit higher), and it has great tenants. You close on the property, sight-unseen, and later find that the owner wasn’t quite honest with you. The unit is occupied, but several of the occupants don’t pay rent on time, the rent the current owner shared with you isn’t what the tenants are paying, and some of the tenants really don’t take care of their space, which causes a whole host of other issues. Now you’ve spent hundreds of thousands, or millions, of dollars on a great deal that turned out to be more trouble than you anticipated.
You are going to need to go through your tenants list, possibly make evictions, and find new renters. You’re going to have to raise the rent, which your current tenants aren’t going to appreciate. And you’re going to need to renovate almost all of the units to clean them up, repair, and get them up to date. Your new investment isn’t going to make the profit you had hoped for, you are pouring more money into renovations than you’d planned on, and you wish you had negotiated a difference price with the previous owner. How could all of this have been avoided? Do your due diligence on your multifamily investments.
THE DUE DILIGENCE
You wouldn’t invest in a stock or company without thoroughly researching them and checking them out: their history, their management, and their returns. The same should be true for multifamily assets. You have to check them out to make sure that they are going to make the profit you need, and ultimately be a sound investment.
Before making a large-scale investment, you want to make sure all the financial matters are as reported by the current owner. Once you are under contract, look at things like tax returns, operating statements, rent rolls, copies of all the leases, and bank statements for three years. We did just this on one of our more recent purchases, an eighty-unit multifamily property that we’ll be closing on soon.
So, we got the deal. We are under contract on this eighty-unit property and it’s time to do our due diligence. We took a look at the tax returns, rent rolls, leases, etc., as well as mapped out all the tenants. We noted things like how long a tenants lived in the units, if they’ve been late on payments, how much they are paying, and how many bedrooms they have. Next it was time to set eyes on the actual units. It was time for the walkthrough, and this is where it gets interesting.
The walkthrough is always interesting because you are walking in someone’s home, or in this case, several people’s homes. Always remember to be respectful.
During a walkthrough we are looking for:
- Does the tenant have a job? Are they reliable and able to make their rent payments?
- Is the tenant clean or dirty? Are they taking care of their unit? It’s important that they are respectful of their things as well as their environment. If not, it may be time to evict them.
- You want to note what you will be turning in each unit. Will it be a full-turn, and you are replacing and updating everything? Is it a half-turn, and you are just repainting and replacing carpet? Is it a no-turn, and everything is fine just the way it is?
- The last thing you are looking for is leaks. Check the kitchen sink, the bathroom sink, the bathtub, and the toilet. See what plumbing needs to be fixed and if there is any water damage. Plumbing issues and water damage can add up quickly.
These things will give you a good estimate on which tenants may need to be evicted and who is okay to stay. It can also give you an estimate on just how much money you’ll want to put into the units, depending on if you do a full-, half-, or no-turn.
Potential Issues When Doing the Walkthrough
When doing the walkthrough, you may experience some resistance from some of the tenants about coming into their home. We certainly had some interesting experiences when we walked through our eighty-unit property. The residents were all informed beforehand about our “inspection,” but many people still weren’t happy to see us. From suspicious questions to a man going and reporting us, to a woman letting us know she had a gun, we weren’t welcome everywhere we went. Most of the people were okay with us looking, but some people were not. We were safe for the inspections, it’s just something to keep in mind when going in for walkthroughs.
Owning real estate can be complex, especially in a multifamily investment situation. You are dealing with real humans who have lives and maybe a challenging background. We encountered a gentleman who had an apartment that wasn’t in great shape. It was dirty and the smell was very strong. If you didn’t know anything about his background, you may just jump to the decision to evict him and get him out of there. BUT this gentleman happened to be older and a veteran, he looked like he’d had a stroke and was in a wheelchair. Clearly, he was on a fixed income. He’d been living there for 25 years. You have to take your business sense and combine it with compassion. It’s important to look at the human side of things as well as the business side of things.
If you are looking at investing in multifamily assets, check them out thoroughly before closing. You could save yourself time, energy, and money by being thorough at the front end. You want to protect your investments and make sure you know what you are getting into. Do your due diligence and make sure you know what you investing in. Your portfolio will thank you. Need help in getting your real estate business started? Sign up for coaching at JoshCantwellCoaching.com.
Listen to the full episode here.