After having a great discussion during my last class on Commercial Real Estate Due Diligence, I wanted to take this opportunity to share with you some of the key takeaways. This article is intended mainly for apartments/multi-family, however many of the same principles will apply across different areas of commercial real estate. I’ll start with a brief overview, then dive into each topic a bit more, and finally leave you with my powerpoint presentation that gives an overview of the topics I covered in my class. It is my hope you will add many of these ideas to your property analysis toolkit.
What is Due Diligence?
Due Diligence is a necessary part of any real estate transaction.
It is the process of examining a property, related documents, and procedures conducted by or for the potential lender or purchaser to reduce risk.
Applying a consistent standard of inspection and investigation to determine whether actual conditions reflect the information represented.
The process by which you confirm that all of the facts of a deal are as they have been represented to you by the seller.
Conducting proper due diligence can be the difference between turning a profit or suffering a financial loss in a real estate transaction.
If you’re new to commercial real estate transactions, I recommend that you consider bringing in someone with more knowledge. It’s OK to admit you need help. Getting help from an experienced commercial real estate broker can add a lot more money to your pocket and make the process much easier for all parties involved.
Start With Initial Due Diligence
Once you’ve found your target property, begin by requesting all of the information in the seller’s possession (expense reports, property records, profit and loss statements, etc…). Often you will find on smaller to mid-sized apartment buildings that owners do not keep detailed records. This means you will need to do a little more investigating to get the accurate expense numbers.
Talk to the current tenants about things that are wrong with the building. Ask how long have they been there, if they are happy with things, what’s the neighborhood like, etc.… Current tenants can be a tremendous resource for learning about a property. If there is a current property management company in place, ask the tenants how responsive they are to their needs. A lot of times it’s easier to keep the same management company in place for the first few months of acquisition if they are doing a good job. Talk with the maintenance people about matters not tended to or problems that will have to be fixed in the future. They are often going to be more honest than a seller would about the actual condition of the property.
Financial Due Diligence
Review the profit and loss statements (P&L). Make sure you pay extra attention to any areas where significant gains or losses occurred and try to spot any discrepancies.
Underwrite the property. Never take a seller and brokers provided pro forma at face value. Their numbers are usually a smaller look at the property and might not reflect how the financial performance of the property in a few years time.
Look at rent and sales comparable in the area.
Since your evaluation of the property will depend upon income today and tomorrow, the accuracy of the historical data, as well as the validity of projections, will significantly alter your potential financial return.
Look into the rent roll and leases including the terms, deposits, and payment history.
Be aware of handwritten changes to the leases
Get written confirmation or an Estoppel Certificate from the tenants if you can’t read the document or if the statements are unclear.
Tenant Estoppel Certificate
An Estoppel Certificate is a statement signed by the landlord and tenant that states that particular facts are correct, that there are no defaults, and that rent is paid on a specific
Look for rent concessions
Are the security deposits mentioned in the lease the same as those outlined in the rent roll? (This is usually a problem area)
Cross check the rent roll against the income statement.
Get a lease abstract. This is a summary of the essential financial, business and legal information that exists in a commercial real estate lease. It should bring to the reader’s attention any important lease provisions, financial obligations or other issues of importance.
Always add your property management fees back into your expenses. Quite often, the current owner could be managing it and won’t factor that cost into their expenses, which could make the NOI appear higher than it would be if you bought it.
Reconstruct the financials on your own… add things back like long-term capital improvements (HVAC, electrical, roof, cabinets)… then show how that would affect your financials as you spread those costs out over time.
Recommend taking CCIM classes for understanding the financials and underwriting a property.
If you’re an expert in the location you’re interested in; you may still feel comfortable buying a property without the expense reports because you’re familiar with what expenses should look like. This is another reason why having an experienced broker could help because sometimes you will find properties that could be good deals but may lack proper financial reports.
Make sure you’re comfortable with the deal above all else.
Here is my quick financial due diligence checklist
Physical Due Diligence
Walk every unit. It sounds like common sense but make sure you take a look at everything.
Don’t trust the seller/broker to tell you the unit is in perfect condition.
As you walk the units, I recommend using a “walkthrough sheet.” I have included a sample in my PowerPoint, which you can find at the end of this blog post. If you would like the full checklist, please let me know if the comments below.
As you walk the units, assess the overall condition of them. Take inventory of things that need to be addressed, breaking it into what must be fixed and then a “wish list” of items you’d like to get to eventually.
Look for any warning signs or safety concerns.
Are there any tenant concerns? Things like hoarding, multiple pets, an excessive number of occupants, unapproved alterations, illegal activity, …
Building inspectors are never a bad thing to have. Often you’ll get your money back in the deal.
Legal Due Diligence
Here are some necessary things you’ll need.
Title inspection and survey
Environmental inspection (typically paid for by the buyer)
Inspection for building code violations. This is critical for understanding any potential hazards or areas that need immediate addressing.
Checking to make sure that the property is in zoning code compliance
Commercial Property Owner’s Guide to Earthquake Safety (pre-1960 buildings)
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Seller property questionnaire (CAR Form SPQ) or Exempt Seller Disclosure (C.A.R. Form ESD) if TDS-Exempt
Commercial Property Owner’s Guide to Earthquake Safety (Pre-1960 Buildings)
Tenant Lease Agreements
Tenant Estoppels (TEC) if agreed in the contract
Survey, plans and engineering documents, if any, prepared on seller’s behalf or in seller’s possession.
Permits and structural medication documents – if in seller’s possession
When using CAR Residential Income Purchase Agreement (cont’d)
Lead-based paint pamphlet and form
Applies only to residential property built before 1978
Natural and Environmental Hazards
Seller is required to disclose if the property is located in a special flood hazard area; potential flooding (inundation) area; very high fire hazard zone; state fire responsibility area; earthquake fault zone; seismic hazard zone; and (iii) disclose any other zone as required by law and provide any additional information needed for those zones. These are satisfied with an NHD Report.
Seller shall deliver to the buyer or qualified substitute, an affidavit sufficient to comply with federal (FIRPTA) and California withholding law (C.A.R. Form AS or QS)
Condominium/Planned Development Disclosures
Seller has seven days (standard) after acceptance to disclose to the buyer whether the property is a condo minimum or if its located in a planned development or other common interest subdivision.
The California Association of Realtors (CAR), is real estate trade association to develop and promote programs/services that enhance a member’s ability to conduct business with integrity and competency. They have many tools designed to help you thrive in your real estate career. From their zipForm transaction tools to their education courses and more, they are a great resource. Learn more by clicking here
Curtis Gabhart and Gabhart Investments, Inc – 2018 All Rights Reserved
The information presented in this article represents the opinions of the author and does not necessarily reflect the opinions of Gabhart Investments, Inc. The material contained in articles that appear on gabhartinvestments.com is not intended to provide legal, tax or other professional advice or to substitute for the proper professional advice and/or commercial real estate due diligence. We urge you to consult a licensed real estate broker, attorney, tax professional or other appropriate professionals before taking any action in regard to matters discussed in any article or posting. The posting of an article and of any link back to the author and/or the author’s company does not constitute an endorsement or recommendation of the author’s products or services.
Here is a quick recap of some things I look for when doing a quick inspection of an apartment building or even a single family home and common issues I come across.
I like to do a quick review to the outside condition of the property in order to gain insight as to whether it warrants further consideration for purchase or investment.
Now, before getting into the details, let me summarize the most important factors regarding the physical condition of a property.
Some of the important visible considerations are:
Reviewing the foundation and cement
Checking the siding
Reviewing the sprinkler systems
Analyzing the quality of the landscaping
Looking at the windows
Looking at the roof
Inspecting at the front door
Looking at the gas meters
Looking at the train gutters
Reviewing the quality of the paint
Looking at the overall neighborhood
When buying a property, whether it’s an apartment building or single-family house that you may plan on flipping, some of the concepts are going to be very similar, if not identical. With many investment properties, you will find an inside inspection is subject to an accepted offer. This means you will need to make some assumptions about the property before you submit your offer. This can prove difficult, especially when you’re not able to view the inside.
I’ll look from the ground up – I’ll start by looking at the ground and taking an overall look at the condition of the property to see what level of care has been maintained. As a general rule, if it’s a piece of shit on the outside, it’s probably a piece of shit on the inside. There have been a few exceptions where I’ve been pleasantly surprised when I got inside a property, but that’s exactly what they are – exceptions. I’d use this analogy as a general rule of thumb – if you see a car that looks junky on the outside, it probably just as junky on the inside.
Foundation – I’ll look at the foundation,all the cement on the ground near the foundation, and all landscaping near the foundation. I’m looking for things like sprinklers spraying on the building. I’ll then check if there is stucco peeling off the building,which can sometimes indicate moisture intrusion into the building. I’ll also check if the ground is sloping towards or away from the building; it should be sloping away from the building.If it’s sloping towards the building, it may indicate that a possibility of having a foundation or other problem that relates to water. If there’s cement, I’ll look for big cracks in the cement, which sometimes can indicate unstable soil or cracks in the foundation.
This could indicate further foundation issues
Landscaping – what is it going to cost me to improve the landscaping, what do I need to do to it, are there sprinkler systems, and are they automatic or non-automatic?
Building – what kind of siding is there? Is it stucco, brick, vinyl, wood? I pay close attention to the condition that it is in. If it’s wood, I will check for visible water or termite damage.
Eaves – Does the wood going into the eaves have damage? If there’s a lot of damage in the eaves, it very well could go into the attic rafters, which could be a lot more expensive. If it’s on the siding, what kind of siding is it? If it’s an old building, a lot of times replacing siding can get very expensive for two reasons:
the eaves is the part of the roof that meets or overhangs the walls of the building
First is the fact that you may not be able to find that particular kind of siding anymore without having it specially milled.
Second is anytime you pull something off an old building, you’re very likely to find unforeseen surprises. Because you can’t be certain of the magnitude of these surprises, it is safe to assume everything is going to cost you a little more than you think. Whatever you think the price is, assume it probably cost more than you originally estimated.
Windows- Are they new or old? If it’s an old building, are they wood sash or aluminum windows? Is that something that’s going to need to be replaced? Typically, the double-wood-hung windows that you see in houses or old apartment buildings are not in very good condition. With aluminum windows, I essentially just look at them and decide if I’m going to replace them or not. What you need to be aware of is in many areas where you replace these windows, there may be architecture review committees that require you to replace them with historical windows. This could prove to be very costly, especially if they are wood sash.
wood sash window
Building Corners – Does everything appear straight? If there’s siding, are the lines of the siding vertical or are they all straight? On the corners of the building, what does the wood look like? Is there stucco coming off?
Roof – Does the roof have something called a drip edge? This is a little metal edge that goes into the lip of the shingle roof. Are there rain gutters? If there are no rain gutters, water may not have been running away from the building. Because of this, I will spend more time thoroughly inspecting the foundation.
I look at the shingles of the roof; if there are many noticeable curved edges, it is likely on its last leg. Then, if I think I may need to replace the roof, I will look at how many layers of roofing there are. Typically, you don’t want to go past two or three layers of roofing. What that means is that if you replace a roof that has two or three layers, you need to put in your budget funds to tear off that existing roof before replacing it. You also will need reserves for unexpected issues when you pull of the old roof because you may need to repair the plywood underneath. Depending on how much work you do around the roof, you may have to re-sheet it.
re-sheeting a roof
Fence –Do I need to replace or paint it?Is the fence wood? Is it leaning, does it look like it’s on my property line, does it look I could add private yards for apartment units? Many times, you will find large open areas in the back of apartments that are shared. What we can do is put up a fence around the units and now each unit has their own backyard – a very inexpensive fix that not only can help you get higher rent but can reduce costs because you may not have as much landscaping to maintain
Paint (for older buildings) – If it’s pre-1978 and you have peeling paint, you’re probably going to want to get a lead-based paint test conducted. That’s going to tell you whether you’re going to need to do any kind of abatement or work on the property. If work is needed, you may need to use lead-based paint best practices, which can prove very costly. I usually recommend getting a test. Paint used in older buildings in San Diego is less likely to have lead in it compared to the east coast, where the weather is harsh and requires more durable paint. Most of the properties I have tested did not contain lead, but it is still important to get it tested.
If it is tested and comes back negative you do not need to follow lead based paint best practices. If you have a pre-1978 property and decide not get it tested, you still must work on it like it contains lead based paint – which is a good reason to get it tested in the first place.
Front Doors – Aesthetically, are they looking good? Are there any gaps? If I look at top of door, I will look for a little pie-shaped gap at the top. If this is present, it indicates there may be some settling in the property.
Meters– Is it gas or electric? Are there gas meters for all units? If the property runs on gas and there is one water heater, there should be gas meters for each unit and also for the building.If it’s a multi-unit building, I count how many individual meters there are. There should be as many individual meters as there are units, plus one additional one, which would be for the common area. If you’re missing a meter, you may have something called a bootleg property, which means one of the units may have been put in unpermitted(just something to look at). These are important things to note because in San Diego the tax assessor will charge for all the units, and state on the public website that it is X units, but that does not necessarily mean they are legal units.
Electrical –As far as electric meters go, I’m looking at what kind of panel it is. If it’s old, it could be something called knob and tube, which could indicate that I’m going to have to put a lot of money into upgrading the electrical. This will likely increase the interior costs as well. I then look at the circuit panel – is it updated? Then, I’m looking at how many amps each unit has. Ideally, you want 100 amps, but for many apartments, you’ll have between 30-50. Newer apartments should have 100.
Knob & Tube Wiring
I’m also looking at the type of panel; Murray Lampert typically have problems, so I want to check what kind of panel there is. Are there circuits in the units? Is there any room to add additional circuits if you want to add appliances or anything else inside the property? Is the inside of the panel painted? If so, it could indicate that the previous people who worked on the property weren’t doing things the proper way. This would lead me to believe other things were not done the proper way.
This is quite the mess!
I’m looking for bunches of electrical or cable lines running all over the place. We’ve bought properties where it looks like spaghetti running all over the building, and we’ve ended up having to rip it all off and start from scratch simply because it’s easier to do instead of trying to sort it all out.
Staircases –When I walk on the stairs, I make sure to walk very heavy.I’m looking to see if it seems squishy. Is termite damage visible, are the railings stable? In compliance with code, railing spacing should be about three and a half inches. For me, if I can make a fist or place my hand through the pickets of the railing, it is most likely not up to code and I’ll have to replace it depending on my insurance company and how bad it is. I look at the stairs to see if the tread rise and depth are consistent. It should be around 7” of rise and 11” of depth. If they are not to code they may need to be replaced.
Inconsistent stair depth
After An Inspection– Once the inspector gets into the property and finds things that I may not have found, do I decide not to buy the property? No, not at all. It just helps me to figure out what it’s going to cost to fix or if I even want to fix it, and what exactly I’m getting myself into. That’s what is critical about the inspection. You can make a well-informed decision on the property rather than going in blindly and being surprised later.
It is naïve to think you can figure out how to hit a certain number or certain profit, or how to stay within a tight budget, without being informed of all the problems. This is valuable while I’m negotiating in the beginning. If I’m coming in lower than the initial offer, I can right away talk to them about some of these problems, which, most likely, the owners already know about but haven’t disclosed yet or many times they had no idea there were these problems which make it easier to negotiate.
Keep in mind, none of this is 100%. These are just good rules of thumb when looking at a property. They have served me well to establish if an investment property warrants further investigating and analysis, and if so, what kind of offer to submit. This obviously isn’t everything. I depend on inspection in most cases. I will be posting an interior walk through an article in the weeks that follow. I’m interested to hear your story and what else you may look at when walking a property. Please share your take in the comments below.
**Disclaimer** – make sure you are walking the property with the consent of the current owner. Please keep in mind we are in the San Diego market and practices in your area may be different. I highly reccommend you get a building inspector to look at the property unless you are highly confident in your ability.
Curtis Gabhart, CCIM President Gabhart Investments, Inc.
Edited By Blake Imperl, our newest intern at Gabhart Investments. Check out his Linkedin page by clicking here.
Gabhart Investments, INC. (GII) is a privately held real-estate investment firm based in San Diego, California. We operate in a rapid paced project driven environment. The employees at Gabhart Investments, INC. (GII) are close-knit, highly qualified professionals, possessing the necessary competence to meet our clients’ goals. GII promotes ethical balance for continuous training, leadership, and teamwork. Since 2000, GII has acquired and converted multi-family properties into condominiums throughout San Diego County. The new real-estate market has presented us with many opportunities to take advantage of. Along with our equity partners, Gabhart began to grow its portfolio in, arguably, the strongest housing market in the country. Thus, we consistently generate superb risk-adjusted rates of return for our investors. In 2005, Gabhart’s private investment portfolio had transactions in excess of 40 million dollars. We intend to accelerate our business model by maintaining our focus within the purchasing and rehabilitation of bank owned real-estate property. Our additional services include consulting, brokerage, venture funding, development, construction management as well as property and asset management.
As I am approaching the end of my first month as an intern at Gabhart Investments, I’d like to reflect on what I’ve learned, and what has changed thus far.
What I’ve Been Doing
Over the past few weeks, I have been spending a lot of time reading the material Curtis has provided me on Property Valuation & Investment Analysis. Although it is mainly an overview of the subject, it has proved to be some highly valuable content. This material essentially picked up where I left off in my Real Estate Investment Analysis class that I took last semester at San Diego State. I have been brushing up on subjects like tax benefits, 1031 exchanges, expenses, leverage, returns, evaluating cash flow, and much more. I still have a great deal of learning to do on these subjects, but it is exciting to see how what I’ve learned in the classroom correlates to real world applications. It is my intention to continue to read up on these subjects and ask as many questions as I can.
I’ve also been observing how Curtis and his team assemble marketing packages for commercial properties they are listing. I was doing things similar to this at my last internship at Realty National, so I’ve enjoyed seeing how this translates in the commercial arena
Commercial Real Estate Blog Posts
Another task I have taken on is the editing of Curtis’s blog posts. My first edit was a post on property walkthroughs. One tremendous benefit of doing this has been the information I’m learning is sticking much deeper than if I just glanced over it. It’s proved to be a great learning tool for me and I’ve even taken on the task of researching some of the topics I was curious about. Writing has always been a passion of mine, so getting the opportunity to revise and write some stuff has been great. I’m excited that I will get to continue to edit blog posts during my time here.
This past week I had a great learning opportunity with Curtis to do a walkthrough of a 13-unit apartment building in Fallbrook. I was able to learn about some of the things you should be looking for in a property, both on the interior and exterior. This was a neat real life application after reading Curtis’s article on property walkthroughs. This is certainly the kind of stuff you’d never learn in a class room.
13-Unit Apartment Building In Fallbrook
La Jolla Multi-Family Building
Another property we looked at was a 5 unit multi-family building in La Jolla. This was a very intriguing property because it had great bones, was less than a block to the beach and offered several routes for renovation. When walking the property, we looked at things like the condition of the floors, the bathrooms, kitchens, balconies, electrical, etc… It was far from move-in-ready, however, at the right price this could prove to be a great deal.
Curtis and Abe inspecting the condition of the upstairs balcony
the interior of the detached studio
Co-Star Lunch & Learns
In addition to the property walkthrough, I’ve also attended two Co-Star lunch and learns with Curtis and his assistant Dianne. The one that stood out to me was on the housing forecast over the next few years in San Diego County. I enjoyed this meeting because this is a real problem we will be tasked with fixing over the next decade. This past semester in my investment analysis class I did a great deal of research on this subject, so it was neat to hear the industry take on the issue.
Lastly, I have very much enjoyed the opportunity to pick Curtis’s brain. He’s always offering me valuable tips and knowledge about real estate and just life in general. Whether it be tips on client relations, listing properties, or even just financial management, I’ve been trying to act like a sponge of knowledge. He’s always honest about things and I respect that.
My views on real estate are growing stronger than ever and I’m excited all the learning opportunities that lie ahead. I am finding that the San Diego Commercial Real Estate Market contains more possibilities than I ever could have expected. Stay posted for my final update in August!
Blake Imperl – 22 Year Old Aspiring Commercial Real Estate Professional
I moved from Milwaukee to Scottsdale, Arizona when I was 5 years old. Spending my formidable years in the desert climate, I always had dreams of moving to the beach. As the son of a former real estate developer, I was exposed to real estate from a young age. My dad specialized in multi-family and student housing developments in and around the Milwaukee area. Upon graduating high school at 18, I moved to San Diego to study marine biology at San Diego State University. I quickly realized I wasn’t cut out for the science world and changed my focus to pre-business. It wasn’t until my sophomore year that I decided I wanted to be a management major with a real estate minor. I accredit this route to the all inspiring business professors I had at SDSU and to my involvement with The Real Estate Society. As a person who thrives on leadership and entrepreneurial opportunities, the knowledge and values I acquired during my time at SDSU will serve me for the rest of my career. Outside of real estate, I am an avid musician who plays in a local indie rock band called Stray Monroe. We’ve had the fortune of playing at some great venues around San Diego including The Casbah and Soda Bar and have also been played on 91X and 94.9FM. I also enjoy traveling, spending time with my girlfriend, and practicing Portuguese.
Why did you choose to intern with Gabhart Investments?
I chose to intern with Gabhart investments for several reasons. First, Curtis seems to have an amazing drive and motivation to succeed. From the first time we met, I could sense that he carries himself to a high level of professionalism with an immense entrepreneurial spirit. Though I had been exposed to commercial real estate before meeting with him, I never entertained the idea of making it into a possible career. He definitely opened up my eyes to all the opportunities that could be had in commercial. Second, Curtis is a very generous person who gives back to the real estate community. His involvement with past interns, students, and aspiring professionals, really spoke volumes to me. I sensed that if I gave it my all during this internship that I would get a lot back. Lastly, I really liked the opportunity to learn in a small team environment. I felt that I would get a great deal of hands-on experience and intangible knowledge.
How did you hear about the internship?
I heard about this internship through my former boss, Randy Zimnoch, who is the owner of Realty National. Realty National is an investor-friendly and full-service brokerage based out of Pacific Beach. They’ve developed a stellar team of over 30 agents since their inception in 2011. Randy was crucial in setting me on the career path that I am on now. Without his guidance, I think my focus in real estate would have been entirely different.
Why would you work for free?
Knowledge is invaluable. What I will be learning over the course of this internship far outweighs any minute compensation I could currently earn elsewhere. I realized early on in my college education that you can’t monetize the value of experience, because it’s that very experience which will make you more money down the line. In my initial meeting with Curtis, he asked me about my professional goals. One of the things I told him was that it was a personal goal to be a millionaire by the time I’m 30. He told me through hard work, smart decisions, determination, and a bit of luck that it could be possible. This isn’t to say I anticipate real estate being a get-rich-quick process; I fully understand you need to be in for the long-haul. Judging by how successful he has been thus far, I think it’s safe to say I’m learning from somehow who could teach me some things on how to make that possible.
What are you trying to accomplish?
It is my goal to walk out this internship a much stronger professional that I was before. I will achieve this by applying myself and acting like a sponge of knowledge. I want to understand the commercial arena better and pick up on some things that have made Curtis so successful. I’d like to also understand how I can hit the ground running upon graduation in December of this year. It is my hope that I can add many invaluable tools to my real estate belt that I will be able to utilize for years to come. Lastly, and most importantly, I want to add as much value as I can to Gabhart Investments.
Why is it you are interested in Real Estate?
I touched on this early, but I attribute my interest in real estate to my father and The Real Estate Society at SDSU. From a young age, I remember walking properties with my dad, doing napkin math, and talking real estate. Though I may not have realized it at the time, he was planting the seeds that would eventually grow into a profound interest. Once I got involved with The Real Estate Society in my sophomore year, I began to apply a lot of those concepts my dad and I initially discussed. I went to every guest speaker event, every case study, networked, took notes, and constantly worked on my professional development. I also served as Director of Marketing during my third year and this past year I was Vice President on the executive board. Lastly, I need to thank my many mentors who have helped me along the way; David Smith, Sean Bascom, Kris Kopensky, Mark Goldman, Mike Wolfe, Cody Zindroski, Jessica Barber, and many others. Their support and knowledge have proved to be invaluable.
I will be making monthly posts on my progress here at Gabhart Investments, how my views are changing in regards to real estate, and any other new updates. Stay posted!