Investing in multifamily real estate properties can be a great way to diversify your portfolio, but performing due diligence is essential when determining an asset’s viability as an investment. Due diligence requires the investor to look at several aspects of a property before making a purchase decision, and we’ll take a closer look at each of those aspects. With the right understanding of how to perform due diligence, you can prepare for your entry into the multifamily real estate investment world.
Understanding Due Diligence
At its core, due diligence is the process investors go through to help ensure they’ve met all the legal requirements for making a purchase and to determine if they should move forward with that purchase. The information gathered can reveal important information, such as major repair needs uncovered during the inspection to potential tax liabilities.
Reviewing Financial Statements
You’ll want to know how well a multifamily real estate property has performed in the past before deciding to invest. This means reviewing financial statements to help determine the current and potential future cash flow for the asset. You can ask to review profit and loss statements (P&L statements) and T-12 report (Trailing Twelve Months Report). These reports review operating expenses and income for a property, breaking everything down into easy-to-read line items.
The P&L reports should go back several years to give you a better look at the property’s financial strength over time. The T-12 report provides essentially the same information as a P&L, but it lets you look for any changes in the asset’s performance within the last year. While a multifamily asset might have a strong history of profits, there may have been changes in recent months indicating potential red flags. By looking at both documents, you can get a better feel for the way the property will perform for you. Additionally, you can ask to see vacancy reports and records of property tax payments to further analyze the property’s cash flow and potential liabilities.
Just as with purchasing a home for personal use, an inspection is essential for purchasing a multifamily real estate asset. The inspection should look at the roof, basement/foundation, plumbing, electrical, and structural makeup of the building or buildings you’re looking to purchase. While some repairs are likely needed for any property, big-ticket fixes such as a new roof or bringing electrical wiring up to code may lead you to decide against making a purchase. You can use the information in the report to estimate the cost of necessary repairs and take them into account before investing. Depending on market conditions, you may be able to negotiate with the owners to have some repairs done for you or to lower the purchase price based on the need for repairs.
Legal Review and Tax Review
Having a lawyer and accountant on your team can help you further vet a property. The lawyer will be able to look at the property’s current leases to ensure compliance with local laws and regulations, and he or she can also examine the property for any potential liens, easements, or competing legal claims you might need to contend with. Your lawyer should also look at any past litigation associated with the property and review zoning information to ensure the property is compliant with local regulations regarding its intended use. A full legal review may prevent costly surprises after the property has been purchased.
Similarly, your accountant can also identify potential financial liabilities with an asset before you invest. Examining tax certificates and ensuring past payment of property taxes can prevent you from taking on additional debt and headaches immediately after purchase. Your accountant may also review the financial documents you’ve gathered on the property to help you better understand all the information, such as individual line items in the P&L statement and how they might impact the bottom line.
Comparative Property Analysis
If you’ve ever purchased a new home, you’ve likely heard your real estate agent talk about comps. The concept behind a comparative property analysis for multifamily real estate is similar to the comps you’re familiar with from your home purchase. The comparative property analysis, also known as a comparative market analysis or CMA, is an estimate of a property’s price based on certain market factors. For multifamily real estate assets, these factors might include:
- Rental rates
- Occupancy rates
- Property amenities
Commercial real estate agents may have comparative property analysis reports available for review, but you can also create your own estimate based on other similar properties in the area. It’s important to remember that the analysis is not an appraisal; it is an estimated value. An appraisal should still be performed for any property you are interested in investing in, as part of the due diligence process, and you may find the appraised value can be higher or lower than the comparative property analysis indicates.
What it Means for Investors Like You
If due diligence sounds like a lot of work, that’s because it is. You have to examine a property from many different angles, including its financial history, tax history, and potential legal liabilities. The process can be time-consuming if you do it all on your own, but it’s essential for making an informed investment decision. Fortunately, you don’t have to do it all. DiversyFund offers a host of investment options for individuals of all experience levels, and we carefully vet each property before offering it as an option for your portfolio. All the steps of the due diligence process are taken care of for you, so you can invest with confidence and without having to do all the legwork yourself.