Earlier this month (February 2019), my company closed on a 400+ unit apartment community, which put our portfolio at over $510,000,000 worth of apartment communities across nearly 6,000 units.
After closing on each deal, I like to reflect and extract any new lessons I’ve learned from the process. Click here for the lessons I’ve learned on previous deals.
The lesson learned from this recent acquisition is simple but one that you may be overlooking, especially if you are a newer syndicator or accredited passive investor: do adequate due diligence on the seller.
Fortunately, this is a lesson I learned early on in my syndication career. I had always known that an important question to ask a seller is “why are you selling?” On one of my earliest deals, when I asked the seller’s broker this question, they said, “They plan on taking the money and moving to Greece for retirement.” Fair enough, right?
Eventually, through further investigation and due diligence, I discovered that the seller didn’t plan on using the proceeds to retire to Greece but rather to develop a new apartment community directly next door! Maybe the seller initially planned to retire to Greece but came across this development opportunity and changed their mind. Or maybe it was their intention to develop the neighboring land the entire time. Either way, I was fortunate enough to uncover the truth prior to closing and was able to adjust my business plan accordingly.
Now, back to this most recent deal – when we asked the seller’s broker why they were selling, they said they were shifting their focus from value-add to new construction. Upon further due diligence, we discovered that they were indeed transitioning to new construction (and it wasn’t going to be next door).
Since we knew their motivations for selling, we were able to put together a more compelling offer. In this case, since we knew that the seller wanted surety of closing so that they could use the proceeds for a new development deal, we offered a large nonrefundable deposit from day one and a strong sales price. As a result of our strong offer that addressed their needs, we were awarded the deal.
The lesson learned (or shall I say confirmed) on this deal is to perform adequate due diligence on the seller in order to determine their true motivations for selling the property. And this requires more than simply asking the seller “why are you selling?”
Of course, you still want to ask the seller why they are selling. But when you do, ask open-ended questions and have the interaction be more conversational than formal. Examples are:
- What do they plan on using the proceeds for? Retirement? Same business plan but a new deal? New real estate product? Something non-real estate related?
- How do they plan on using the proceeds? Will they 1031 into a new deal? Do they have a new opportunity identified?
- How quickly do you need to sell and why?
It is also helpful to ask the same questions multiple times, because you may receive different answers as the seller’s motivations change or as you build more rapport with seller and they open up to you more.
Then, you want to conduct further investigations to learn about the seller’s reputation:
- Talk with the listing broker, asking them about the seller’s motivation to sell
- Look at their website. Are they institutional investors or a private group? My company prefers to buy deals from institutional investors because the asset is likely maintained better. Do they use a 3rd party management company or their own management group? We prefer to buy deals that were managed by 3rd parties because there is likely better financial documentation and less uncertainty about their CapEx projects, which decreases the risk of the deal
- Look at their company and property reviews. What are other apartment operators, their investors, their vendors, and their tenant saying about them?
- Speak with local owners. Commercial real estate is a small world, and if you’re tapped into that world, you can use your relationships with other owners to learn about the seller. But only speak with local owners with which you have a pre-existing relationship.
Through your investigations, you should have a clear picture on the owner’s reputation, which will give you an idea of the quality of the asset, and the owner’s motivation, which will allow you to evaluate the risk points of the deal and submit the most competitive offer that is curated to fulfill the seller’s needs. And in doing so, you put yourself in the best possible position to preserve and grow the capital of your accredited passive investors.
Are you an accredited investor who is interested in learning more about passively investing in apartment communities? Click here for the only comprehensive resource for passive apartment investors.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.