June 7, 2019

JF1738: How To Perform Due Diligence On An Apartment Syndication Deal Part 2 of 4 | Syndication School with Theo Hicks

Part two of Theo’s due diligence series will teach you about five more documents you’ll need to be familiar with in your apartment syndication due diligence. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!


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Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.

Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the Apartment Syndication School, go to syndicationschool.com, so you can listen to all the previous episodes.


Theo Hicks: Hi, Best Ever listeners. Welcome back to another episode of the Syndication School series, a free resource focused on the how-to’s of apartment syndications. As always, I’m your host, Theo Hicks.

Each week we air two podcast episodes, every Wednesday and Thursday, that are part of  a larger podcast series that’s focused on a specific aspect of the apartment syndication investment strategy. For the majority of these series we offer some sort if document, spreadsheet or resource for you to download for free. All of these free documents, as well as free Syndication School series can be found at SyndicationSchool.com.

This episode is part two of what will likely be a four or six-part series entitled “How to perform due diligence on an apartment syndication deal. If you haven’t done so already, you’ll need to catch up to get to this point, because this is the process that you perform after you put a deal under contract, and in order to put a deal under contract you need to underwrite the deal. In order to underwrite the deal you need to find it, and there’s also additional foundation you need to create to find a deal in the first place… So if you haven’t done so already, I highly recommend starting from series number one and working your way through these Syndication School podcast episodes.

But if you have a deal under contract, the three things you do is 1) secure financing, 2) perform due diligence, and 3) secure investor commitments. In the previous series we discussed number one, which is secure financing, and right now we are continuing our discussion on how to perform due diligence.

Now, in part one of this series we talked about the first five reports. Those are the financial document audit, which is essentially an audit of the owner’s historical income and expenses, as well as the bank statements and the rent rolls. Two is the internal property condition assessment, which is essentially an assessment of the exteriors of the property to determine the priority of repairs, so things that need to be repaired immediately, things that don’t necessarily need to be repaired now, but are recommended, and then any ongoing future repairs, as well as the estimated costs of those repairs.

That is performed internally, whereas the one we’re gonna talk about today is one that’s performed by the lender. And then 3, 4 and 5 are usually combined into one report, and that is the market survey report, which is a detailed rent comp analysis performed by your management company, a lease audit report, which is the auditing of all of the leases and comparing the terms of the lease to the actual rent roll provided… And then five is the unit walk report, which is essentially the property condition assessment of the interiors of the units.

We talked about what each of those reports are, we actually walked through an example of a report that we received for a deal that we did, we also discussed how to obtain each of those reports, and approximately how much those reports will cost.

Today we’re gonna do the exact same thing, but for the reports six through ten. Then, as I mentioned yesterday, or if you’re listening to this in the future, in part one, next week we’re going to go through all ten of these reports again, and this time we’re going to talk about how you should review these reports once they’ve been received, what to look for and what adjustments need to be made based on the results of these reports.

I know we’re gonna talk about this next week, but reports one through five – the results of these reports will have you either confirm or adjust your assumptions, whereas these next reports, if the results of these reports are bad, then you might not even be able to do the deal. So these are deal-breaker reports; most of them are, the last one isn’t. But six through nine could potentially be deal-breaker reports.

Really quickly, the next five reports we’re gonna discuss are 6) the site survey, 7) the property condition assessment, 8) the environmental site assessment, 9) the appraisal, and 10) the green report.

Number six, the site survey. The site survey is going to be a map of the apartment community and its grounds, that indicates the boundaries of the community, as well as the lot size. Then included in this report will likely be a written description of the community. The site survey needs to be performed by a third-party vendor that specializes in site surveys. So like any other third-party, you can either find them via Google, or you can get a referral from your consultant, your mentor, your property management company, a local owner, a meetup group – really anywhere or from anyone that has bought an apartment community before; because if they did, they had to get a site survey performed.

We recommend getting a few bids, just because the approximate cost of the site survey will be around 6k. So if you can find one for cheaper than that and they actually get the job done, then by all means take that cost savings.

When you’re looking at an actual site survey, it’s gonna be essentially a black and white map of the property. Right in the middle you’re gonna have a 2D drawing with the outside being the actual boundaries of the lot, and then somewhere around there it’ll say exactly what the lot size is. For example for this property, the lot size is 8.29 acres. It’ll have any streets that are on the boundaries that are surrounding the property, so in this case it’s right on an intersection.

Then on the actual map within the boundaries it will show you exactly where all the buildings are, and the actual sizes of those buildings, the actual type of the buildings… For example, right here it says “Two-story brick and frame, 3,600 sq.ft, height 2,600.” Then it’s got actual dimensions of the right-hand side, the left side, the back, the front, any patios or doorways, what is the length and width of those. It does that for every single building. You also see the actual parking spots and the number of parking spots. For example, it says “Here’s 14 covered spaces, here’s 6  covered spaces, here’s 7 regular spaces.” You can also see any type of amenity that’s there… For this property there’s a pool, there’s a playground… Again, this map is very detailed.

They also go into where the electrical lines are running, where the water lines are running, it talks about any sidewalks, it’s got actual coordinates… It’ll tell you essentially what is surrounding the property; if it’s a road, it’ll be  a road, and if it’s another apartment, it’ll tell you another apartment is out there. So there’s a lot of detail.

On the left-hand side or somewhere around there there’ll be a legend that explains what the abbreviations mean. For example, “AE” means an aerial easement. There’s a W with a circle around it, which means a water well. There’s a C with a box around it that means cable box… So you’ll likely have to zoom in if you want to actually read this entire document, because it’s so detailed and the fonts are really small.

In the bottom there’s going to be some notes on the actual map. Right here it says, “Okay, here’s how many parking spots there are.” There’s 69 regular parking spots, there’s 222 covered parking spots, there’s 5 handicapped parking spots.

Then there’s some overall notes, for example “The surveyor did not abstract the property survey based on legal descriptions supplied by the title company. The survey as shown in the legal description as per and on the ground survey. Easements, building lines etc. shown are identified by GF number blah-blah-blah of Chicago title insurance company.”

It’ll also have any flood notes. For example, this property is within flood zone X, and it says the date when that classification was determined. It’s also got a legal description, so for example beginning at a [unintelligible [00:09:38].00] So it’s basically saying how they actually did the survey.

Then there’s something called a schedule of B items, which is just more explanation of how they performed the survey. Then there’s the surveyor’s certification saying that “Hey, I’m a certified surveyor.” So that is number six, the site survey.

Number seven is the property condition assessment. I’m not gonna spend too much time on this one, because I’ve already explained what the property condition assessment is when we talked about the internal PCA in part one. The only different here is that rather than being performed by a third-party contractor of your choosing, this PCA is performed by a third-party vendor selected by the lender. So you’ll have two PCAs, and ideally you will compare and contrast the results of these two PCAs. For example, maybe the lender caught something that your inspector didn’t, or vice-versa. Expect to pay around 2k for this PCA.

Again, the PCA is an inspection of the exteriors of the properties, and it gives you the overall condition of the different exterior items, any recommended repairs that are prioritized based on immediate, recommended and future, and then also the approximate costs to fix those.

This PCA from this lender is actually 136 pages long, so even longer than the internal one. As I mentioned, these are all gonna be different, based on who’s performing it. This one, just looking at the summary section, it kind of goes through the actual description of the property first, it says who did the assessment, so you have their contact information… And then this one actually has a summary of all historical repairs and replacements from 2013 to 2016, so any repair that was made over the past three years – in this case four years – were logged here.

Then it just goes through the overall results of the actual report. They have a property useful life table, where they go through all the different site components and says “Here’s the average life and here’s how old it actually is.” A summary of recommended repairs and replacement cost estimates… For this one right here it says “Immediate repairs – life safety items. May impact health or safety. Costs: $2,250”, and then there’s a reference for how they determine that later on in the actual document.

They’ve got a summary of known problematic building materials, for example fire retardant plywood; identified no action recommended, so for this building, all of these are actually no. Then it goes into the actual needs of the document, which is essentially all the raw data that they use in order to create that summary.

Number eight is going to be the environmental site assessment. The environmental site assessment is an inspection that identifies potential or existing environmental contamination liabilities at the property. It looks at the underlying land, as well as the physical improvement to the property, so the actual building, and then the report will offer conclusions or recommendations for further investigations if an issue is found. Similar to the PCA, this report is created by a third-party vendor selected by the lender, and the approximate cost is about $2,500.

Now, this environmental site assessment, this ESA, is actually 648 pages long. So they do not mess around with these. Obviously, it starts off with the executive summary, where it goes through all the different things  that they looked at, and then they’ll have their findings, so anything that they believe needs to be done, anything that’s fine, the historicals… Very, very detailed, and it ends with their conclusions and opinions and recommendations. For example, on this one they didn’t identify any REC (recognized environmental conditions), so no further action is needed.

Next, number nine is the appraisal. Most people know what an appraisal is. It determines the as is value of the apartment community. A certified appraiser will inspect the property and then calculate the as is value of the apartment community using the three appraisal methods, which are the sales comparison approach, where they compare the subject property to similar properties that were recently sold, the income capitalization approach, which is using the net operating income and the market capitalization rate… So that’s the net operating income divided by the market cap rate, in order to determine the as is value. And then the cost approach, which is the cost to replace or rebuild the property.

The appraisal report is created, as I mentioned, by a certified appraiser who is selected by the lender, and the approximate cost will be about $5,000.

Like most documents created by the lender, they’re pretty long. This one right here is actually 166 pages. In the beginning it’s got a summary tab saying “This is the property, this is the size of the property, here’s the occupancy of the property. The property is under contract for this price. The as is price is this”, so for this example the contract price was 13.3 million dollars, the as is was 13.7 million dollars. So there’s a free equity of $400,000 at the purchase.

Then it says “As the date of the inspection, the property was operating slightly below a stabilized occupancy level, at 89.3%, but the rent roll that was provided said the occupancy was 92.3%.” So they’re saying that we would only need to add a few tenants in order to reach a stabilized occupancy. So they haven’t made any adjustments based off of that; they assume that the occupancy was 92.3% with their appraisal.”

Like all of these reports, it starts off with a summary tab, and then it provides the pictures of the property, and then it talks about any assumptions or limiting conditions that were made. Then it goes into the meat of it, which is the analysis of the metropolitan area, as well as the apartment market, and the smaller market, the neighborhood that the property is in… There’s a site analysis, a zoning analysis, an approvement analysis, it does a highest and best use analysis, a real estate tax analysis, and then it talks about their appraisal process, and then they go into how they did the sales comparison approach, the income stabilization approach and then the ensurable value, which is another word for the replacement approach. Then any final value conclusions that they have for the actual deal.

Lastly, number ten is the green report. The green report is not really required, it’s more options, but it evaluates any potential energy-saving or water-conservation measures for the apartment community… So is there any way to essentially save money overall by installing something that decreases ongoing utility expenses.

The report is gonna include a list of all measures that were found, any recommended changes that are found, along with the associated cost savings and the initial investment amount to actually implement that measure. This report is created by a  third-party vendor, also selected by the lender, and the approximate cost is about $3,500.

If you plan on implementing the RUBS (ratio utility billing system/service) program, which essentially evaluates the usage of utilities and then reports the amount that you can bill back to your residents, you wanna consult with a RUBS company in a local market to obtain a few quotes. So that will technically be an eleventh report if you wanna do the RUBS program… But let’s take a look at the green  program…

What’s interesting – because as I mentioned, obviously you’ll have the summary of all the information, all the raw data below, and the summary will have all the different energy and water conservation measures that they’ve found, they’ll talk about the location of the measure installation; typically it’s either in the common unit or the tenant unit. And it’ll say “Here’s the estimated annual electric savings for this” and whatever the energy measure is; right here it’s kilowatt/hour.

And then it says the estimated gas savings in therms, then it says the estimated total energy shavings… I don’t even know what that measure is – kBTUh. Then it says the estimated total energy shavings as a percentage, and there’s the same thing for water as well. So there’s for energy, for electric, for gas and for water. Then it does the same thing for the tenants. If you were to implement, for example, windows, dual pane, vinyl frame, then you’ll end up saving 4% total energy in the common areas, and then for the residents, they’ll end up saving some large kilowatt/hour amount.

Then it’ll have the actual costs associated with each of those, as well as the cost savings. With the windows, the estimated cost to install would be $19,000 for the common areas, and it’d be $425,000 for the tenant units. The actual cost saving to the owner will be $626; the actual savings to the residents will be $13,000… So the payback period for installing windows in the common areas is actually only 31 years. So unless you plan on holding on to the property for 31 years, you probably don’t wanna do that…

But here’s a better example – low flow shower head in the tenant units. The initial cost would be $16,000 and the estimates cost saving would be $16,000. That’s to the actual owner. So the ROI is actually one year.

There’s another one – put a cover over the pool; initial investment is $600, cost saving $409. 1.4 years ROI.

That’s really what’s the most important – to take a look at that data table and you can determine the energy savings, the initial investment and the cost savings associated with each measure identified. Then below that it just goes into all the details on how they figured all that out. So that’s number ten.

As I mentioned, number eleven could technically be a RUBS report, where you find a RUBS contractor who goes through the RUBS program with you and determines how much water is being used, or how much other utilities are being used by the residents that you as the owner pay for, and then you can determine how much money you can bill back to the resident.

That covers due diligence reports six through ten, so now we’ve gone through all ten due diligence reports. We described what the report is, how to obtain the report, how much it costs, and then we walked through an example document. Then again, since they were for live deals, I cannot share those. I guarantee you can find some of these documents by just googling them… But I think I did justice by explaining them, so once you actually see these reports,  you’ll be able to at least recognize and be somewhat familiar with the actual report.

Next week we’re gonna go over all ten reports again, and this time we’re gonna talk about how to analyze the results. So after listening to this entire (what will likely be) a four-part series, you should have all the knowledge you need to perform due diligence on an apartment-syndicated deal.

In the meantime, if you haven’t done so already, go back to yesterday’s episode and listen to part one. Also, check out the other Syndication School series about the how-to’s of apartment syndications, and download some of our free documents. All those can be found at SyndicationSchool.com.

Thank you for listening, and I will talk to you next week.

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