The Good Stewards Real Estate Podcast

Good, Bad And The Ugly With Apartments

Episode Summary

There’s a lot of intricacies to be aware of when analyzing apartments and this is the long-awaited part 2 from episode 26. If you’re new in this space, be extremely thorough and if you’ve done one before, be thorough better. Submit letters of intent, write your contracts with your best interests, and get third-party inspections.

Episode Notes

Finding Any Dirt:

1:36: It's worse to have an apartment full of tenants who aren't paying anything and are causing all sorts of problems and have an apartment full of...no one.

2:50: You want to make sure of what they reported to the IRS. If anything seems off there, it probably is.

5:10: You should never rely on a proforma, which is just an estimate and they will always be in the seller's favor.

6:33: Schedule E’s are part of the 1040 IRS form which is where income or loss from rentals, royalties, S-Corps, partnerships, estates, trusts, etc. is reported. Basically not “earned income” but investment income only.

8:32: You want to see their list of capital expenses for at least the last year for two reasons. (1) you need to see how much they're spending and (2) you need to see whether they're correctly capitalizing things.

10:43: Pay attention to utility costs. What tenants would pay and what the landlord would pay.

Contracts & Analyzing Property Actuals:

13:11: Write up 30-30-30 contracts that are in your favor. 30 until the contract is hard, 30 to line up financing and 30 days extra for something that might come up.

16:23: You want to look at the rent roll and get copies of all the leases. Look for rent price, deposit amount, late fees, when the late fee is charged, pets, etc.

19:28: Talking with the property manager is always a good point of contact.

20:50: Ryan has seen a lot of landlords spend their security deposits, so make sure to pull those out from proceeds .

Inspections & Holding Your Emotions:

24:30: You don’t need an inspector to walk through every unit, but maybe 1 for each building.

26:50: Get a 3rd-Party inspection to go over key systems and the units the sellers don’t want you to see.

30:21: If there are red flags, regardless of how much work you’ve put into it, let the property go. The “Well I just spent X money” is going to keep going.

32:12: Include a letter of intent (LOI) before the contract so you clearly dictate what you’re anticipating.

Connect with the Good Stewards:

Episode Transcription

Ryan: (00:00) You're probably going to hear the line on apartments of “Oh, yeah. We just put in a ton of work”. Like you're going to want to look at those things that were done. And there's a guy in Indianapolis who tried to sell, I think it was a 13 unit and he wanted $2 million. I offered him $100,000. Well, I just did all this work. Well, almost all of it was done without permits and it was going to need to be redone.

INTRO: (00:26) Welcome to The Good Stewards podcast, the only podcast dedicated to seasoned real estate investors who want to maximize the cashflow potential in their business. We are “buy and hold” investors with a thousand plus properties and markets across the U.S. who bring an insider's view into the nitty gritty details of real estate investing. If you're looking to develop the mindset teams and systems that can dramatically build your real estate business and network, you're in the right place.

Ryan: (00:59) Welcome to this episode of The Good Stewards podcast. I'm Ryan Dossey.

Amanda: (01:03) I’m Amanda Perkins.

Bill: (01:04) I'm Bill Syrios.

Andrew: (01:06) And I'm Andrew Syrios.

Andrew: (01:07) Hello, everyone. Welcome to The Good Stewards podcast. We are going to pick up for part two of our discussion on due diligence for apartments. But first please visit us on our website of thegoodstewards.com, download our free eBook and check us out on Facebook, Instagram, and all the rest of those social media websites. But we're going to jump into the financial part of due diligence, because we did a deep dive on a previous episode about the maintenance, the condition, the TLC, all those things, but there's another side of it and that's the financial one.

(01:36) And this is actually probably even more dangerous for investors is missing on things like tenants, who aren't actually paying, but appear to be paying. It's actually worse to have an apartment full of tenants who aren't paying anything and are causing all sorts of problems and have an apartment full of no one.

(01:51) So the first thing you want to look at, you want to get a series of documents. Preferably you want a lot of these before you even make your offer, but you at least need to get them afterwards. That is, you need the operating statement. The operating statement is their real numbers. This is their... How much they put into, how much they're bringing in an income, how much they're spending on all their operations, how much the taxes are, how much their insurance is, how much their maintenance, all those things like that. And what is their actual net income. And it's not as important what their debt service is. That's not really relevant to this, because your debt service is going to be different. So, you want to look at what their income has been preferably for several years, but at least for the last year and what their expenses have been.

Amanda: (02:36) And I want to just interject one thing in that, along with our operating statement, you should demand to see their schedule SE or anything that they filed their tax returns with and the depreciation schedules for the property. Just because sometimes operating statements can be what they'd like for their property to look like, but you want to make sure what did they report to the IRS. And sometimes they won't give that to you, but you should be able to be able to have that.

Bill: (03:02) And if you don't, I think that right away, you're thinking discount in your mind, because if they're bringing you their income statements on a piece of paper that they are having in the back pocket that they're going to hand to you, then all of a sudden, you think this is very unprofessional. Well, that's okay. Maybe that just means you're going to get a better deal on it because you have to kind of create in your own mind what the income is. Oftentimes this is true with people who are kind of an amateur in it, and with smaller apartments, I'm talking about things…

Ryan: (03:38) Or old schooling it like the mom and pop types. A lot of the times why we're able to get deals is we end up knowing more about their building than they do at the end of our due diligence. I think one of my favorite ones, Bill was actually when you and I ran like, well, how's it going? And they like, well, we bought the minivan cash. It was like, okay, what is like, PNL and ROI? And they were just like, I mean blank. They didn't know what we were asking.

Bill: (04:04) Yeah. And some people are doing all kinds of things with cash. They get cash from their residents and they're putting in their pocket. They don't put it on their PNL.

Ryan: (04:14) And that's not going to be on the IRS paperwork.

Bill: (04:17) Yeah. So, again, I mean, what Andrew is talking about due diligence is the term, but you go as far as you can go and then you have to make judgment calls yourself if you're dealing on that kind of a fairly unprofessional level, which is not a bad thing for you, because it can mean a much stronger negotiating position.


 

Ryan: (04:40) Chances are, if somebody has all their ducks in a row and all their docs and everything lined up, you're not getting a 10 cap. Like you're getting a 3 or a 4. So at least that's been my experience. The folks who have really clean books, they get an ask top dollar. So that's another thought if you're are looking at repositioning as if your books are clean, the more likely you're going to be able to sell for a premium.

Andrew: (05:07) Yeah, absolutely. Now you should have gotten their operating statement even before you made your original offer. You should never rely on a proforma, which is just an estimate and they will always be in the seller's favor. You put your own proforma together to try to figure out what the estimate will be in the future.

Ryan: (05:21)Youcall those profakas, don’t you?

Andrew: (05:23) Yes, profakas.

Bill: (05:26) All sellers lie, all the time. They're seeking to sell.

Ryan: (05:33) We're not cynical. We're just real.

Bill: (05:36) Well, maybe we won't call it a lie. We'll call it a “I wish”. They wish upon a star that their properties are performing that well.

Andrew: (05:43) It's best case scenario with a few more generous assumptions. Generally, other than just looking and wanting to get this schedule E’s and whatnot. There are ways to backtrack this for what reason you can. You can try to get all of their, you can get their bills. You can call up the utility companies and see what they're paying or stuff like that. You can try to… You can ask for them to send copies of their bills. You can get… It's not a bad idea to get copies of their rental deposits if you can. Especially for smaller apartments, it can be harder for bigger ones, but those, schedule E’s are better. But if you have a 4-plex or a 6-plex or something like that, getting copies, getting the bank statements or copies of the deposit slips or something like that to prove that the money is actually going into the account. This isn't just numbers on paper.

Ryan: (06:33) For anyone who's kind of a new to these terms. So, schedule E’s is part of the IRS form 1040 and it's going to be where they report the income or loss from rentals, royalties, S-Corps, partnerships, estates, trusts. Basically, it's not earned income. It's what the IRS views as like, “investment income” or “passive income”. I Googled that while we were here because I wasn't familiar with the abbreviation, but obviously I know what a 1040 is, but the schedule…

Andrew: (07:03) I don’t think you are supposed to mention that you're Googling things while doing a podcast, but that's okay.

Ryan: (07:07) Oh, it’s fine.

Andrew: (07:09) Now, in addition to making sure that the numbers are correct, you also want to make sure that you're getting all the numbers in the right category. There are two broad categories for expenses. There are operating expenses and there are capital expenses. The difference is in operating expenses, anything that is expense for that year. So, it's like if you're paying for the utilities for the last month of gas or something, that's an operating expense. If you're doing a maintenance item or something like that, like the toilet's backed up, that's a maintenance item. That's an expense. Taxes are an expense.

(07:37) But items for things that are supposed to last for over a year, like a roof, like a driveway, like a HVAC system…

Ryan: (07:46) Water heater.

Andrew: (07:58) Water heater. Yeah. These are capital expenses. These do not go on the operating statement. They go on the balance sheet. And what that means is you don't see them when you're looking at an operating statement. So, you want… But a lot of these expenses are recurring capex or what's recalled replacement reserve. Banks call it replacement reserve. Usually about $250 to $400 a unit is generally approximations more for houses. But what it accounts for are the fact that every year you're going to have to do some of this stuff. Maybe you don't have to do the roof for another 20 years, but you'll have to do four furnaces, two AC units. You're going to have to do, you're going to have to repay the driveway and you've got to replace a hot water heater or whatever. Every year you have some of this.

(08:32) You want to see their list of capital expenses for at least the last year for two reasons. One, you need me to see how much they're spending on this stuff, but also you need to see whether they're correctly capitalizing things. Certain things that are capitalized that are really questionable, like carpet replacement, vinyl replacement, appliance. I mean, you can justify this, but it's like, it's kind of pushing it. And I've seen a lot of, a lot of investors capitalized, pretty much everything. And then it looks like, “Oh, well, the other operating statement is incredible”, but they're just piling up expenses that just because they go on the balance sheet that makes the operating statement looks look better, but it's still cash out of your pocket.

Amanda: (09:08) But you can still… Sorry to interrupt you. But you can still see that because you can pull their depreciation schedule SE that go along with their schedule e’s and then also look at their balance sheets from year to year, if they will provide them for you or if they've kept them. But there is a way for us to verify that information, but you need to know what you're looking for. You need to take an accountant's eye view at this sort of thing.

Ryan: (09:30) You also want to make sure it was done right. And in my experience, a lot of folks when they choose to sell something, especially like an apartment, they've had a ton of capex and they can't see the light at the end of the tunnel. So, they're like, okay, it's time to sell now. And they're trying to make something that, I mean is literally bleeding to death look appealing and typically trying to get top dollar for it, in my experience. But if you're looking at that and you're probably going to hear the line on apartments of “Oh, yeah, we just put in a ton of work”. Like you're going to want to look at those things that were done. And there's a guy in Indianapolis who tried to sell, I think it was a 13 unit. He wanted $2 million. I offered him a $100,000. Well, I just did all this work. Well, almost all of it was done without permits and is going to need to be redone. Sold the property on the MLS for about $200,000. And then the guy who bought it, actually reached out to us for a cash offer and was like, Hey, this thing's a mess. I'm looking to get $400,000. And I was like, yeah, no, I told the original owner I didn't want it. So, make sure, especially if they claim there's a lot of callbacks that things like permits were pulled and stuff was done right. But that's in my experience, just kind of a red flag.

Bill: (10:43) And another big thing to look at is utilities. That can kill a deal right there because if the utilities are generally used, like gets on a boiler or there's… The big question is how much utilities do the residents pay and how much utilities does the owner pay and this can “make” or “break” a deal real simple.

Ryan: (11:07) I would also make sure you have that verification in your purchase and sale agreement as a reason to terminate or re-trade. I think I've only been sued once and that's what it was over. I was going to buy a duplex as a rental property and the seller gave us particular financials as part of my due diligence. I called the utility company and said, what are the utilities run? I think the building was pulling in $900 or $1,000 a month and utilities were $600 a month in winter. And he was paying all of them, not quite the “Oh, about a hundred bucks that he threw out”. So, when we went to terminate, he had his attorney basically try to sue us for EMD. It went away, nothing ever came of it.

(11:48) But make sure when you're making offers, especially on apartments or things where you're doing due in the financials our purchasing sale agreements are super like in our favor. And literally say during the inspection window, we can terminate for any reason and we are entitled to our EMD.

Andrew: (12:05) EMD is earnest money deposit just in case anyone is…

Ryan: (12:08) Andrew had to Google that.

Andrew: (12:10) I’m not typing down here.

Bill: (12:13) Andrew, it might be a value to describe how we do an earnest money with an apartment and how we stretch it out, give ourselves extra time.

Andrew: (12:23) Yeah. In our purchase and sale agreement we basically state that for a larger apartment, for a duplex it would probably be a little bit less, but for a larger apartment, large apartments are usually done over 60 days, where a house is 30. And so, we usually give ourselves 30 days of an inspection period. Then the money, the EMD goes hard. In that point, it's no longer refundable. And then we allow in our purchase sale contract, the right to buy another 30 days for like, if the loan or something like that has slowed down or whatever. We give like kind of to get the loan docs in place or whatever and etc. Always put that etc. in there. Don't put the whatever in there. That's not legal language. And then that allows us to put another earnest money deposit down same as the original and stretch the contract and got another 30 days.

Bill: (13:11) So, it's a 90 day situation - 30, 30, 30. 30 until it goes hard, your earnest money deposit. Another 30 to get the financing together. And another 30 just in case…

Ryan: (13:23) Which you can “buy”.

Bill: (13:24) Yeah. That you can still buy it assuming you definitely want it. You certainly don't want to be torpedoed by a bank having a hard time, pulling all the financial, the closing together at the last minute, and then you get X out of your earnest money because of what a bank did. Actually, that's happened to us before. So, 30, 30, 30, not a bad way to think about.


 

Ryan: (13:50) And it is important to have the ability to buy that extra time. Because in my experience with some of these apartment folks, they can be a little bit less flexible than some of the homeowners of “Hey, we need another 30 days”. - Oh, no problem. Some of them are like, “Nope, your money's mine”. So, having it in writing that you can do that and it not being a question of “Can I have 30 days?” Hey, I'm putting down another $5,000. Closings are being extended is super smart. If you don't like giving away money.

Andrew: (14:20) Returning to the operating statement, the next thing you want to look at is whether or not this is a cash accounting or accrual accounting statement. Pretty much I'd say virtually all small investors use cash accounting, which just means whichever month the money comes in it's recorded that month. Accrual accounting is based on when the money is basically earned.

(14:45) So let's say you make a thousand dollars from… You sell somebody something for a thousand dollars. Then you have an accounts receivable for a thousand dollars. And then once they've paid it, then that account receivable turns into cash. So, it's like all, when your money is earned and when your money is spent, not when it leaves the account, that's accrual. The most important thing here is that accrual accounting can be a bit deceptive because if you've received money from a tenant, it could be an accounts receivable. You were supposed to receive this money. It doesn't mean it's…

Ryan: (15:23) Rent is due.

Andrew: (15:24) Rent is due. That's all it means. And so, and some are not very good at charging off bad debts. We actually had a property manager a while back that would do it once a year. And so, you occurred... a large amount of people haven't paid. Say your apartment is not doing well. And most of the time when you're trying to buy apartments with some sort of value-add motivated seller, there's going to be tenants who are paying. And so, if you've got a lot of bad debts that haven't been written off, you might not be anywhere near the income that it looks like is on that operating statement. And you've kind of got to work through it and you make sure the numbers there are, all the bad debts have been paid off or figure out what they are. You can find it on the balance sheet and try to reconstruct it.

(16:11) That is probably a good summary of the operating statement and the schedule e’s and you may need to have an accountant help you look at some of those things. There's somebody who's a specialist in this area. But those are the general points you want to look for.

(16:23) The next thing is you want to look at the rent roll and you want to get copies of all the leases. And the first thing I want to do is make sure that they line up. So, in the leases, you're looking for a couple of key points. You're looking for what is the rent price? What is the deposit? What is the late fee? When is the late fee charged? Is it a month lease or is it an annual lease? And do they have pets? Is there a pet rent? Is there a pet deposit? And then any weird things in there. I've seen stuff where people like, generally you'll find this very quickly. And this is generally only with very small apartments. They get a rent discount for doing their own maintenance. You don't want any of that. That's a big problem. Tenants do not do good maintenance and there's just endless arguments and liability issues. Don't settle for that.

You want to make sure all those things line up with the rent roll. Sometimes you'll see, like, this person is paying $300. That's what their lease says. The rent roll says $500. We've had ones where like, “Oh yeah, we increased the rent. We just never signed a new lease. Never had an idea”. That was like, oh, okay, well then, we're going to go with the original one.

(17:28) You buy off the operating statement. You buy off the leases. You don't buy off of their proforma, you don’t buy off anything like that. Yes. You want to add value to the property or you want to find ways to increase the rent and all the rest of that stuff. But you buy off the operating statement, you don't buy off its potential. That spread is how you make your money and get a good deal. So, make everything lines up, make sure you're looking for what there… At the rent roll. And who's behind. Remember, if a tenant is behind by more than a hundred or so dollars, they're probably going to be eventually got evicted. If they're behind by a full month, the odds of them staying are very low. If they're behind by more than one month, it's basically zero. So, you want to look at the rent roll. And also, their aged receivables. Age receivables is how long people who… Are they 30 days, 0 to 30 days behind? Are they 31 to 60 days behind? Are they 61 to 90 days behind? They might not have those reports. They do definitely should have a rent roll. If they don't have a rent roll, they basically have no documentation and you need a major, major discount for that.

Amanda: (18:31) Well, and one thing to pay attention to, because this has happened to us before, kind of take a look at everybody's move-in dates. We had a particular deal where every most, I want to say maybe like out of 40 units, two thirds of them had moved in within two months of each other. And then, so we made the offer. And then as we're getting down the line, we asked for updated rent roll. And essentially like none of those two thirds of people were paying any rents. And when we dug a little bit deeper, they'd offered basically like a $200 move in special or something to that effect just to get people in the door. Not even, I don't remember…

Ryan: (19:09) Warm bodies.

Amanda: (19:10) Yeah. I don't know for certain of if they even collected security deposits, but essentially, they moved in completely unqualified people just to kind of make the building look full. And that was, I mean, if we would have pulled the trigger at that point, that wasn't going to be our problem to evict 30 people all at the same time.

Bill: (19:28) If you can talk to the property manager, that's a key person. As a matter of fact, that was the key conversation I remember you and I, Amanda had with the property manager who as we quizzed him about his policies, he said, “Well, as long as somebody hasn't had a eviction in the last year, I'm good with that”. And that wasn't our criteria.

Andrew: (19:53) Yeah. You want to ask the manager all like, “What's their rental criteria? What's their biggest problem? What are the base maintenance issues?” You definitely need to talk to the property manager. That should be essential and not negotiable.

Ryan: (20:05) A good indicator as well as if one of the tenants is also the property manager, and he answers the door in a bathrobe. That's probably not what you want. Bill and I ran into that. Another thing I'd mentioned on the leases when you're going through them, make sure they're signed. For whatever reason, like, “Oh yeah, here's the lease”. Like, well, this isn't really filled out. This isn't real. The other thing I would throw in there with the security deposits is make sure you note those, make sure your purchase and sale agreements as security deposits are going to be transferred and ideally rent is getting prorated.

Andrew: (20:40) I'd say that is mandatory. That is prorated. Unless they're taking a discount somewhere else, you should want prorated rents.

Ryan: (20:46) Correct. Everything's negotiable, but we always have them prorate and pass along. In my experience, a lot of landlords take security deposits and spend them. So, a lot of the times they don't have it. So, you want to make sure that that is pulled out of proceeds and transferred to you because otherwise if those people decide to leave, especially if you're buying a building, you probably don't have before pictures. So, it's pretty hard to ding security deposits when we don't know what it looked like before they got in there. So, you're going to probably have to send over some security deposits. You want to make sure that's coming out of the previous owner's pocket, not out of yours.

Bill: (21:26) Yeah. And always remember that a lease supersedes a sale. So, it is ever on the lease, controls the sale. We bought a property, it wasn't a multifamily, but where the owner had his sister living there and I think they had a two- or three-year lease kind of thing that he put into place. And basically, that made a difference when we found that out, obviously that that was going to control the sale. We had to abide by that lease. Another thing that you'll find in leases is that pay periods are often not… We have people pay on the 1st it's late on the 5th. That all lines up for us to easily then pull the eviction lever when we have to, at the same time with all our properties. But oftentimes we'll find leases that start on the 15th that are not late for 10, 15, 20 days later. The late fees are different. All that is kind of just a mirage of things you need to be aware of.

Ryan: (22:28) Bill and I bought a 12 unit that was like that. And it made us setting up our systems for posting notices and scheduling evictions, kind of a pain because instead of doing it once a month, it's twice a month and the guy's lease also had things like they had a 10 day grace period and things that made it like, “Okay, these people basically can live there for free for a month before we can even really start the eviction process”. So always check into that. And then I'm also a big fan, if you can, if somebody is on a month to month or a lease has expired and gone month to month and you want to keep them, even if you're going to keep them on a month to month, try to get them on your own leases. Our leases have things like bed bug provisions, which if you're in the Midwest, you've experienced the pleasure of. If you're in a market that doesn't have them congrats. Things like pest problems and who pays for treatments. And, our lease really covers a lot of ground to protect us as the owner from damage that a potential occupant could do. In my experience, most of the properties we purchased that have residents in them, their leases don't really have some of those necessary provisions. So just keep that in mind.

Andrew: (23:40) Last thing I'll mention on this is if you are buying commercial properties, you should get an estoppel letter, which is just basically you sent it to the tenant and they tell you what's in their lease to make sure that it actually is the same thing. You can do those with apartments too. We don't. Some do. I know Ryan knows some people who would do that. That's I think a little arduous, but we have commercial tenants where they're big parts of like, we're talking about office buildings or something like that, where they make up…


 

Ryan: (24:06) Like $8,000 a month in rent.

Andrew: (24:08) Yes. Yes. Then you want to make sure that they're saying the exact same thing as the lease says.

Ryan: (24:12) And an estoppel Andrew, if I'm correct, that's basically a legal document that they'd basically be perjuring themselves if they falsified. Is that correct?

Andrew: (24:20) I believe so. Yeah. I mean, it's certainly fraud to lie about what's in your lease. And so, I believe that is correct. Yes. So, let's move over to third party inspections. You definitely want to get… So, we don't have an inspector go through it with us on a 30-unit apartment and do every single unit. That'd be very expensive. Well, we generally have them look at our..., whatever. When we do a first walkthrough, we look at everything that we have any questions about. And then we bring an inspector along. And we also, usually hadn't looked through at least one unit entirely. Especially if you're early in your investing career, you probably want to look at least one unit each building if they have separate buildings. But you want to look at least one full unit, possibly a couple more. And you also want to look at any items, any major items and any items that you have questions about.

(25:07) If the electrical panels look odd, you definitely want him to have him look at the electrical panels.

Ryan: (25:12) Boiler systems.

Andrew: (25:13) Boiler systems are always going to be a little bit questionable. So, you definitely want them to look that. We want to look at the electrical panels. You probably can't off the top of your head point out what a Federal Pacific panel looks like. Maybe you can do with a Pushmatic or whatnot, but you want to know these things. Federal Pacific panels have basically been recalled. They're utterly useless. Pushmatic are better, but they're not very good. You want to have them look at all those things. You definitely want to get a roof inspection because especially in apartments, those are going to be extremely expensive. You probably want to get a pest and dry rot inspection to look at whether or not there are carpenter ants, termites, where there's major dry rot issues and things like that. And you want to look these inspections carefully.

Ryan: (25:53) I would also throw sewer or septic on there as well.


 

Andrew: (25:56) You should get the sewer lines scoped. You should do that with houses, anything over the age of 1980, you should probably get anything older than that. Definitely get the sewer scoped and make sure that the sewer line hasn't collapsed or there's no…

Ryan: (26:08) Root intrusion or…

Andrew: (26:11) There might be root intrusions. That doesn't necessarily mean you need to replace them. So, you probably want to be there when the plumber is looking at them. If they're just some roots here and there, they might be like, “Oh yeah, you should probably just replace it to be safe”. No, you can probably scope that out, but you need to know like, Hey, this might be something you need to do fairly regularly.

Ryan: (26:25) Those are great for re-trading.

Andrew: (26:27) Yes, absolutely.

Ryan: (26:28) Here, your sewer system is full of roots. Even if we're not worried about it.

Andrew: (26:31) Inspections are actually the best thing for re-trading. If you can point, “Hey, look at this inspection report says they're carpenter ants in building three” or you've got…

Ryan: (26:40) Bed bugs.

Andrew: (26:41) Bad bugs. You've got federal Pacific electric…

Bill: (26:44) Dry rots.

Andrew: (26:45) Dry rots. All sorts of things. This is the best thing to point to other than your rent roll doesn't actually match up with the leases is the inspection reports. They're very good for re-trading. But you definitely want to, especially new investors, you definitely want to have a third-party inspector, at least look at all the key systems as well as at least one, but probably a couple of units to make sure you get a second set of eyes on it, who are familiar, who are professionals that do this all the time.

Ryan: (27:13) I would also say a special attention on flat roofs.


 

Andrew: (27:16) Oh, yeah, absolutely. Flat roofs are particularly questionable and also particularly expensive. They go out quicker. They have more problems. They shouldn't exist. But you want to make sure…

Bill: Particularly in Oregon.

Ryan: (27:30) Just flex seal it. It's fine. On the third-party inspections, I would also try to see the units they don't want you to see. Because if you say, hey, show me one per building. I mean, I know what I would do. They're going to see my best one in each of those buildings, right?

Andrew: (27:45) Well, you need to walk every single unit.

Bill: (27:47) Yeah, by the time, before you pull the trigger, I would say you walk every unit.

Ryan: (27:51) Absolutely. But I would particularly push the third-party inspector into the units that they initially didn't want to show. because those are, that may be the unit that like, well it leaks in the corner or what have you.

Andrew: (28:05) The units that you noted when you were walking each unit were the worst.

Ryan: (28:08) Correct.

Andrew: (28:09) That would definitely be true. I'd agree with that completely.

Ryan: (28:10) Especially, if there's something you couldn't see or like you couldn't get into a room. We get a lot of that of like, “Oh, like the kid's sleeping”. And it's like, no, the roof caved down in their room. Like come on. So, I would trust but verify.

Andrew: (28:25) I would hope that even a newbie doesn't need a roof inspector to tell them that the roof caved in. But once you have all this stuff gathered, you have from the previous episode, your walkthrough, all of your notes on the repairs, do they align with your expectations upfront once you have all of your financial analysis, your lease analysis, your rent roll analysis, have you looked at their tax returns or at least their bank deposits, whatever you can.

(28:53) After you've looked at your third party inspections, your inspector, your roof inspector, other specialists, phase one, once you've gotten all those third party inspections and as much analysis as you can, at least on the financial side, at this point, you want to get that all done in the first 30 days assuming you have a contract with 30 days until your earnest money goes hard and you need to make a decision. And there's two ways to do this wrong. The first one is to just go in and assume like I plan on re-trading right from the beginning. No matter what, I'm going to find anything I can to just keep negotiating this. You will sooner or later get the reputation of kind of a scumbag.

Ryan: (29:28) Retrader.

Andrew: (29:30) Retrader. This guy is a retrader. And if you're going to be in a big commercial space, you're going to get that reputation. It doesn't mean you don't retrade. It just means don't go in planning to. The second one to have that inertia, that you going through the process of due diligence with a confirmation bias – “I'm trying to prove that this property is what I thought it was”.

Ryan: (29:52) And you are trying to sell yourself on it.

Andrew: (29:54) You don't want to have this sunny optimism or whatever. You want to go in as neutral and as detached and objective as possible. Like we've even had worked around like this sort of a Devil's Advocate where we make a case, “What is our case for not buying this property?” or what is the case? And then if it's just doesn't make any sense, if it's way out there, maybe it's just worth backing out.

Amanda: (30:21) And one thing is once you've been working on something for so long, you feel a certain sense of emotional investment in it. And so, you end up trying to talk yourself into it when all of those red flags are saying, “Don't do it”. But it's like, oh, like I've invested in the inspectors and I've got the phase one and I've done this. Those were all reasons for you to not pull the trigger if you found things that you didn't like. Those are not things for you to say, “I already spent this money so I'm going to keep going forward”. That it takes a strong person to walk away from a situation that they need to walk away from. So, it is good. Like Andrew was saying to like play Devil's Advocate, talk to other people about it. And if you're hearing, you're laying all this stuff out and somebody who saying “Don't do it, don't do it” and you're like, “Oh, but it was $10,000”. Well, that $10,000 could turn into hundreds of thousands of dollars of loss and you were shown all the signs for the reason to not move forward and you moved forward. So, you're looking for reasons to not pull the trigger or else for reasons to get a good discount.

Ryan: (31:34) We all want to be investors but part of being an investor is buying deals that you can make money on. Not just buying deals.

Andrew: (31:42) Including the ones you don't buy.

Bill: (31:44) That's exactly right. And Andrew, you have a really good mindset and going into a negotiation about setting up the seller in terms of this is what I'm expecting to see. And if I see this, there'll be no re-trading. But if I don't see that, then there will be re-trading. I don't know if you want to comment on that but I really like it…

Andrew: (32:05) I include in my LOI what my assumptions are.

Bill: (32:08) What's an LOI? Letter of intent.

Andrew: (32:12) Which is what you send to… You do that before contract with larger purchases, because larger purchases have more complicated contracts. So, this is basically, these are the terms we're offering. Do you accept them? What do you set them in principle? And so ours, I list out what I think the occupancy is, what I think the economic occupancy is, what I think the rehab is, etc. The condition.

(32:31) We had a 72-unit apartment that we were assuming would be around, I don't know, I think it was around $200,000 if I remember correctly. And it ended up being, our new update was more like $450,000. Plus, we thought the occupancy was 90%. They said it got leased up to 90% is at 77%, I think. But it was at least up to 90%, but they didn't include the people moving out. So, it was actually back to 77% when we started due diligence. So, when we looked at, hey, this is almost 15% lower occupancy, it's got much more rehab. Actually, has one less unit. Because it says 72-unit apartment complex, but no, no… Two less because one of their units was used for storage and one was used for the leasing office.

(33:12) Another thing to check on, make sure if they're using a unit for the leasing office, you know that. That's not a rentable unit. That doesn’t count. And when we added all that up, it just didn't make sense. And so, we backed out of that one. Another one had a bit more maintenance than we expected. It was older stuff. A lot of these mom and pop type sit. There's a third unit department, a lot of mismatched carpets, went to this paint store and see like the miss tinted paint. So, everything was different. And so, we had that bit of an issue. We ended up deciding on that one, we would like a bit of a discount. So, we asked for re-trade. We ended up getting $20,000 off. It wasn't a big thing, but it's kind of like you work through kind of figure out what is…

(33:52) Because due diligence is all about like confirming what you thought was true. Did you confirm what we thought was true? If it's better? That's great. Just go with it. If it's worse, they need to see, “Okay, is it just a little bit worse and still make sense? Is it substantially enough that we should actually ask for a discount and go back into negotiation? Or is it just so bad that this is a lost cost and we need to move on?” That's the decision you make.

Bill: (34:14) Well stated.

Andrew: (34:16) I think we have pretty much hit close to the 35 minute mark. I think that's probably enough for this episode. Thank you again for joining us. We very much appreciate it. Again, go to our website, thegoodstewards.com. Also look up us on social media and download our free eBook. Thank you and have a great day.