Confused about Deal Flow

[Matthew Fiebig]

Hello,

I am a new to the area of real estate and one of the biggest problems stopping me from investing is that I do not understand the general flow "the deal". I'm specifically interested in this from the perspective of acquiring apartment buildings in Washington state.


As I understand it, the flow occurs something like this:

Acquire Lead

Letter of Intent
Acquire Finacials (P&Ls)

Negotiate Offer
Under Contract
Due Dilligence (Rent Rolls, Structure, Title, etc)
Escrow
Management Reorg

The part I'm confused about is Due Diligence is likely where the treasure trove of info is going to be, but by the time I reveal that information, I'm already under contract. If I find something unfavorable to the seller how do I get out of the contract and negotiate a better price?

I feel very uncomfortable making an offer without that due dilligence info, but as I understand it, that comes after the contract is executed.

[Eric Fernwood]

Hello @Matthew Fiebig ,

I am a Realtor in Las Vegas and I do not know about Washington state contracts. However, the contracts should be similar so I will explain the process here.

The Las Vegas purchase contract has a period of time called the due-diligence period. I typically set the period to be 10 days with single family homes and 20 days with most multi-unit properties. During the due-diligence period the buyer can terminate the contract for any reason and get their earnest money back. You need to have similar verbiage in your purchase contract. If not, then you have the wrong contract. Below is the actual verbiage from the Las Vegas contract.

"Due Diligence Period: Buyer shall have ____ calendar days from Acceptance to complete Buyer's Due Diligence. Buyer shall ensure that all inspections and certifications are initiated in a timely manner as to complete the Due Diligence in the time outlined herein. (If utilities are not supplied by the deadline referenced herein or if the disclosures not delivered to Buyer by the deadline referenced herein, then Buyer's Due Diligence Period will be extended by the same number of calendar days that Seller delayed supplying the utilities or delivering the disclosures, whichever is longer.) During this period Buyer shall have the exclusive right at Buyer's discretion to cancel this Agreement. In the event of such cancellation, unless otherwise agreed herein, the EMD will be refunded to Buyer. If Buyer provides Seller with notice of objections, the Due Diligence Period will be extended by the same number of calendar days that it takes Seller to respond in writing to Buyer's objections. If Buyer fails to cancel this Agreement within the Due Diligence Period (as it may be extended), Buyer will be deemed to have waived the right to cancel under this section."

A few thoughts on due-diligence of multi-unit properties:

• Add verbiage to the contract that the due-diligence period starts upon I have access, utilities are on, I have copies of all lease agreements and access to their record of rent deposits.
• Never believe anyone’s books. Not infrequently they have generated some just for the sale.
• Make a point to talk to all tenants. What you want to ask are things like: are there any maintenance issues of which you are aware. Are you planning to renew you lease? If not, why? How much are you paying per month? Are there any changes you would like to see to the building?
• Have an qualified inspector go over each unit and the building in detail. Pay special attention to the roof and drainage. Check the water pressure. I find a lot of (expensive) deferred maintenance issues on the multi-unit properties here so be careful.

Keep in mind that multi-family properties have different characteristics than single family properties. For example, multi-family properties are generally only purchased by investors. Investors determine the value of a property based almost exclusively on its rate of return (or cap rate). If rents don't rise then the property value does not rise. So, unlike single family properties, multi-family property appreciation is largely based on rising rents. This means that if you are in a market where rents have been (and are likely to remain) flat, you need to consider a multi-family property only for cash flow; not for appreciation.

Multi-family advantages:

• Lower rental risk. A single-family property is either 100% occupied or 100% vacant. With a multi-family property if one unit is vacant you still receive a portion of the rent. With multi-family properties, vacancy risk is distributed across multiple units.
• Per unit cost is much lower with multi-family than single-family homes.
• Multi-family properties with four units or less (currently) qualify for standard 20% down investor loans. This is very attractive. My understanding is that more than 4 units may require commercial financing which is a more complex and expensive financing option.

Single-family home advantages:

• In Las Vegas, tenants in single family homes tend to move less frequently than the single people who are the dominate renters of multi-family properties. I believe this is because people who rent single family homes tend to be families with children. Parents want to provide stability for their children and thus do not want to move them to another school district.
• When it comes the time to sell, you have two potential buying groups with single family homes: investors and home owners. You could be in a market where rents are not increasing (so CAP rate valued properties do not increase in value) but the prices of single family homes are increasing. Or, you could be in a market where rents are increasing but property values are static.
• Financing is usually easier with a single family home investment loan.

Other multi-family vs. single-family considerations:

• In Las Vegas, multi-family seems to appeal to a different market segment than single-family. Because of the different market segments, the vacancy rate can be very different between the two. For example, currently the vacancy rate for multi-family properties is about 15%. For single family homes it is closer to 5%.

Matthew, I hope the above helps. Do not hesitate to post questions or drop me an email if I can help.

Best Wishes,