How to verify rentroll in multi-family property due diligence ?

Question

Hi Fellow Investors,

I am in contract with 30 unit apartment complex. Sellers, 3 months ago moved over Property from 3rd party Property Management company to his in-house property management company.

Questions:

1. How do I verify if the rents claimed in rentroll are accurate and not delinquent or incorrect besides looking at leases.

2. Can their be another catch or mis-representation seller trying to do by moving over property into in-house property management ?

Will highly appreciate your guidance or response on this

Thanks, Gary

Jill F. · Answer

We have had, on multiple occasions situations where the security deposit listed in the lease had previously been applied to rent or water bills and was therefore not transferred to us. We have had multiple tenants make claims regarding promises of former owner for upgrades or lease terms We have also had cases where the tenant was paying a different amount (both more and less) than was specified in the lease.

Estoppels make sure the buyer, the tenant and the seller are all on the same page. Both tenants and sellers go on record regarding the current status of security deposits, ownership of appliances, pet deposits, water deposits, current rent amount etc. The lease is often a picture of a point in time. We have inherited numerous tenants living in properties with an oral lease with the seller and have bought properties where the tenant names were not even completely documented-- all they had was a first name and an oral lease (jodi, apt. #1, 375.00, tommie smith, apt #2 ) We have tenants where the original lease holders have moved out and left adult children who never signed a new lease.

And we have never received a full set of working keys from any seller ever.

The seller will be out of the picture when once you close. Estoppels help you avoid disagreements, bad feelings, and court with the tenants that you will have to deal with. You say if old landlord promised you new paint and carpet when you resigned why did you sign an estoppel saying otherwise? Oh you had security deposit, well you signed an estoppel saying your security deposit was applied to your rent in 2018. It also prevents unethical sellers from saying they applied the  security deposit to past due rent back in 2008. Estoppells also helps avoid disagreements over the ownership of appliances.

Jill F. · Answer

Require estoppels signed by owners and tenants verifying rent, all deposits (security, water, pet, etc), and past due amounts and the fact that no other promises have been made by owners to tenants.

Steve Morris · Answer

First thing in any case - GET COPIES OF THE ORIGINAL SIGNED LEASES.  Your PSA should have some sort of assignment/assumption of them.  Then you match them up to the rent roll.

Title will need it anyways to do prorates on rents and refundable deposits (those are tenant monies that go with the building).

On REFUNDABLE deposits, if they total $200K, then you should see a $200K credit and seller gets a $200K debit since he'll keep the amount of the deposits he collected.  Sometimes, he can assign a 3rd party account, but its more cumbersome and the same thing.

As far as collections, that's a tougher question.  Usually title will have to make some assumptions at close.

For example, if total rent due on the 1st is $100K and you close effective the 20th, they'll assume seller collected 100% of rents (make sure this is clear).  Title will credit you 10/30 of $100K and debit seller for same amount.

Sticky issue is if the seller is owed previous months rent he hasn't collected, but you did.  Those should be their money.

Anyways, ask title and the seller's agent on this since you need to understand.

Steve Morris · Answer

In a nutshell, here's my issue with estoppel.  You may have 2 docs regarding tenant occupancy that disagree.

If I'm a buyer, my defenses are it wasn't written, tenant has no proof and I had no clue - Which is a decent defense.

If a tenant lawyer gets those two docs (lease and estoppel), first thing is there are two that disagree so anything is fair game.  Next thing is, buyer got notice and seller didn't fix something right or didn't pay contractors (mechanics lien).

I'm not trying to discourage estoppels since they do serve a purpose in other types of commercial properties, I think for apts, they just add murkiness.

However, give me a real example where the estoppel saved you if the lease didn't, maybe I"m wrong?

Dan Biber · Answer

Great question.  We ask for several items from the seller in form of a due diligence checklist that's part of the PSA as an exhibit.

1. IRS 8825 form.  Shows what they've reported to IRS in prior years, which should match up with P&L for those same years.

2. Certified rent roll.  Seller certifies it is correct and you could have an "hold back escrow agreement" holding back a certain amount of $$ in escrow after closing to protect buyer in case of false representations and warranties from seller.  Can't really sue the seller since most commercial real estate is held in single purpose entities that get dissolved soon after closing.

3. Copies of monthly bank statements showing exactly what has been deposited.

I would find a way to contact the previous mgmt company and find out what happened.  Typically, seller going to in-house and going through the efforts while the property is already under contract is certainly suspicious.

Good luck,

Dan Biber

Jill F. · Answer

@Steve Morris Here any collections of past due rents go to the current lessor so long as the previous lessor hadn't already filed an eviction on the delinquent tenant. We rarely have to go to court, but we have found that estoppels (of course in addition to signed original leases) help avoid disagreements (& lies) and bad feelings.

Steve Morris · Answer

Interesting, almost never use estoppels on apartments (on retail/industrial they do) in OR.

Almost always, the tenant-signed lease is as enforceable (and lawyers/courts get it a lot better) than an estoppel.  The whole idea of making something NOT in the lease (verbal promises) part of the estoppel is an issue.

On past due amounts, that's the seller's issue for collections.  Assumption is buyer gets property with all rents current.

How to verify rentroll in multi-family property due diligence ?

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