property evaluation & due diligence

PROPERTY EVALUATION & DUE DILIGENCE

National Apartment Association Education InstituteCertified Apartment Property Supervisor

HOUSEKEEPING Restrooms Breaks Lunch Cellular Phones Smoking

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INTRODUCTIONS Name Company Number of Units How Many Years In

the Business Have you been

involved with the Due Diligence process in your career?

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GROUND RULES Participate fully. Help us stay on track. Be on time Ask questions Offer ideas and opinions as

perceptions Have fun.

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LEARNING OUTCOMES: PROPERTY EVALUATION & DUE DILIGENCE

• Due Diligence Process• Why Owners/Companies

Buy, Sell, & Renovate Properties

• Market Analysis• Property Inspections• Operational and Financial

Analysis• Analyzing and Reporting

Property Evaluation Results

• Property Acquisition• Property Renovation• Property Disposition and

Refinancing• New Development

Feasibility

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1. INTRODUCTION TO PROPERTY EVALUATION AND DUE DILIGENCE

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WHAT IS DUE DILIGENCE

Due diligence means assessing possible risk to the business when a

buyer or investor is considering acquiring, refinancing, or renovating an existing property—or developing a new

one.

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WHO PERFORMS DUE DILIGENCE Buyer has the primary responsibility. The multi-site supervisor:

May lead the evaluation and due diligence process for the owner in a smaller company.

May be a member of a larger due diligence and discovery team and be assigned certain responsibilities in the process.

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TYPES OF RISK TO ASSESS Inflation trends Interest rate changes Management efficiencies Market condition changes Physical improvement needs Obsolescence issues Staff performance Neighborhood or community changes

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OVERVIEW OF THE DUE DILIGENCE PROCESS

Rent Roll Analysis Service and Maintenance Agreements Government Compliance Issues Recorded Documents and Litigation Full Physical Inspections Open Tax Issues Insurance Policies and Risk Management Claims Personal Property Market Conditions

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ACTIVITY: DEBRIEF QUESTIONS

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2. WHY OWNERS/COMPANIES BUY, SELL, & RENOVATE PROPERTIES

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WHY OWNERS BUY, SELL, AND RENOVATE

There are many reasons why owners choose to acquire, sell, or renovate a

property. The chief reason, however, is that owners want to further their

investment goals.

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OWNERSHIP TYPES Individual or Sole Proprietorship Limited Liability Companies S-Corporation Limited Liability Partnership Joint Venture Real Estate Investment Trust (REIT) Tenants In Common

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RENOVATING PROPERTIES Intended to improve the properties’

positions within the marketplace Primary intention of higher rent

production and/or lower operating costs May be necessary in order to maintain

the asset and protect current rent levels

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CURRENT OUTLOOK FOR APARTMENTS Renter-occupied households represent

33% of the number of households in the United States

20 million households moved between 2003 and 2005

The younger the household the more likely you are to find renters

78% of renters have household incomes of less than $50,000

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ACTIVITY: DEBRIEF QUESTIONS

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3. MARKET ANALYSIS

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MARKET ANALYSIS A market study delivers the information

necessary to allow the buyer to make an informed judgment on the value and price of the acquisition.

The evaluation should describe regional economic trends, describe economic, social, and demographic trends in the neighborhood, and prepare a competitive property analysis report.

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THREE COMPONENTS OF A MARKET ANALYSIS

Regional analysis Neighborhood analysis Subject Property analysis

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ANALYZING A REGION

Purpose:

To investigate the economic conditions in the larger geographic area that serves the apartment community

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TYPICAL SOURCES OF DATA U.S. Bureau of the Census (www.census.gov) American Housing Survey

(www.census.gov/hhes/www/ahs.html) U.S. Bureau of Economic Analysis

(www.bea.gov) State Agencies and Local Governments

(www.statelocalgov.net) Local Chambers of Commerce The National Apartment Association’s Annual

Income & Expenses Survey

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KEY ITEMS TO RESEARCH Zoning Restrictions

Rent Control

Building Codes and Restrictions

Infrastructure23

ANALYZING A NEIGHBORHOODPurpose: To investigate the conditions of the immediate marketplace of the subject property identifying strengths and weaknesses of the neighborhood and its offerings:

Neighborhood Amenities

Educational Facilities

Entertainment Venues

Job Sources

Shopping Areas Job Growth Unemployment Rates

Household Formation

Population Growth or Decline

Demographic Data

Population Size Density

Age Race Gender Income Levels

Planned Infrastructure Improvements

Neighborhood Government and Associations

Schools Transportation

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NEIGHBORHOOD BOUNDARIES The property’s neighborhood is a small

geographical area, such as a few multiple blocks.

The boundaries can be natural, such as rivers and lakes, or manmade barriers, such as streets and highways.

Competition defines the physical perimeter within which prospects are looking at properties.

A map can be used to plot competition, work locations and city services.

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ANALYZING THE COMPETITION

Review property records Review public records Review publications Talk with local industry professionals Talk with local multifamily brokers Shop competitors

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UNDERSTAND SUPPLY & DEMAND Supply refers to the number of

apartments available in the market at a given time.

Demand is the need or request for those available apartments.

If Supply is less than Demand – the value and rent of the apartments increase.

If Supply is greater than Demand - there is a decline in rents and difficulty leasing.

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ABSORPTION RATEUnits Vacant At the

Beginning of a Perio

d

Units Built during the

period

Units Demolished

or removed from suppl

y

Vacant

Units at

End of

Period

Units

Absorbed

•When supply is less than demand = vacancy decreases and absorption is positive. •When supply greater than demand = vacancy increases and there is negative absorption. • Understanding the circumstances that caused this is important. 28

RENTAL COMPARISONCreate a market rental schedule for each competitor and compile a rental comparison chart. The chart compares base rents and market rents. Compare specifically:

Unit type Square footage Market rent including additional recurring charges for

amenities Market rent per square foot Amenities Incentives – these will reduce market rents to effective

rents

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ACTIVITY: DEBRIEF QUESTIONS

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4. PROPERTY INSPECTIONS

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PROPERTY INSPECTIONSThe property inspection should identify any environmental issues and document the review of: Exterior structures Interior apartment units Mechanical facilities Maintenance Leasing/business offices Common areas and amenities

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BEGINNING THE INSPECTION Owner’s objectives and purpose of the inspection Inspection checklists for all inspections Proper recording equipment. Cooperate with current onsite management Legal notices if required Minimum disruption to current management and

residents.

NOTE: Sellers sometimes do not tell existing site personnel about considering selling a property. Make sure you are aware

of what information the current onsite team knows.

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EVALUATION STEPSLook for Deferred Maintenance

Functional Obsolescence

Economic Obsolescence

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ENVIRONMENTAL INSPECTIONS Most lenders and prudent buyers will require

a Phase I Environmental Survey before funding a loan or acquiring a property.

Based on the extent of any renovation or rehab, environmental inspections may also be required.

This is especially true with regard to asbestos, lead, mold and other indoor air quality assessments.

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PROPERTY EXTERIOR INSPECTIONS Hazards & Liability Resident Safety Drainage and

Irrigation Systems Landscaping Garages and

Covered Parking Trash Containers

and Compacters

Drives/Parking Areas Perimeter Fencing or

Enclosures Access Gates Sidewalks Energy Evaluation

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BUILDING INSPECTIONS Roofs Façade and Carpentry Foundations Building Envelope (Windows and Doors) Decorative Items (Shutters, Vents, Etc.)

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ACCESSIBILITY INSPECTIONS Parking Entryways Corridors Stairs Elevators Drinking

fountains Bathrooms Alarms

Signs Phones Common areas Building to

Building Access Access to

office/units

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MECHANICAL INSPECTIONSMechanical inspections include the major systems that serve the property, such as: •Electricity•Gas•Water•Sewer•HVAC• Fire Safety Systems • Internet/Fiber Lines

•Elevators• Irrigation•CATV•SATV•Controlled Access •Telephone service•Trash disposal

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INTERIOR INSPECTIONS

Individual

Units

Common

Areas

Recreational

Facilities

Employee

Work Areas

Storage Areas

Commercial Areas

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PUT ON YOUR MARKETING HAT!Will the property be marketable?

First ImpressionsSignageExterior AppearanceUnit Interiors

Considering inspection and market conditions, will the acquisition or renovation produce a marketable product?

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ACTIVITY: DEBRIEF

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5. OPERATIONAL AND FINANCIAL ANALYSIS

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ANALYZING INCOME SOURCES Rent Fees utilities Fees for garage or parking spaces Fees for pets Fees for cable, recreational amenities or

other services Income from laundry and vending facilities Income from furniture or equipment rentals Administrative fees

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RENT ROLL ANALYSIS

The rent roll is a record of occupancy and collection activity at a given time. It allows

you to compare rent potential with lost income due to vacancy, concessions, and

collection loss.

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LEASE FILE AUDITS Rental Application Lease Processing Checklist Lease Agreement Lease Addenda (Community Policies,

RUBS, Sub-metering, Safety, Access Gate) Move-In Inventory and Condition Pet Agreement, if applicable Anything Else Required By Law

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ANALYZING EXPENSES When evaluating a potential

acquisition, it is necessary to analyze current and potential expenses in three areas: Operating Expenses Capital Expenditures Renovation Expenses and Costs

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CRITICAL OPERATING AND FINANCIAL INFORMATION REVIEW

Current vs. Post Property Taxes Expected Insurance Costs Management Fees All service contracts – Do they survive

an ownership change? Delinquency – Who will own the bad

debt? Personal Property Inventory Others?

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ACTIVITY: DEBRIEF QUESTIONS

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6. ANALYZING AND REPORTING PROPERTY EVALUATION RESULTS

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THE EVALUATION REPORT SHOULD INCLUDE:

Market and competitive surveys Regional and neighborhood analyses Interior and exterior property

inspections Income and expense analysis Lease file audit findings Budgets and recommendations

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KEY CONTENT FOR A DUE DILIGENCE REPORT

Section 1: Title Page Section 2: Letter of Transmittal Section 3: Description of the Property Section 4: Market Analysis Section 5: Physical Condition of the Property Section 6: Operational Analysis Section 7: Conclusions and

Recommendations Section 8: Disclaimer

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7. PROPERTY ACQUISITION

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PROPERTY ACQUISITION AND MANAGEMENT CHANGE

The Property Supervisor plays a critical role in the smooth and successful transition from one

owner and/or manager to another.

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CHANGE IN MANAGEMENTCritical Areas to Anticipate

Insurance coverageUtility and bank notificationsResident communicationStaff alignment and benefitsMarketing and market presenceForms and legal documents

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CLOSING DOCUMENTS The current rent roll at closing All original lease agreements and resident files Security deposit list and funding instructions Property tax records Utility accounts list and unpaid bills Outstanding bills if the purchaser agreed to assume

them as a condition of closing List of vendors used by the property Current vendor and service contracts Pest inspection records Inventory of personal property Physical inspection reports written for the owner Legal records

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FIRST DAYS AND WEEK AT THE PROPERTYThese are critical days in which to:

Welcome and evaluate new staffManage risk and liability issuesAddress open legal issuesCommunicate with residents and vendorsPlan maintenance programRamp up leasing and marketing plansOrganize administrative and financial areas 57

ACTIVITY: DEBRIEF QUESTIONS

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8. PROPERTY RENOVATION

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PERFORMING A NEEDS ASSESSMENT Projecting the costs and benefits,

including the property’s repositioning that might result

Participating in the bid and contract process

Handling leasing and marketing during renovation

Evaluating whether renovation meets the owner’s objectives

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QUESTIONS TO ANSWER BEFORE STARTING

How will this renovation impact my stabilized residents?

How will this renovation impact my occupancy?

How will this renovation impact the leasing process?

Are there safety concerns to employees, residents, prospects, or guests during this renovation?

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ACTIVITY: RENOVATIONS - WHAT WOULD YOU HAVE DONE DIFFERENTLY?

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9. PROPERTY DISPOSITION AND REFINANCING

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BEFORE A PROPERTY DISPOSITION

Consider the potential benefit of leverage

Consider expected future property performance

Consider market conditions for sellers Consider financing and refinancing

options Consider ownership wishes

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REFINANCING Equity builds over time Loan balance relative to current value

lessens Less financial leverage Refinancing increases the property’s

financial leverage Refinancing provides additional

investment funds. Refinancing is an alternative to a sale

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REFINANCINGThe borrower must evaluate the incremental cost of the refinancing. If the interest rate on the new funds

borrowed is higher than the interest rate on the current loan, the incremental cost is even higher than rate on the new funds.

If the rate were lower, there would also be a lower incremental cost of the additional funds.

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10. NEW DEVELOPMENT FEASIBILITY

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FEASIBILITY FOR NEW DEVELOPMENT

When evaluating a potential, to-be-built property, it is critical to understand the proposeddevelopment’s market supply and demand.

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AREAS OF A FEASIBILITY ANALYSIS Supply and Demand Issues Cost Feasibility General Market Absorption Location relative to the anticipated

demand Financing Costs Income and Expense Projections Lease Up Projections

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ACTIVITY: DEBRIEF QUESTIONS

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11. KEY TAKEAWAYS AND CLOSING

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LEARNING RECAP: PROPERTY EVALUATION & DUE DILIGENCE

• Due Diligence Process• Why Owners/Companies

Buy, Sell, & Renovate Properties

• Market Analysis• Property Inspections Operational and

Financial Analysis• Analyzing and Reporting

Property Evaluation Results

• Property Acquisition• Property Renovation• Property Disposition and

Refinancing• New Development

Feasibility

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ACTION PLAN

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THE ACTION PLAN This plan is yours and yours alone You decide on which areas you want to

work You set the number of goals You decide on the action steps and

timeline.

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