8B — March 29 - April 11, 2019 — POA Expo 2019 — Owners, Developers & Managers — M id A tlantic
Real Estate Journal
www.marejournal.com
POA/Expo 2019 By Bruce E. Gudin, Esq., Ehrlich, Petriello, Gudin & Plaza, PC
Performing your real estate due diligence
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ver the years, our firm has been engaged by a wide range of real es-
be required before the deal is closed, there is going to be au- tomatic trouble in getting to the closing table. When a seller is presented with a thorough list of required due diligence items by a prospective purchaser, the seller can be overwhelmed. Many of the items that must be examined are personal and private, i.e., tax returns, and sellers are not usually comfort- able with just "turning loose a box of documents." Including a list of required due diligence items, therefore, is essential in the purchase agreement and it is expected that there will be some nego- tiation as to what will and will not make it to the final draft. Ample time (at least 30 days AFTER the delivery of all doc- uments) should be provided to complete due diligence. Agree- ments should state that the purchaser must give written notice that all due diligence is complete and satisfactory, or that there would be no further obligation to proceed with the transaction. Gener- ally, due diligence should not be undertaken until after the contract is executed by all parties. Any time triggers should be tied to the delivery date of the LAST document supplied by the seller, with provisions for the extension of time based on the appearance of any non-disclosed material documentation. By requiring written acceptance of the due diligence items, control of the deal can be maintained. PROCEEDING WITH DUE DILIGENCE - LEAVE NO STONE UNTURNED Beyond the physical condi- tion of the property (discussed below), there are a multitude of intangibles that must be taken into account when eval- uating a site for acquisition. Literally EVERY document concerning the land, building and its operation MUST be examined. This includes leases (with any and all extensions and modifications), notes and mortgages, (whether the buy- ers are assuming them or not), title policy, certificate of oc- cupancy, New Jersey Depart- ment of Community Affairs (DCA) "green cards" insurance policy(s), ADA compliance, el- evator maintenance contracts, tax history, licenses (in some jurisdictions), parking lot con- tracts, etc. There are sophisticated companies that provide due diligence services. Several
provide their clients with a detailed market analysis of income, operating expenses, vacancy rates, rental com- petition, sold comparables, on-market competition, and available sources of financing. They will also gain knowledge of the property and all inter- nal and external factors likely to affect its economic health, now and in the future. The benefit of having an independent evaluation en- sures that an enlightened and clear assessment of a project's potential and pitfalls will be exposed. This is especially so if a buyer does not have enough experience in real estate in- vestment to do a complete and thorough job. The detriment is usually the cost. An evaluation of factors which an astute purchaser must consider includes: (1) Cash flow projections; (2) Appraisal, environmen- tal and engineering reports; (3) Sales and rental compa- rables; (4) Market trends and prop- erty values; and (5) Financing strategies and alternatives. To accomplish these 5 broad evaluations, a buyer should request that the seller produce the following documentation. These are not exhaustive lists. • Financial statements • At least one year of monthly P & Ls (preferably two years) • Balance sheet (three years) • Rent roll including term, deposit and payment history • Tax returns - three years (five years preferred) • Insurance - policy, including all riders, risk assessments and disclosure affidavit for carrier • Existing loan documents including notes, deeds of trust, closing statements and title policy rate riders • All leases, entire copies plus any addendums or riders • All security deposit records • Any service contracts - trash, extermination, maintenance, management, commission agreements, union agree- ments, vending, billboard, pay telephone, etc. and any contract to be assumed by purchaser • Copies of all prior apprais- als, engineering reports, en- vironmental reports • Survey (as built), legal description, architectural and engineering plans and specifications • Payroll register, list of
employees including name, position, wage rate and en- titled benefits • Business licenses • Utility bills - water, sewer, gas, electric (at least two years of monthly statements) (or recap report from provider showing usage and cost) • Fire system inspection reports • Property tax bills for the past three years • Litigation history - details of any past or pending litiga- tion (if none, then affidavit from owner) • Tax appeal status, if any • Department of Community Affairs (DCA) "green card" with prior inspection reports When considering the ex- ternal physical conditions of a target property, an informed purchaser is well advised to secure the services of a licensed inspection service. Depending on the nature of the physical attributes of the property, the following items should be considered: • Engineering inspection and survey • Environmental inspection and survey; key issues: as- bestos, lead paint, testing of underground tanks, wetlands • Environmental Phase One • Environmental Phase Two Assessment/Subsurface In- vestigation if recommended by the Phase One inspection, which may include but are not limited to subsurface drilling and sampling, moni- toring well installation and sampling, ground penetrating radar, and asbestos and lead sampling • Survey for abandoned un- derground storage tanks • Type of roof - consider num- ber of layers of roofing mate- rial installed and identify evidence of damage • Assess leaks or moisture damage inside the structure (both roof and basement) • Drainage system should direct water ways from the structure • Availability of municipal water and sewer • External electrical connec- tions and boxes • Condition of chimneys. If the chimneys are masonry, are there signs of loose mortar. If the chimneys are metal, are there signs of rust or corrosion • Cracks in sidewalks or drive- ways that are large enough to present a tripping hazard Condition of any retaining walls. Signs of movement
• Major cracks, bulges, or other visible signs of settle- ment in the foundation. Condi- tion of the exterior surface of the foundation, especially at ground level • Has the septic tank been cleaned and inspected • Have handrails been in- stalled where needed When considering the internal conditions of a particular piece of improved real estate, one should consider the following items: • Are ground-fault breakers installed at bathrooms, kitch- ens, outside and other wet locations • Have modern garage door openers been installed that will reverse if someone be- comes trapped underneath • Age of heating system - equipped with modern safety controls; also when it was last serviced • Signs of rust corrosion or scorching around heating unit • Sufficient source of outside air provided to the heating system • Condition of piping or duc- twork • Test heating equipment for carbon monoxide production • Carbon monoxide alarms installed/tested • Smoke detectors installed/ tested • Cracks or bulges at the inte- rior finish surfaces • Do doors or windows bind in their openings, or are the openings out of square • Are interior floors level • Is there any earth/wood contact in the crawl space or basement • If there sufficient fireproof barrier to utility rooms and garage • Is there sufficient electrical service • Is structure insulated to typical standards • Was urea-formaldehyde or asbestos-containing insula- tion used • Property serviced by private water or sewer systems. • Water-potability test and a drawn-down test • Main water shut-off valve operational and accessible • Is there a main sewer clean- out • Is there sufficient water pressure • Age of water heater and properly installed tempera- ture and pressure relief valve One result of a thorough due diligence process is that continued on page 18B
tate buyers ranging from the first-time home buyer to the highly sophisticat- ed organiza- tion looking to purchase a major com-
Bruce E. Gudin
mercial site. Regardless of the nature of the proposed acqui- sition, we advise each one to perform their real estate due diligence. A thorough due diligence assessment process removes uncertainty from key deci- sions that must be made when analyzing the cost/benefit of any real estate transaction. A comprehensive inquiry should be designed to provide a buyer with clear pictures of where their strategies and decisions are taking them, or to put it simply - what it is they are buying. Even though the term "due diligence" may seem daunting, it can be defined simply as "the responsibilities of a person or business to exercise proper care and planning prior to making any business decision, or entering into any business venture." There are a multitude of de- tails whichmust be considered when dealing with purchasing a parcel of real estate. Many of these details are easily overlooked. The function of due diligence is to indepen- dently verify all representa- tions made by a prospective seller as well as to uncover pertinent facts which have not been disclosed but which are important to the buyer. A multi-tenant property, ei- ther residential, office/retail or mixed use is the most complex for evaluation purposes. I have attempted to put together a detailed outline of what should be considered both by the nov- ice, as well as the seasoned real estate professional in con- nection with performing real estate due diligence. Even in a high-performance real estate marketplace, astute investors and lenders know to look both ways before they leap. After identifying a target property, due diligence starts during the contract negotiation stage. Unless the seller under- stands at the beginning of the process what document produc- tion and other information, will
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