Expert: Troy Labani - 3/29/2009

Question
QUESTION: I am a first time buyer of an 8 unit apartment building.  What are the important questions i should ask when inquiring about the building?  Can I ask for Schedule E? I just want to make sure I ask the right questions.  I am going to look at it tomorrow.  Thanks.

ANSWER: Sandy,

Congratulations on your first deal! I hope that you are very successful with it, and go on from it to do many more.

Your question is a very good one. First, yes, you can request nearly anything that you like by way of documentation from the seller to verify their claims of income and expense. Not all owners and operators might use schedule E though, and as well, the asset it self could be only part of a partnership which holds numerous assets and therefore the income or loss may be indiscernible with respect to the specific property that you are looking at.

It is always a good idea to request from the seller a "certified" financial statement which reflects all income and expense for the property. A "certified" financial statement will give you recourse against the seller in the event that you find later that the financial performance was not truthfully reported. The good news, is that few sellers, and even fewer brokers, are willing to misrepresent financial data with false numbers. Typically, those inclined to misrepresent, will do so by omission. Meaning that they simply wont give you all of the expenses that were actually incurred. Or even more likely, will try to focus your attention on "potential" income and expense, not the historic. Requiring the seller to provide you with a "certified" financial statement or statements, simply means that attached to the financial statement is language similar to; "I (the owners Name) hereby certify the attached financial statements for (the name & address of the property) are a true and accurate accounting of all income and expense which occurred during the reported period (date to date) and that all income and expense figures herein represented can be relied upon by the buyer as accurate in making their decision to close the purchase of said property".

It truly depends on the property and it's operating condition at the time of your purchase, and for the preceding period as far back as two or three years how much, and what, you should ask for. If the seller has owned the property for only a short period of time, I am generally very suspicious of their financials. I have a few "tricks" I use to "verify" their information. One, is to ask for, subsequent to their providing operating figures, written authorization to verify their data with the source such as utilities, insurance, and vendors. You can learn a great deal from all of these. For instance, with authorization for utility data, you can accurately see any major occupancy swings by looking for changes in water consumption. If a property has had high vacancy the use of water is typically diminished and a good thermometer. Certainly take into account seasonal changes that would affect this. The same sensibility applies to talking to the carpet cleaning company, if they have cleaned carpets far more than the rent roll reflects move ins and move outs, then you will know their information is inaccurate.

I have a "standard" set of things that I usually request at the time I write my letter of intent. Those are; A "certified" copy of the current rent roll to include move in and move out date, lease expiration date, rental amount, deposit paid, name, and unit number. Copies of all leases, and addendums, a 12 month financial operating history shown by month, which includes all income and expense for the period, any relevant past or pending legal issues affecting the property, employee records and payroll data if any, all existing contracts for service or otherwise associated with the property and all work order or resident requests and or complaints received by the operator, and "any other information known to the seller to affect or potentially affect the operation of the property".

These documents will, collectively, give you a fairly accurate assesment tool to determine the true operating history on the property, and the last line, will cover any "secrets" the seller may be trying to avoid telling you about like market conditions that are about to change, local government issues, etc. It is also advisable to request that the seller provide you with copies of any permits that may have been pulled, or code violations that may have been issued, related to the property.

Even if you are looking at the nicest property, in the best of markets, the above should be absolutes that you review. Of course in addition, and typically a required part of the contact for purchase, is the sellers responsibility to provide you with title information. You MUST review it, and accept it or deal with any issues that may present there.

In addition to all of this, I usually want a direct answer from the seller as to their reason for selling the property. I ask for this in the form of a written summary of their experience with the property and reason for the sale. Most sellers will be happy to provide such a short "story" if asked.

I hope that I have given you a good idea of the detail to which you should investigate. While you did not ask, I would also strongly recommend that you inquire with nearby competing properties about their own operations, and their knowledge of your target property. This is usually VERY helpful in learning about the market and your target, as well it gives you good working knowledge of your competition and ideas on how to out lease them!

I wish you the greatest of luck, and again congratulations!

---------- FOLLOW-UP ----------

QUESTION: Thank you so much for all the info.  I have just found out the building is an REO and is held by the Bank of NY.  It is being sold as is. (disappointment)  I'm still going to go look at it.  How do I look up any history on this building.  I have the pin number and got the taxes paid on the building which are current. It is  only a 5-unit not an 8 unit as first discribed.

Answer
REO property can be very rewarding, and open doors of commonly unknown opportunity. The REO manager for the entity that has the debt may or may not be able to answer your questions. That will depend on their policy, and possibly legal limitations. It is not unusual that you may only be able to get information from the broker who has the property listed. Ask the broker what the limits are, if any, to your communicating with the REO manager. Sadly, often the REO manager has very little information besides that which became available through the foreclosure process. The good news is that most of that information is public record, and can be obtained from the court.

In most cases, it is just "in the trenches" investigative work to get the important information you may want. Much of what I explained earlier still applies, though the source is different. That means instead of the seller being the previous owner, the seller is the bank, or in lieu of, the broker. As an additional source, you might research the local news paper, looking back through the past three years, looking for both articles and advertisements. Think creatively, what is the old phone number, property name, etc. to use as search parameters. And certainly, armed with a copy of the title report, you might contact prior owners of the property. This is a potential gold mine of information, but can also create competition. That said, it is important to mention that really none of the work I have suggested is advisable unless you control the deal. What I mean by that is that you have an accepted, well written offer. A well written offer, in addition to giving you exclusive right to purchase for some term, will give you a way out of the deal without penalty, and a way to modify your purchase price down if, among other things, you discover information that is contrary to that which was presented in the marketing package you initially received. The issue here is investing a great deal of time and energy in a deal that you may not even be able to close.

When all is said and done, it is the physical plant, the market you will serve with the property, and the economics of the deal, both short and long term. In more lay terms, if the physical property is in good condition, or can be economically refurbished, and the market you intend to rent to has demand, and you can bring the product to that market and do so with sufficient return on your investment to satisfy your requirements, then past history and all of the other issues are truly minimal in their importance. Good deals are never "found" they are created. If you could simply look for them and "find" them, they would be found by someone usually long before you became aware they were there.

I hope that I have been helpful, and again wish you success in your deal. Feel free to e-mail me at apt.equity@gmail.com if I can be of assistance specific to this deal, and not best shared in this forum.