Organizing and professionally presenting your due diligence documentation always enhances the probability of consummating a sale. Excluding the buyer’s review process, lenders and appraisers more than ever are scrutinizing and analyzing all aspects of the due diligence documentation.
The current lending problems created by Wall Street and the subprime loan industry have virtually shut down the usual and customary lending practices. In the past, sellers and brokers could put a “happy face” on due diligence records and projections. This practice is no longer acceptable and does not work.
At a minimum, financial records for self-storage investment properties must corroborate and confirm adequate cash flow, market strength and historical financial stability. Without these general factors intact and verifiable, the probability of securing traditional bank financing is limited if not impossible. Therefore, absent of seller financing, accurate due diligence documentation will “make or break” the deal.
The Right Documentation
Every property has distinctive, idiosyncratic features. Be prepared to review your property with the buyer in order to conduct a thorough due diligence. The creation of a due diligence document binder is a critical step in the process. If possible, the information should be saved electronically for ease of transmission to interested parties.
The binder should contain all the necessary documents a potential buyer and lender will need to review during the evaluation period. This procedure will expedite the due document review process and flush out potential problems. A non-exhaustive list of information that may satisfy a prospective purchaser’s information needs includes:
- Bank statements (two years)
- Real property tax invoices (two years)
- Rent roll including term and payment history
- Tax returns (three years)
- Insurance policy (including riders, risk assessments and carrier affidavit)
- Personal property
- Utility bills
- Income statements (current year-to-date and last two years, both detail and summary information)
- Occupancy reports (current year-to-date and last two years, both detail and summary information)
- Service agreements (cancellation rights/penalties)
- Preliminary title report and legal description
- Site plan
- Lot size and zoning information
- Architectural drawings
- Licenses (description and name of licensed entity)
- Lease(s), sublease(s) and/or operating agreement(s)
- Natural hazard disclosure report
- Ground lease (if applicable)
As with any real estate transaction, unnecessary holdups or information gaps cause deals to be delayed or cancelled. The potential buyer needs to be provided with all due diligence information promptly and within the prescribed time frame documented in the purchase agreement. This will ensure the property will not remain off-market for an extended period of time in the event the buyer decides not to proceed with the transaction.
Provide the buyer with a detailed checklist of documents that were provided with a short description of each item and the source of the information (i.e., public records, tax assessor, court, etc.). Also include contact information, e-mail addresses, phone numbers, etc.
In the event a document is not included, provide an explanation as to why it was omitted. This procedure should prevent unnecessary delays during the buyers due diligence review period. Remember, any inaccuracies in the information provided to the buyer will cast doubt on the transaction and may lead to greater uncertainties, which may equate to increased perceived risk, possibly leading to a lower selling price or cancellation of the transaction.
A prudent and experienced buyer will look for omissions or the lack of accurate information. Inaccurate or incomplete disclosures predictably result in the buyer spending more time fully evaluating the property. This could also exert downward pressure on the property value as well as delay a timely closing.
It is always a sensible and practical policy for the seller to disclose all aspects of the property. Not doing so could lead to post-closing issues including but not limited to potential legal action.
Carefully walk the exterior of the building and note any unusual items in need of repair. If any construction deficiencies are detected, contact a professional who specializes in potential construction defects. Any questionable construction that may not meet current building codes needs to be addressed with the seller and, if necessary, corrected.
Other general mechanical items that need to be examined include elevators, HVAC systems, security systems, fire sprinkler systems and telephone systems. Get a copy of the roof warranty, if available. If the document is not available, have the roof professionally inspected.
Your due diligence should also include a thorough interior inspection. Look for any problems you’ll have to fix in the coming years. Watch for water or fire damage or vector issues. Some fire departments will conduct a free inspection to verify the building meets current municipal codes. If possible, casually speak with some of the tenants without disclosing your identity and intentions. You don’t want to unnecessarily alert anyone to a pending sale. In short, leave no stone unturned.
What Really Matters
The primary and most important result of thorough due diligence is a smooth and uncomplicated financing and closing of the property. A secondary benefit will be your industry reputation. When you go to market with your next property, your track record will speak for itself, and investors will have a level of comfort with the due diligence information you provide.
Finally, I always recommend the seller and/or buyer consult with legal and financial advisors to confirm due documentation is acceptable for either party. This discussion is only intended as basic coverage of due diligence mechanics.
Stephen I. Grossman is a senior vice president with Lee & Associates, Newport Beach Inc., which specializes in self-storage brokerage. Grossman has been responsible for the sale of more than 800,000 buildable square feet of entitled self-storage land and the sale or escrow of more than 3 million square feet of existing self-storage facilities. For more information, call 949.724.4709; e-mail [email protected].