The Multi-Family Property Purchase Process

We want to talk about the transaction process to get a multi-family property from a target to in-the-bag.  It doesn’t hurt to quickly review why we’re buying a multi-family property instead of single family rental homes:

  • Cash flow – This is pretty simple; more rental units in one location multiply cash flow and reduce cash flow risk. A few vacant months with a single family home are 100% lost-revenue months.  A couple of vacancies for a few months in a 10+ unit apartment project result in around a 20% loss in cash flow.
  • Economies of scale – When you concentrate multiple units in one location and/or under one roof, you gain some advantages in the cost of services and supplies. You save money in the areas of maintenance and purchases of major appliances and supplies.
  • Hired management – It’s much more difficult to transition from self-management to hired management with single family properties. With multi-family you are ready with the cash flow to pay for it and you can dump the tenant relations headaches.

As we launch into this process, we’re assuming that you’ve already done your initial due diligence to determine the basic financial condition of the property, cash flow, costs, net operating income, etc.  In other words, you’re ready to buy.

The LOI, Letter of Intent

In most single family property purchases, you will be submitting a purchase contract offer, and that’s a binding document if accepted by the Seller.  In multi-family and commercial transactions, it is common to use a Letter of Intent.  This offers several advantages.

You aren’t locking yourself into anything with the LOI.  You are presenting your basic major offer price and terms, as well as other transaction components for the Seller to consider when they respond.  It’s not binding, just a starting point to move toward a contract in an organized way.  A good LOI will cover most or all of these points:

  • Purchase price – You’ll make your initial offer based on your research and due diligence to that point. However, even if the Seller accepts this offer, it’s not binding in the format of the Letter of Intent.
  • Financial terms – You present your earnest money offer, describe your financing contingencies; how long and funding terms that are acceptable for you to complete the purchase.
  • Inspection(s) & due diligence – Outline the inspections you expect to do on the property, and the timeline for delivery of those inspections and reports. This includes further financial due diligence; such as lease audits to verify income.  Be clear here as to any documents or supporting information you will need for your due diligence and the timeline for their delivery.
  • Brokerage commissions or fees – Unlike residential transactions with the usual splitting of a commission paid by the Seller with the buyer’s brokerage, commercial transactions are more varied in brokerage compensation. You may be paying your broker/agent, or you may want the seller’s commission split with them.  Outline that here.
  • Timeline for contract preparation/acceptance – This is actually three different deadline items. You want to give the Seller a deadline for acceptance of your LOI, then another for preparation of a contract (including who is to prepare it, you or the Seller).  The third item is a hard deadline for acceptance of the contract or for a counter offer.
  • Other contingencies or conditions – There can be other conditions or contingencies you want satisfied before it’s a done deal. An example might be the removal of certain items from the property, perhaps some storage structures, etc.  This section can have virtually anything else of consequence that you want part of the deal.
  • Closing date – You specify an “on-or-before” date for closing the deal and taking possession.

Your LOI goes to the Seller and follows a path as you’ve just outlined.  They respond with either an acceptance of the Letter of Intent’s terms or some counter offer or terms.  You may do some more negotiating, including changing schedules for different parts of the transaction, such as your inspections.

Inspections

This is a crucial piece of the multi-family property purchase.  It may involve some code or governmental requirements over and above your normal structural and other concerns.  You may need to do inspections on:

  • Structural integrity, foundation, roofing, etc.
  • Pest inspections.
  • Each unit inspected for damages or necessary repairs.
  • Age and condition of appliances, heating and cooling equipment.
  • Any required or desired environmental inspections; example being nearby recorded hazardous material sites.

Basically, you want to know what you’re buying, the current condition, as well as a projection of coming repairs or replacements that may be necessary.

Financial Due Diligence

You’ll definitely be carefully examining all financial data, tax returns and doing a rent audit.  You need to be certain that the rents stated are actually being charged and paid.  If any trade-offs of rents for services are happening, it should be fully disclosed.  You also want to look at late rent histories, lease expirations and opportunities to increase rents.

It’s in this phase that you can uncover any opportunities to increase cash flow and NOI by reducing costs.  Some properties may be paying too much for services, and you can uncover that in your financial due diligence.  Sometimes you can even find enough to trim to improve the cap rate number for the property.

Maintain the Schedule

Between the LOI and the contract, you should have a transaction schedule to closing that has hard deadlines and you don’t want to miss any of yours.  You also want to hold the Seller(s) to their delivery and other deadlines.  Moving through the transaction on time is the goal.

Part of this whole time thing is your analysis of the leases, especially expirations, payment histories and the current rental market.  If there is an opportunity to raise rents, you must balance it with the market, not raising if demand is soft.  Tenants with late rent histories may go on your list to vacate at the end of their leases.

When you leave that closing table, your multi-family property purchase is complete, but your long term management is just beginning.  Hire the right management company, do what is necessary that first year to adjust leases and tenants, and then just enjoy going to the bank.