Financial due diligence in New York multifamily real estate acquisitions

In the commercial real estate market, multifamily investments are currently hot. The continued strength of the rental market has investors flocking to buy rental property. But the process of buying commercial real estate in New York requires savvy. The key lies in very thorough financial due diligence. Many experienced investors believe they know enough to do their due diligence themselves. But there is no such thing as an acquisition that can afford to forgo a rigorous financial due diligence review, and there is no commercial asset acquisition that is "simple" or risk-free in today's ever-shifting real estate landscape. This is especially true of the multi-family investments. Analyzing past operations in order to project future property performance is never a black or white endeavor - it's a thousand shades of grey. Evaluating the true value of an apartment building is a complex, multi-phase undertaking that can elude clarity. Variables conspire to conceal a property's true value. How can an investor be sure that they are getting the benefit of their bargain and avoid the financial and legal pitfalls that lie at every stage of the process? Although risk is an unavoidable element in any commercial real estate purchase, the stakes are even higher when buying distressed assets in today's erratic market. Whether purchased through short sale or by buying notes or bank-owned (REO) properties, every distressed asset is unique and requires a multi-step process of examination, including valuing the note, valuing the real estate and conducting due diligence on the loan, property and seller. Rushing to purchase troubled assets before conducting thorough and comprehensive due diligence can all too often lead investors to pay inflated prices and eventually lose money. Cash-rich funds have been especially susceptible to this mistake. Assumptions utilized in the past are no longer accurate (and possibly never were). Instead of accepting underwriting based on past expectations, it is important to find the "true value" of the asset. The primary task, then, is to gain a clear financial picture of the asset today and uncover any current or potential trouble spots. This is accomplished through a comprehensive financial due diligence review and an honest and conservative market analysis. It is a process that few companies are qualified and staffed to conduct in-house. Because of the complexity of the analysis, savvy investors are increasingly turning to financial due diligence specialists for help. In addition to a market analysis, financial due diligence specialists conduct comprehensive financial audits, compiling and interpreting many layers of documentation within sharply restricted time frames. Such specialty shops validate and verify all rents, as well as any income from additional sources, such as parking, vending machines and the like. They validate and verify all expenses. These are generally more numerous and variable than income items and can include outlays for anything from snow removal to elevator replacement. They also establish the historical record of income and expenses in order to verify the accuracy of the sellers' projections for future budget and cash flow. Last but not least, they review bank statements to confirm that income is reflected in statements. When specifically conducting due diligence on a distressed note, it becomes necessary to conduct multi-layered due diligence. The first step is to organize and abstract the loan documents to ensure a clear understanding of the rights, obligations and responsibilities of all parties. Next, a financial review of the underlying property is needed, to the extent that access to available documentation allows. There is simply no other way to properly evaluate the value of what is being acquired. Proper and accurate due diligence can also be helpful post acquisition with the complex organizational and logistical issues that arise should the investor need to take ownership of a foreclosed property. The purchase of notes on distressed properties also has many legal pitfalls to avoid. Investors need to hire qualified counsel to ensure the enforceability of the loan documents and protect against any potential lender liability claims brought by a borrower in connection with an acquisition. For any individual investor or fund targeting the acquisition of distressed real estate, the goal is always to minimize risk and maximize return. In today's market, upfront financial due diligence of the asset will go a long way to achieving that goal for distressed properties and notes. David Tesler, Esq., is founder and CEO of Real Diligence, LLC, and LeaseProbe, LLC, Lakewood, N.J.