In the past, due diligence has largely been a responsibility of the buyer. After having heard some horror stories about sales that did not close and transactions that did close, it came to mind that the SELLERS might benefit from due diligence.
You Have To Kiss A Lot Frogs To Find A Prince
There are thousands of purported “buyers” of self-storage out there, and most of them are honest, capable buyers. A property listed for sale is likely to attract the attention of many qualified, and many unqualified “investors”. The lower the price, and the higher leverage (lower down payment or equity required), the greater the likelihood that you are going to attract some unqualified prospects. With hundreds of inquiries, how do you know who to engage in negotiations?
There are several signals that your buyer may not be real. The first are the hundreds of “investors” who have attended a nothing down seminar that want to buy your property with no skin in the game. There are hundreds of these same “investors” who are asking sellers to enter in lease/master lease/lease to own deals.
On a recent listing on LoopNet, I was bombarded with inquiries from just one California seminar group, with over a hundred calls from recent graduates who represented themselves as investors, affiliates or principals. None of them had actually closed deals, and not one had any self-storage experience. What they knew about self-storage, they learned from the presenter, who made much more money selling seminars than owning or operating self-storage. He told them what to tell sellers, and the party line was identical, almost verbatim.
How To Qualify Your Buyer
Early in the negotiations, find out who you are dealing with. Qualified, real investors are always able and usually pleased to present their credentials. Some will have printed brochures; others have websites that indicate recently closed transactions. Some buyers will have established brands and multiple locations; all these are good signs that they are real. Beware of those buyers who dance around the question or are unwilling to show you they are for real.
Do not press to hard at this stage, as lookers are not buyers. Once you have negotiated a Letter of Intent, it is time to qualify your buyer. It is at this stage that you may be spending money, and you are entitled to know who you are dealing with. If you are going to take your property off the market, you have the right to make sure that the buyer is real.
First, ask for POF or proof of funds. This is usually a letter, (on bank letterhead, with a contact name and telephone number), that indicates the buyer has funds sufficient to close. If a letter is not available, you may ask for bank statements or brokerage account statements that verify availability of funds. Watch out for very recent deposits, or many quick in/quick out transactions!
A letter from a loan broker or equity source is not a verification that the BUYER can close. If that is all that is available is an equity broker's letter, then the equity broker must provide a verifiable list of closed transactions and financial statements.
Second, ask for a financial statement. This will tell you a lot about who you are dealing with. Make sure it is dated and signed. The property may be purchased by a bankruptcy-remote Single Asset Entity (customary) and may be formed specifically to purchase the asset. That likely means that the buying entity has no history or assets. With that in mind, you will have to research the Principals ability to close.
In the absence of the former, ask for a title company reference, and verify with the title company that the buyer has closed transactions, and verify the date and size. Six months is the maximum time lapse since a closing, and the deal size should be similar to the transaction at hand. Remember, it is easy to create a fictitious title company, so make sure that they are licensed in the state of the transition and you are dealing with the branch at the licensed address.
Here is a list of danger signs that might indicate your buyer is unable to perform:
- Requirement for less than traditional down payment/equity
- Refusal to provide a financial statement or proof of funds
- Unable to provide a verifiable track record of closed or owned properties
- Unable to provide a list of Principals, if not single ownership/control
- Unwillingness to provide verifiable information
- Lot's of flash, no cash
- Inability to immediately place earnest money (three days max) and verify the source of earnest money is a party to the transaction (not borrowed)
- Inexperienced in self-storage ownership or management
- Buyers broker is not experienced in self-storage transactions (multiple)
- Google results on seller are not favorable, recent bankruptcy or litigation
- Beware of the buyer who makes it sound too easy like no appraisals are necessary, or very short due diligence periods
- Lack of due diligence. If the buyer is not going to thoroughly audit your property, require surveys, environmental reports, structural reports and appraisals, it is a danger sign!
Nothing Like A Good Reputation
Most credible investors are happy to let you speak with a recent seller with whom they closed a transaction. The seller can tell you how the transaction went, what kind of “hitches” and if there were delays. Most valid buyers have a history of successful transactions with their investors, if they are not acting solely on their own behalf. The buyers broker may have closed a couple of large transactions, and can verify that the buyer is for real.
Remember, offices can be rented, and it is easy to create a facade. A reputation is built over time, so look at the history of the buyer. The longer they have been successful (and you proved and verified the success), the higher the likelihood they are going to complete the sale at hand. Do not listen to their boast and brag, look at the facts.
Remember, these are different times. Buyers used to be able to get standby loans and letters of credit from their bank to offer proof that they could close, and the banks could easily and quickly produce them. In today's challenging market, banks are very hard pressed to provide those kinds of assurances. Deals are taking longer than ever to close, and are more complicated. Banks, investors and financiers require more time and due diligence than ever before. Be aware of those facts, and patient in your transaction. If legitimate buyers need an extension, and have a valid reason, you may want to grant an extension, rather than lose a qualified buyer.
If you are carrying paper, you have become a lender. Your requirements to provide financing should be as stringent as the bank's. And, if you do not have as much money to lend as the bank does, you may want to be even more careful! Remember, banks rarely lend their own money they are borrowing money from their depositors or the Fed's. It is always easier to lose OPM (Other Peoples Money) than it is to lose your own.
There are lots of examples of deals gone bad, and sellers left holding a bag of broken promises. If you are desperate, you may not have the luxury of checking out the buyer, and a smart buyer will know if you are desperate and take advantage of you. If you are about to lose the property to a bank, many investors take the position they would rather deal with the bank, and will wait for a foreclosure.
Fraud or Friend?
There are numerous frauds currently in the marketplace who have never closed a self-storage transaction and do not have the ability to close. They have tattered and torn histories with bankruptcies, and a trail of investors behind them, whom may have lost millions of dollars. They are in the market today, tying up properties with no ability to close. So, again be aware of the facts and patient with transactions.