Due Diligence: Deal Maker or Deal Breaker?

The essence of any good real estate transaction is due diligence. There is a cat and mouse like game that is played between buyers and sellers, between lender and borrowers, that defines the risks in a transaction. Here are some of the trade secrets from the world's leading provider of self-storage due diligence that you should be aware of. Buyers and sellers alike can benefit from knowing more about the due diligence process.

This year, I have had two opportunities to work on due diligence assignments that had potentially tragic results. First and foremost, I want to explain that the time to conduct due diligence is BEFORE you sign on the bottom line! Once you own the property: You own the mistakes and the genius. It amazes me that novices to this business would not seek expert counsel when putting hundreds of thousands, or millions of dollars at risk.

The first situation was one in which the purchaser did not conduct a thorough due diligence effort, purchased the property, paid cash, and then sought financing. I was performing due diligence for the lender, and found that the purchaser had been “duped” by the seller, and that the property did not generate nearly the income the purchaser had relied upon from the Seller's data. In fact, the actual performance of the property was less than 75% of what had been reported.

Due Diligence Guidelines For Purchasers

Buying Scenario #1

PURCHASERS: The following question must be answered satisfactorily before you buy a property: Why has the property not been sold to one of the major buyers of self-storage properties?

I can assure you there are numerous buyers of self-storage properties that are ready, willing and able to close on self-storage transactions. If the property you are purchasing is the correct size, price, located properly and is in a good market, you will never get a chance to buy the property, except for a very, very, very, small number of reasons. Otherwise, the property or transaction has “hair on it”. Keep in mind when you want to sell it:

—->> The same reasons it did not sell to the institutions before will likely be around to haunt you in the sales process.

—->> Lenders may have the same “beef” with the property as the major buyers of self-storage and in order to get it financed, you may have to find a lender who does not know enough about the property or industry to make a good lending decision!

Buying Scenario #2

The second situation was a little less traumatic. The purchaser engaged our firm to conduct due diligence (after he closed) and found out there was a moratorium on building or expanding his property (and one of the compelling reasons for purchasing was to expand), and that a new 80,000 square foot property had been approved and permits were ready to be issued. So, not only, could he not build if he wanted, he had a 1st generation product in a market with a proposed “state of the art” property ready to go to market. He wished he had hired us BEFORE he closed.

PURCHASERS: Never close on a property unless you have conducted a thorough due diligence effort. If due diligence is not your “core business”, then get a professional, do not risk the purchase without help.

Due Diligence Team of Professionals

The following question must be answered satisfactorily before you buy a property: Who should be on my due diligence team?

Legal

From a legal point of view, I am certain that you want to have an Attorney review the legal documents:

• Purchase And Sale Agreement
• Entity Documents: Does The Seller Have The Right To Sell
• The Property (Partnership Issues)?
• Title Insurance Binder
• ]Non-Compete Clauses
• Zoning Compliance
• Ability To Replace Improvements As Grand-Fathered (Non-compliant Sites)
• Environmental Reports (Particularly If There Are Issues)
• How Are Prorations Handled At Close?
• How Are Receivables Handled At Close?
• When Does The Close TECHNICALLY Take Place:

On The Day Of Escrow?
When Funds Are Sent?
When Funds Are Received?
When Deeds Are Filed?

• Personal Property Purchase Agreement
• Trade Name And D/B/A Documentation And Rights
• Issue And Opinion Letter On Lease Document
• Reps And Warrantees

Accounting

In the Accounting realm, a C.P.A. (or storage consultant ) should be checking:

• Bank Statements Compared To Financial Statements
• Cash To Accrual Basis Conversion
• Accounts Receivable And Accounts Payable Reports
• Reconciliation Of Site Management Reports To The
• Documents Originally Submitted For Making The Purchase
• Decision
• Physical Inventory
• Retail Sales Inventory

Self-Storage Consultant

A self-storage due diligence professional should:

• Audit Lease Documents
• Conduct Verbal Estoppels
• Market Evaluation
• Examine The Propensity For Rental Rate Improvements
• Interview And Assess On-Site Personnel
• Interview And Retain Or Hire 3rd Party Management
• Company
• Prepare 3 Years Budgets
• Examine Manager And Employee Incentive Program
• Evaluate Retail Sales Program
• Software Evaluation
• Evaluate Office Technology
• Software
• Computers
• Printers
• Broadband/Internet Connectivity
• Firewalls & Data Security
• Telephony
• Archive Integrity
• Make Operational Suggestions To Enhance The Property
• Inform You Of Ways To Reduce Operating Expenses

Title Insurance Agent

The title insurance agent will inform you of survey liabilities, such as:

• Easements
• Encroachments
• Setback Violations
• Ownership Issues
• Pending Litigation
• General Title Flaws
• Construction Or Contractor Liens

Environmental Consultant

When purchasing a Self-Storage property or business, it's usually necessary to employ the services of an Environmental Consultant who will provide assistance with the following:

• Phase I
• Further Testing As Needed
• No Further Action Letters
• Indemnification Agreements
• “Bugs & Bunnies, Turtles And Owls”
• Wetland Delineation

Property Inspection Engineers & Surveyors

There are certain “land” or physical conditions reports related to your Self-Storage purchase that will have to be conducted by licensed Property Surveyors and Engineers. Here are a list of the reports needed from these professionals:

• Property Condition Report
• Structural Evaluation
• Permit Compliance
• Code Violation Exam
• Life Safety Issues
• Cost Segregation Basis
• Boundary
• “As-built”

The Insurance Agent

Insurance Agent's give you a great snapshot of your liabilities and will discuss:

• Current Insurance Coverage
• Cost Of New Insurance

Property Tax Consultants

You may not have known this, but there are professionals in the commercial industry that specialize in property taxes, knowing about tax abatement programs and likewise. Property Tax Consultant's can predict:

• Special Tax Considerations In The Past That Will Expire
• Future Tax Liabilities
• The Likelihood Of Appealing Tax Billings And Winning

Benefits Of Due Diligence Reports

Conducting a thorough due diligence effort will serve two purposes:

1. To determine if the information upon which your original offer was made was accurate.
2. What the lender will discover when they conduct their due diligence.

For whatever the purpose, you soon begin to realize the complex nature of the due diligence process and the difficulty that ensues when judging a property's ability to generate and sustain income. The lender will be much more critical of the property on more of a macro basis.

In summary, the due diligence process is not one that you want to conduct on your own unless you do it every day, for a living. You may be a good operator, but that does not necessarily mean you are a good BUYER of real estate. There is a very big difference.