DUE DILIGENCE: How has it Changed for New York City Multifamily Owners?

The political and regulatory environment for New York City Multifamily owners is becoming increasingly complex. The real question is, “How has it affected values and transactions?” One direct impact is that the process required to sell a building has changed. Instead of due diligence being a formality, it has become a major part of the process and critical for the seller to maintain pricing.

A seller who is pleased with the price they are receiving for their building should look to minimize the time between accepting an offer and signing the contract. In order for that to occur, items the buyer will want to review must be organized and prepared ahead of time.

There are three components of a buyer’s due diligence:

1. Income review of tenant leases and related files
2. Expense review
3. Physical property review

Income Review

The most time-consuming and complex aspect of the due diligence process is the tenant file review. Due to the nature of this component, it is the perfect place to start.

The first thing to realize is that there are no perfect buildings. If you, as a buyer, are looking for the perfect building, you will never complete a transaction. That being said, here is what the marketplace is expecting for these different multifamily units:

Free-Market Units: Attorneys will advise that a buyer approve the paperwork at the point of a unit’s deregulation. This means seeing the following:

1.  The last rent stabilized lease, regardless of how long ago the apartment was destabilized
2.  Copies of canceled checks spent on apartment improvements
3.  Copies of itemized contractor invoices for that specific apartment

Another point of concern is the interpretation of the “Altman” case.  That would require that a unit’s legal rent surpassed the deregulation threshold while the tenant was in occupancy.  In cases where the apartment improvements only were used to bring the legal rent above the threshold, a buyer and seller may not see eye-to-eye on the legal status of that unit.

Rent Stabilized Units: In a paradoxical twist, the verification for rent stabilized rent has remained fairly simple.  The DHCR records need to be filed, up-to-date, and match the rents on the current leases.  Occasionally, you will encounter past rent reduction orders, or other rent charge disagreements between a prior building owner and a stabilized tenant that will show up on the DHCR report. Documentation of the problem and solution are needed in these cases.

For further information, you can read my book called Family Secrets: Secret Strategies for New York Multifamily Investing.

Expense Review

Most buyers utilize their own expense projections during due diligence. However, if you are selling a stabilized asset versus a value-add, your fixed expenses should match up with what is shown on the marketing materials. That means the following bills may be requested by a buyer:

• Property taxes
• Water
• Electric
• Any payroll, especially if you have union labor
• Gas or oil heating bills

Physical Property

In many cases, buyers purchasing older New York City buildings will do their own physical property inspection. For buyers who are using outside funds, whether an institutional or private buyer, they will normally request an environmental report and a structural report to be completed before they sign a non-refundable contract.

As far as building violations, they come primarily from three city agencies:

•NYC Housing and Preservation Development (HPD)
•Environmental Control Board
•NYC Department of Buildings (DOB)

As I said, no building is perfect and it’s unusual to find a building with no violations at all. However, sellers should remove any serious, Class C, violations from any of the above agencies, or it’s likely a buyer will request an escrow or credit.

Removing Uncertainty

Businesses don’t like uncertainty. Mistakes made in this category can cost the seller money, with buyers requesting credits for imperfections. When buyers can purchase with an accurate understanding of the risks involved, and sellers are fully prepared, it’s a win-win for everyone involved. I look forward to your feedback and comments.

Peter
212-430-5114

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