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Strategy Saturday
SS13: Understanding LOIs, PSAs, and the Due Diligence/Inspection Process
March 14, 2021
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Charles discusses what LOIs and PSAs are; while explaining the due diligence and inspection process.

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Transcript:

Charles:
Welcome to Strategy Saturday, I’m Charles Carillo. And today we’re going to be discussing letters of intent purchase and sale agreements and the due diligence and inspection process when purchasing a piece of real estate. So what is the LOI? Well, the LOI or letter of intent is used when purchasing commercial properties. It’s also used for purchasing businesses, but in this sense, we’re going to talk about commercial properties and it shows the buyer’s intent. The goal of the LOI is to begin the conversation with the seller. It starts the process and the negotiations. It is used prior to a contract. Many investors make dozens and dozens of offers prior to purchasing the goal here is to avoid unnecessary legal fees for each offer. The LOI is a short document. Usually two to four pages, usually nonbinding. In other words, cannot be enforced by law. The LOI includes only the important details the PSA or purchase and sale agreement is the document that contains all the details.

Charles:
It’s going to spell out the complete deal. The LOI will include the property address and property name if applicable. So for example, if you’re buying the apartment complex and it has a name, that’s what you would include. Property tax identification, number, the legal description of the property, proposed purchase price, propose earnest money, deposit amount details of the capital stack. So how much is the buyer is bringing cash to closing and where does the propose a mortgage amount and rate? Um, and if there’s proposed, if there’s seller financing, you’re going to put that in there as well. Due diligence and inspection, timeframes deadlines for receiving all books and records. If the LOI is accepted, who will be drafting the PSA, is it going to be the buyer’s attorney or the seller’s attorney? What is the expected closing date, expiration date for acceptance of the LOI. You want to make sure that any requests out of the ordinary are included in the LOI.

Charles:
So for example, you are proposing because our financing include the terms in the rate. You want the seller to cover certain closing costs or a portion of them. You don’t want the seller to seek other offers for a certain timeframe. You want to assume their mortgage. You want the owner to make certain renovations prior to closing, et cetera. These are things that you want to spell out in the LOI. The purchaser should be an ELOs LLC, with little or no assets. However, you will close in a property specific LLC. For example, in when you’re putting out an offer, a lot people put in their own name and that’s fine, the start, but really what you want is you’re going to have an LLC with little to no assets is where you’re going to make all your offers through. Okay? When you closing it, because your LOI will say that it’s assignable, when you close it, it will be in a property specific LLC.

Charles:
Okay? So you might use, um, you know, velocity partners or something like this, LLC that you put the offer through. But when you close, it’s going to be one 23 main street, LLC. And that is your property specific LLC. The purchase and sale contract, the PSA is the formal offer. Always have an attorney write the contract. If the broker is using their contract, have your attorney review it. You should be working closely with your attorney throughout the process. Now with the LOI, you’ll have your attorney assist you with, with completing and drafting a LOI initially, then you will be completing it for every offer you do. You will then bring your LOI. Once it’s executed from the buyer, or excuse me from the seller, it will be executed by you as well. You bring it to your attorney and they will then draft the PSA.

Charles:
Traditionally, the PSA spells out the complete details of the offer. We’ll have effective dates that need to be followed to avoid missing deadlines. If you’re working with partners, use an escrow agent. Now what this means is that you’re going to want to get the books by a certain date. You don’t want to have the process for due diligence. Start until you have all the documents, because you’re going to request documents, utility bills, bank statements, um, other financials that you didn’t request initially with the LOI, because that was just a simple offer non-binding offer. Now, what you’re going to do is it’s going to be spelled out and tells you exactly what timeframes that those buyer has to abide by you. And then the seller, what they have to abide by for getting you and assisting with you in the purchase process. Now, the due diligence prior to LOI and PSA, you should have done some of it before.

Charles:
Okay? On the market, the area, the neighborhood, these are things that you should be doing prior to putting in any offers on properties. You’re now performing due diligence on the specific property. Okay? So you’re going to be verifying their rent rolls. You’re going to be CA comparing bank statements to w their profit and loss, right? You’re going to be comparing all those and making sure that everything matches up. We use a comprehensive due diligence checklist. You can find these all over the internet. You’re going to edit it as you use it throughout your investing career. So there’s going to be things that you add. There’s gonna be things that you probably take away, or you don’t use. You want to change your thinking from deal sourcing to due diligence. Okay? So this means that you’re going to now to tear apart the deal and find the holes.

Charles:
You will find issues. This is why you begged it extra money for repairs and miscellaneous. So for instance, what we did was we put aside property money for our last property, as we always do in purchasing, we found out during the due diligence process, that there was a roof warranty on the property, which is great. There was, I think, 18 years left on it. The thing though is that it was transferable once, which would be great, cause that would be right to us as the buyer. The problem though, is that the previous owners, the sellers had never activated the warranty. It was good and bad. Now we are able to then, uh, assign this right to the new buyers if we ever sell it. But the problem is that we had to activate, and I think it was a couple thousand dollars or a few thousand dollars to do it.

Charles:
So it’s a good thing because now it’s now an optimal thing for the buyer to have, but now we had to come up with that. That’s why you’re always budgeting extra because going into due diligence, you’re going to find things are going to cost you money. Um, we had another thing too with the trash there, and that was something that we weren’t able to cancel the vendor for 60 or 90 days into us owning the property because the previous owner had not canceled their contract. This is money. You have to set aside and there’s, you’re not going to lose a deal over a few thousand dollars when you’re talking a $6 million deal, um, a few thousand dollars here, a few thousand dollars there, but you want to make sure that you’ve accounted for this because it’s happens in all purchases, especially with larger commercial properties.

Charles:
You want to check County offices, city planning, zoning, check with police, call the non-emergency number and see if there’s any issues, learn about violations and permits. Any open permits, um, changes coming to codes in the area that might impact your property. So you really want to gather as much information as possible from third-party sources that do not care if you buy it, or if you don’t right. They’re non-biased is there any deferred maintenance? What needs immediate attention are there recurring problems? Now this is something we do too. During the inspection process, we talk to tenants, which gives you a whole nother view of the property that you would not be able to find from any type of document you’re getting, you want to speak to contractors or handymen that have worked on the property. This might be a little difficult, but you might be able to find people that have done it.

Charles:
And this is who you want to speak to. You’ll see some of the receipts in the due diligence paperwork that you get. These are the people you want to reach out to. Um, these are gonna be like HVAC people, electricians, maintenance, people, plumbers. What do they think of the property? Okay. They’re probably going to overhear it through their common. They’re going to over here. Maybe there’s issues with tenants, maybe there’s issues with one building all the time or with, uh, you know, this building always has issues with water pressure or something else. That might be a major problem during the inspection. Now this is physically visiting the property. Everything we’ve done up to date now is really not been going to the property. It’s really been done from afar. Obviously you’ve probably driven the area. You should know the market and everything like that, but this is when we’re physically going to the property.

Charles:
So you want to line up the property manager and inspectors to inspect the property with your team. You bring your contractors, right? Your building inspector, HVAC, plumbing, electrical, uh, foundations, inspector. You want to inspect every unit. We walk every unit and how we do it is we’ll have one person that’s just taking pictures or video and pictures, I think are a little better. It’s a little easier when you can go back and forth and show people different units. So we take a picture of the door number and then the ones for the entire unit, a unit, we know, come from that door number from that apartment. And then what we’ll do is when you go to the next unit, you take a picture of the door number and all the pictures from there. So we have an idea because the chance of you into these apartments might be years down the road.

Charles:
So even an idea of what’s required in those units. You’ll be taking pictures. If there might be water damage, take pictures of the mechanicals, right? Hot water, heaters, HVAC, all this type of stuff. So you know exactly what what’s going to need work. And when you’re going through and doing renovations, what grade a property, you know, what grade greater that unit is now, obviously you should be taking down notes as well. So, you know, but these are just pictures. So you can show when you have an idea of what the inside of that looks like, the new organize on the cloud easily share with partners, which is great because now you’ll have some before and after pictures. Um, prior LOI, you should have an idea of the neighborhood, the area, the retailers, the restaurants, know everything that’s going on there. You should have already done a spot crime.com report, right?

Charles:
You can do it for free, but your tenants only care about the feeling they get when they go there. Okay. They don’t really care about, uh, maybe there is no crime there, but it’s a little dingy area. These are things that you have to know, and you should have known this before putting in an offer. But these are items that are very important because if that will make it how easy or hard it is to rent, we always factor in more lighting. You know, you want clean, safe and affordable housing. So this is something that you’re going to pencil in on your renovation budget. What we’ll do that? What will make it safer? What will make it easier to rent? Um, we’re looking for leaks, you know, possible mold water is the most damaging thing to a property. So AC lines leaking roof leaks, plumbing, leaks, um, you know, I had a property, I had a property, I still own the property.

Charles:
It was a small mixed use property that I still, um, that I probably a decade plus ago, I still own. And it was leaking. There was a leak that was going on to one of my furnaces. I never knew what it was. I had a plumber in there and they found out that previous owners had before patched between two copper pieces, a piece of like outside plastic, rubber water pipe between it. And obviously it was leaking. So what we had to do is take that out and put copper in place there. And these are things you’re going to find all the time. People patchwork here. Um, you know, previous owners might not know it or, or it’s not a problem at that issue. I mean, how many times are you going through the wall for due diligence? So you have to put this money aside.

Charles:
Um, lead based paint is a big thing. Pre 1978, the tenant sign compliance letter. Does your manager work with a number of pre 1978 properties? It’s very important because there’s extra steps that are required, especially this. You need to speak to a professional, if it is present or haven’t removed prior, you know, of, or just avoid it altogether, um, always get a phase one, environmental always. That’s just your bank’s going to require it, but maybe certain lenders won’t, but most banks will, was there some sort of commercial business next door to the property or on the property, a dry cleaners, auto mechanic. These things are very big polluters. And these are issues that can happen because if there’s an environmental issue on your property, it doesn’t matter if you just bought it. And it was from the previous owner. It only matters who the current owner is that has to take care of cleaning it up.

Charles:
So always, always get a phase, one environmental survey. You want to speak to tenants during the inspection, reoccurring issues and repairs. I always have an issue with the AC. Um, it’s always loud in this apartment because of this. Uh, there’s always a problem with bugs in this apartment. Um, you know, any kind of issues. This is the stuff you want, because then you have an idea of what needs to be done right away. And obviously if you start tackling those issues that were deferred, you might keep that tenant. Do they like it? There is it well-maintained overall, will you renew or will you leave after is over what needs to be changed? You know, other tenants pick up a little from each tenant and then you’ll realize a little bit from what’s going on in the property, because you’re not gonna have much time. It’s not, you’re gonna be sitting down having a cup of coffee with them.

Charles:
You’re gonna be walking through these units. I mean, we’ve done, we do hundreds of units in one day when we’re walking, right? It’s usually somebody taking pictures and then two or three other people, someone taking notes, you all the property manager and they’re taking notes. So they can kind of gauge the whole process as well. Um, you don’t do this with a manager owner there, right? Usually the manager or the owner, you’re most likely to be doing some sort of manager or broker. There’ll be opening up the doors and letting people in, um, they’ll usually stay outside, but this is when you can talk and you don’t want that to get them in trouble. So it’s something that, do you like living here? Is there any problems? No, everything’s fine. Or this is a problem or this is always leaking or they won’t fix this.

Charles:
Just take notes of them when you’re doing your notes and you can kind of go through the whole thing. And the best is to have someone taking pictures and at least one person taking notes and you might need, and then they’ll be on your team. You probably have a property manager in there with, on one of the person and they’re kind of grading it a different way. And then my grade at one, two and three, depending on how much work is required and looking for major flaws, you kind of want to go in there and you’ll have someone just taking notes of what they said. And, um, you know, they’re very happy to speak to you. It’s not, it’s not something that they’re going to be usually scared of. So it’s great. You can have a conversation with them and then just review all that information later.

Charles:
Now we’re doing a financial inspection. So you want to take a new one, a match bank statements, and deposits to income statements, okay. And transfers are there transfers, you know, where’s that money going? Do the posits match up. You want to perform a lease audit. This is something that your property manager is going to assist you with. And this is reviewing the leases, the tenants expiration dates of the leases and the amounts. Does it all match up? Does what? The lease audit, when you’re doing the lease audit, the leases match the rent roll that you were giving initially, no, all the lease amounts and the dates, the expiration dates, everything, or all the leases the same, or did they change halfway through? This could be an issue. This is something that you have to be aware of. It’s not a huge problem, but it’s something that there was an old lease.

Charles:
So, you know, 25% of people are on the old lease. 75% of the people are on the new lease. This is just something you have to know going forward, because if you ever have to evict someone, possibly the old lease, isn’t Aus pro landlord as the new lease. And this would be something that you make sure that you have to let your, your everybody know your, uh, attorney at that time. And everybody else when you’re going through and having to do eviction say, well, there’s two leases on this property to you be aware of it is the best thing or all the leases. Um, do they differ at all with any other, any other like utilities? Do someone Elisa say you’re paying utilities and some of the ones aren’t right. These are very important verified utility bills against bank statements and accounting. Okay. Sometimes with mom and pop properties, you’ll see them paying for bills that aren’t even on the property, right?

Charles:
They’re putting a lot of their personal expenses in there. They’re paying someone else’s electric bill or something else that we don’t even have this meter on the property. Okay. Or this bill doesn’t even line up with this property. And that’s something as well that, um, you know, you might have found something that you can deduct as an expense and goes right to the NOI. When you can cut expenses. Now you want to also check the other utilities that are on the property and what’s being paid by the landlord. So make sure you have all the bills for electric water and sewer trash, or any other utilities review all the vendor, contracts, landscaping, pool service, snow removal, laundry contracts, make sure to review these in-depth. They might survive a closing, right? You might have, uh, this laundry contract that the previous owner had because it survives another year into your ownership.

Charles:
So you have to know that you have to be aware of it. And you have to know that this is what you’re going to have to live with. Once you take over the property, if the property was misread represented or important items were left out, you may need to retrade, which has really renegotiate. And this is something you don’t want to abuse. This is sensitive because it’s going to tarnish your reputation with brokers and others involved. You only really use it. If you have to, if you’re unable to come to a reasonable negotiation, you can walk away. And you know, this is something that you’re gonna get a bad. You’re gonna get a bad marketing reputation. If every time you put deals under contract, you just kind of walk away from them or you want to renegotiate them. If it’s a valid reason of why you’re asking for renegotiation, tell your broker, and they will tell you what they think of it.

Charles:
You can ask them, what would you do here? Would you close on it? When I go back to renegotiate, obviously they want you to close on the property, but that’s why you’re working with a broker, right? So they can assist you with the purchase price process. You’ll need to eat any upfront costs, but this is the reason why syndicators charge an acquisition fee. So when you’re doing, you’re going to be paying your management company. A fee might be 50 bucks. A unit might be less, might be more depending on your relationship with them. The PA the, the number of units where their offices, how many people they’re bringing out all this type of stuff, but they’re going to review it. And you’re going to be paying for inspectors due diligence, all these different fees, right? Um, when you have your loan, all this stuff, all this money has to be, you have to take out of your pocket, and this is why you’re in charge of acquisition fee. So you can get this money back right away at closing. Also, the other thing too, is that a lot of these fees, depending on how you write your contract, you might be able to get back. Okay? So I will put any type of links that we spoke about in the episode, in the notes. And please remember to rate, review and subscribe, submit comments and potential show topics at global investors, podcast.com. Look forward to two more episodes next week. See you, then

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar incorporated exclusively.

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