The Importance of Due DiligenceMay 25, 2022
Understanding Due Diligence
Today we're talking about the due diligence period in self-storage. There's no way we can cover everything but I’m going to try to hit a lot of it. I’m going to tell you what we do and some of the processes that we've put in place to make this easier for us. The first thing that goes into due diligence is understanding the time frame within the contract – what is required and what you need to get before certain time frames come up. This is a very important part in our process. Before the money goes hard, we need to identify any red flags. The big ones. The things that make us say,
“Hey, this isn't worth going into unless we can find answers or get it cleared up.”
Timelines and Checklists
The next thing about your due diligence time frames…it is taking forever to get surveys done or to get third party reports. Everything's backed up. You must make sure you can get that done within the time frame of the contract, so you don't go to close and realize you don't have your third-party reports, or you don't have your surveys done, and the bank won't even lend you money because they don't have what's required. To them that's a disaster. You end up falling out of the deal, you lose your down payment, the broker hates you, the owner's ticked off, your investors are mad. This is what you're trying to avoid. This is crisis-level stuff and that is avoided by planning the time frame, executing your due diligence, and by knowing what is reasonable and what you and your team can accomplish before you get into the contract.
So, how we do it is we build out our timeline. Now we have our timeline that is predicated on a 60-day close (in general all the contracts that we're in are 60-day closes). This is the general time frame in which sellers have wanted to close and the competition out there chasing new deals have really tightened up that close, so what we do is we map out on a time frame every single week. We plan everything that needs to happen with our checklist on-hand…a list of all the items we need to get. We have a document that we send to the sellers and as we go under contract, that document is sent out. It’s a Due Diligence Questionnaire and it’s 11 pages.
I know that's kind of obnoxious. They don't have to fill out everything, and we may not get everything, but we put everything in there that we can think of, whether it applies or not, and they can skip it or fill it in. We want to make sure we cover our bases. We also want this in their hands. They're required to give us the information that we need to close, so we want to ask as much as we can. One thing about giving them the full list the day that we go under contract is that now they can't say they didn't know. They can't say they weren't asked, and they can't say they didn't have time. It's within the contract and some things are predicated on receiving the title.
There are certain things that we need in that due diligence process for us to keep moving forward. We want a basic overlay of the facility so we're looking for things like management reports, rent rolls, unit mix, if they have the building plans, we want those. We want to see bank statements, tax returns, active leases.
Here’s why it’s something we need to have. We went under contract, and we ended up purchasing a facility. It turns out that facility had no actual contracts with their tenants. This was a big goof up! It was our fault because we should have done a better job in our due diligence process, and we should have asked to receive a handful of contracts. So, what we did is we changed in our process. Along the time frame we identify 25 to 30 units across their unit mix that we want to see the active lease on. That way when they turn those leases into us, we can see if they're correct. If I have 25 leases and all of them are correct, the whole facility is going to be correct. There's also the opposite where half of them may be wrong. Now this isn't left up to the owner. We don't ask the owner to provide us, we look at their unit mix, we find the units that we want, and we tell them the reason being is we don't want them to play games knowing.
“Oh, I have 10 leases that are actually done so I'll give them to you knowing full well that the rest of the entire facility lease agreements aren't done.”
If they don't have them and we don't know then we think they're all done. You must avoid that. We want to see rate increase history, long-term leases, any tenant agreements that don't fall within the norm of their tenant lease agreement that they give out copy of all vendors contracts.
Online Real Estate and Third-Party Vendors
Contracts are very important. We want to see all of them, and we want to understand what the language is in the contracts that they have with third party vendors on the management of the facility. I want to know the facility's web address. I want to understand what the website domain is. I want to see where it's owned. I want to know if there's multiple domains, and I want it within my contract that I will take over and I will own that domain. This is a common mistake. People buy the facility but, they do not buy the web domain. Now they don't own their online real estate. How many people are employed by that site? Do they have a manager that is full-time? Do they have any part-time employees? Do they have maintenance employees?
These are all things associated with the management that I want to know. I want to see what kind of software they are using to run that asset. What gate system are they running on? How many autopays do they currently have? Where are the physical files and documents kept? Where are the digital ones backed up? What are the vendors and vendor contracts? We have a very large list. This goes through everything from camera software, alarm response, phone companies, internet providers, digital signage display, property management system, lean processing, auction companies, additional computer software or any web-based programs that they may be using, I.T. assistance, advertising and marketing, merchandise supply company, cell phone providers, website management, snow removal, vehicle towing…I want to know who does their gate and camera repair, sprinklers, unit door repair, and installation roofers, alarm maintenance and repairs, janitorial services. We want to know the junk removal, portable restroom services, if they have security personnel, pest control, and even the gutter maintenance. The idea is you want to find out every single third-party vendor who is working on that site.
Who is contracted and what do those contracts look like? Do I need to replace and find somebody new, find somebody better? We also have utilities, so in utilities we have water, sewer, gas, power, phone lines, garbage, sanitations, chilled water steam, storage utilities…make sure you get everything. Contracts for who it's with. You must move those over and if you don't get that done, your site's going to be shut down and you're going to lose power if you don't get it turned over in time. You don't want there to be a lapse.
The next thing we want is to know a lot about the capital expenditures. I want to know things like roof leakage…is there roof damage? Is anything leaking within the facility? Some of the common things we're looking for or we're trying to understand better like insulation finish. I want to know structural problems. Is there something wrong with the flooring, the sidewalls, the foundations? and I want them to sign off in my dock telling me if there is or if there isn't. I want them to explain it. I want them on record. I want to know if there's a basement or crawl space. Is there moisture getting in? Is there mold? I want to know if there's heating capacity, distribution of equipment deficiencies. We're looking at air conditioning capacity. I want to know water treatment system, chemical balancing, there's a whole list and I want to make sure I’m covering and uncovering what may be in there. At the end of the day, I need to put as much as I can because some of the stuff I don't even know going into the property.
Once again, the seller may say “not applicable”. That's great! That's what I want to know in my due diligence. What is applicable to the site and what is not applicable. I want to know any problems within the buildings but also with the operation. Are there lawsuits going on? If so, with who? When was the last time you were in a lawsuit? Has there ever been a fire or has there ever been a flood? If so, where and how was it fixed?
The next thing on capital expenditures that I’m looking for is more of the routine maintenance kind of stuff. I'm looking at asphalt pavement sealant. When's the last time they did it? How much did they pay? Roofing exterior painting…when's the last time these things were updated? I want to know about all the AC units, rooftop package units, especially with conversions these things are a big one. I want to know central domestic hot water heaters…have they broken? When's the last time they were serviced and what condition are they in? Kitchen equipment, individual unit furnaces, these are important to know because this goes into your under. These are big ticket items that if you come into the facility and you must fix, and you haven't planned on it you can really screw up your numbers.
Then we also have our list of documents that we need to know, and we need to understand. I want to know all the sizes and the current prices of every single unit. I want a list of all large or small maintenance projects and supplies belonging to the facility. This is important because if it's not listed on there then they can say that it's theirs and take it off site. I want blank copies of all of the lease rules and regulations on the site, list of fees charged to tenants when they come into the facility, we want rent roll reports, I want automatic withdrawal lists, auto pays, a credit and debit card automatic withdrawal list. I want accounts receivable reports showing the balances, reports showing all rental charges over the last six months. When we're getting into a lot of these documents we're trying to understand when we take over this facility what state every single tenant is in, how much they owe, how they're being charged, and how we assume that responsibility to take money. What fees are they expecting? What have they agreed to? Do we need to change those things? We need three years plus for those changes. That's a profit and loss statement. I'm looking for three years bank statements, electronic copies, all available leases, three years tax returns, last three years of property tax statements, monthly breakdown of occupancy report, and lists of inventory items that are currently in stock.
We deal on two sides. Capital expenditure is the physical nature of the property…what are big ticket items that we need to know about that could screw up with banking or we may have to pay for? Where something built on an easement that it shouldn't attack and then when we go and get a survey, or a report done is that going to show up and the bank's not going to finance it? I need to know the management style. What are they doing at this facility? How are they managing these people? What are the tenants accustomed to?
How we take it over is key to managing the facility and it's also key to understanding the opportunity that really exists as well as understanding the liability. I told you this was going to be in-depth. There's a lot of things going on here. We have a big list to help us. We know that it's better to ask and ask again than to be surprised. All these things, well most all of these things are lists of things that we've discovered along the way that we should have asked for. You don't want to be caught in that position.
The next part of the due diligence timeline is our internal part. This is very important. This is our last chance to say yes or no. When do we need to back out? When does the money go hard? What are all of those reports that we need to have to make sure we are financially approved for that project? When do communications need to go out to investors? How long is it going to take us to get the money from investors to put the down payment on the property? This all coincides with that close time and that due diligence list to show the value proposition to investors. I need to understand what's in the facility and what's made up of the facility. I need to make sure my financials are right. I’ve got to provide those things to the banks so we can all get a loan. This can't happen at the last minute. We have our final approval meeting before the money goes hard.
Now, essentially when our money goes hard, we're buying that property outside anything catastrophic happening…outside something coming back that is an absolute no-go, we need to be ready for it. We need enough information up front before our money goes hard to make sure we make that decision. So, on the 30 day if that's the closing period or on the 60 or 90 day…whatever the date is on that, the day before the buyer objection period is over, we have to have our last final closing documents and we begin to transition that facility under our management. We go into closing and closing can be hectic. Properly executing the due diligence during that period will help your closing go smooth. It will help you have a plan and understand everything that needs to happen. Make sure that you're still able to take payments, make sure you're still able to run that facility. That leads us to onboard bringing on your new asset and your new facility.