Extensive due diligence now critical

Real Estate Weekly, Jan 20, 1993 by Lois Weiss

Doing their homework by using forensic accounting and intensive due diligence, today's investors are trying to find deals that make economic sense without spending all their money searching.

In an effort to avoid unforeseen problems, investors are being forced to allocate thousands of dollars in reserves to conduct due diligence and sniff out these obstacles.

`Buyers are tired of chasing down deals that don't close," said Daniel Forbes, president of Real Estate Evaluation Services of Rye, New York.

Forbes conducts what he deems "SWAT Team" due diligence on behalf of investors, insurance companies and lenders nationwide in an effort to get in and out quickly at a reasonable price.

One issue for potential purchasers, equity investors and lenders who are examining whether to retinanee a mortgage, is that taking too long to uncover the information costs too much.

For instance, he said, a property that is for sale or has a mortgage of $10 million dollars at, 10 percent interest would have payments of $83,000 per month or $2,700 per day. 'We do [the due diligence] in three weeks or less and we save 60 days in the process," he said. 'The key is getting the deal done."

For that, Forbes said, you have to get to a fast 'no.' "It is very important to have someone going in and out on an immediate basis," Mega Invest International's president and CEO, Wilhelm A. Rosenberg, agreed. The fee for conducting due diligence on an asset of $10 million might be less than $15,000, Forbes said, an amount Rosenberg called "merely a pimple on the deal." But investigating a complicated property with many leases and components, or hiring a Big 6 firm in some cases, can cost more and take longer.

While investors and lenders have the skills to do workouts and avoid problem areas, Rosenberg said they must know the obstacles in order to deal with them.

"Most sellers get afraid and try to hide it," he said, noting that a buyer may accept the risk but discount the price.

Sellers sometimes try to bury the risk in the numbers, Forbes explained and often, the buyer never sees the actual assumptions that make up the presentations. Broker Debrah Lee Charatan, president of Bach Realty, said, "If the banks know it they want you to know it. They say, 'These are the problem, these are the issues and tell me what you want to pay.'"

The good conduct their own business acumen to due diligence, Forbes noted. "It's prudent business philosophy and the good bottom fishers have built this up in-house," he said.

But most potential buyers, as well as absentee owners such as foreign investors, do not always have this capability.

Alan M. Simon, executive vice president of Jean-Marc Levet & Partners, said there are companies that specialize in due diligence work for reasonable fees and try to put together packages and numbers that are realistic.

"The secret to any sale is the realistic seller," he said. "That's the hardest thing to find today. People don't realize how the rents have changed."

Harold Siegelaub, managing partner of Realty Venture Capital Associates, has sufficient equity to buy more than $100 million in the next six months but observed that his problem in concluding deals is not the capital, but the comfort. He has walked away from deals because something came up after going to contract and spending "wasted money" on the due diligence.

"Things are not what you thought they were," Siegelaub complained.

Three deals he passed on have since gone bankrupt because the eventual buyers did not see the potential complications when going in, he noted.

Charatan said the investors may be frustrated but they don't get angry when they find something wrong. "They know the process," she said.

Broker Peter Hauspurg, president of Eastern Consolidated Properties, agreed the problem is eliminating the surprise in the deals. "There can be a real challenge to sort out the facts."

Mark Teitelbaum, managing director/Debt Equity Advisory Division of Julien J. Studley, said, "You have to have good detail. A lot of the due diligence has to be done beforehand to screen out the buyers so they don't waste time."

Teitelbaum said investors, particularly foreign ones, are looking for information up front because there are many properties for them to look at. "If you have weak information or a sloppy package a lot of people just pass on it,' he said.

Rosenberg represents European equity sources and was unable to buy enough properties last year because of issues he uncovered during his exacting due diligence.

Since the Germans are receiving 9 percent per year for money that is safely on deposit in their banks, new acquisitions have to show at least a cash on cash return of 11 percent for residential and 15 percent on commercial properties. Additionally, Rosenberg said, the residential investments must have at least a 70 percent occupancy rate while commercial investments must show a 85 percent occupancy.

Knowing the potential downside. in advance would save both time and effort in finding deals a buyer can live with. "You are going to own this thing and want to find out everything before you own it," said Mitchell Rosebelle, manager of real estate advisory services at Coopers & Lybrand, who is a forensic accountant.