Outside the Bricks, Mortar and Numbers: Multifamily Property Due Diligence

Bradley M. Schaeppi

By Bradley M. Schaeppi

In my previous career as a real estate broker, I used to advise clients there are three legs to a multifamily property valuation stool:

  1. Physical – the physical structure and mechanicals.
  2. Financial – the income and expenses.
  3. People – as financial assets or liabilities.

This article addresses the third stool, the people in the property.

The purchase of multifamily property is unlike the purchase of a residential house or other commercial properties including office, retail and industrial. The differentiating factor is that people live in multifamily property and local, state and federal governments regulate “habitability conditions” in the homes and how people are treated when they search for their “home,” live in their “home,” when they leave or are asked to leave their home and the reimbursement of any security deposit and any lawful withholdings after they leave their home.

In Minnesota, controlling Minnesota Supreme Court case law Fritz v. Warthen dictates that if tenants can prove a landlord knew (and in extreme cases should have known) of habitability conditions (mice, mold, non-working utilities, etc.) multifamily rental property owners can be held liable for a breach of the covenants of habitability and therefore be liable for rent abatement (refund past rent paid) dating back to typically the time of first written notification of the habitability issue to the landlord. In sum, unless a purchase agreement contains specific habitability indemnification language or a separate escrow agreement with funds to address habitability disclosures post closing, the purchaser can be financially on the hook for these costs and issues.

While language can and should be added by the purchaser to the purchase agreement to request rental license history and any written notices, real estate agents, investors, or their attorneys are wise to not take the seller by his or her word or volunteered disclosure. Instead they should do their homework and turn over their own rocks.

Purchaser due diligence of the “people” must include:

An informal call to the local rental housing municipality. Contact the municipality directly to have an informal phone conversation about the rental property and ask about tenant complaints to the city. In addition to any office administrative person reading from the file, ask specifically if there is a city or fire inspector who has firsthand history inspecting the property or speaking with tenants on their concerns. This contact will often speak off the record and share concerns, even non-documented tenant concerns, about the property.

A formal document request from the local rental housing municipality. Formally request a copy of the rental license and history at the property. Depending on the municipality and the size of the property, this request may be of a city department or the city’s fire department. In many cases, official requests contain notes from the city officer or agent on the property. These notes typically contain additional information that shed light on mold or other complaints. Documents should include correction orders and subsequent compliance notices. The last 12 months are most critical but request a two-year history.

Request a police report for the property. While not habitability focused, due diligence of the third leg “people” must include a full log of police reports at the property. This typically can be done in person at the local precinct with payment of a small fee. Names on reports can be matched to a tenant rent roll to decipher any ongoing issues that may prove a time and expense cost to the purchaser. The last 12 months are most critical but request a two-year history.

Purchasers of multifamily rental property should know exactly what they are purchasing. Relying on a truth in sale of housing and a rent roll is not enough. Remember the “third leg of the stool” and perform due diligence on the people in the property to avoid legal and financial liability. While anyone can assist with the due diligence, investors and real estate agents would be wise to leave all the final legal implications of discovered habitability issues that may flow to the purchaser to an experienced real estate attorney, preferably a certified real property law specialist.

Bradley M. Schaeppi represents real estate investors, property management groups, landlords, real estate agents and brokers with advice, transactions and problem solving for potential or active litigation. Prior to starting his law practice in 2011, Brad held positions as project manager for local developers, senior project manager for a publicly traded company, and investment sales associate for a large local real estate brokerage and management company. A member of the real property law section of the Minnesota State Bar Association, he holds certification as a MSBA board certified real property law specialist. Brad can be reached at bschaeppi@hjlawfirm.com or (952) 460-9296.