Due Diligence is a timed process for the buyer to inspect and confirm the information about the property and the deal before any money is lost. Most buyers focus on the physical characteristics and the financials of the property. They look at the condition and age of systems, roof, maintenance, etc. On the financials the focus on the Net Operating Income. If everything checks acceptable, they move forward.
These simple and obvious features are easy to identify and verify. However, they are only part of the story.
In order to know the “rest of the story”, you need to meet with the seller and determine why they are selling the property. The seller’s motivation can open the door to opportunities in creative financing.
One of Doc Haller’s students, presented an opportunity to purchase a $3M property operating in excess of 10% NOI. There was only one problem, the student lacked the $1.2 M required to close.
During the due diligence, several things were learned by reviewing the tax returns and the loan documents:
- Property was held by a corporation.
- The existing note from the bank, in the name of the corporation, had 9 years remaining on the term.
- The banknote did not have a due on sale clause for change of corporate ownership.
- The seller did not need the cash from the sale.
- The seller needed to remove the debt from his balance sheet in order to proceed with another project that he needed financing for.
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Using what you learn in due diligence
If you know why the seller was selling, you can get creative with your offer. In this case, the buyer was able to apply the knowledge gained during due diligence to offer a creative solution:
The buyer provided a Letter of Intent to purchase the entity.
- $2.5M offer for the stock purchase.
- $250,000 Down
- $25,000 for closing
- $250,000 Seller carry back
The bank tried to stop the transaction, but realized they had no leverage to call the note. However, the bank did call the ten percent guarantee, $200,000 from the seller.
In light of this requirement from the bank, the seller requested an additional $250,000 collateral from the buyer, until the seller was reminded of a forgotten fact.
When due diligence pays dividends:
Hidden in the tax returns, beyond the view of the accountants and attorneys, was a note on the tax returns. In exchange for the cost of the tenant improvements & betterments for the restaurant tenant, the seller had received thirty percent ownership of the tenant, a restaurant that annually provided in excess of $80,000 income to the seller!
The buyer now had the leverage. Instead of keeping the stock ownership of the tenant restaurant, the buyer agreed to dividend the stock ownership of the restaurant to the seller, which was clearly valuable to the seller.
By examining all the seller information available to the buyer, the buyer was able to:
- Buy a 10+ CAP building at a 17% discount increasing the CAP to over 12%.
- The downpayment required was only ten percent of the offered and accepted price plus $25,000 for closing.
- The buyer was able to retain the financing in place with a 9 year remaining term.
- The seller retained his ownership in the restaurant tenant providing more than $80,000
- The buyer picked up a property providing over 100% annual cash on cash returns.
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