Advantages of a Higher Due Diligence Standard

Mon Jul 23, 2018 at 11:00 AM

Commercial real estate transactions can be highly complex and require technical knowledge in areas such as market analysis, valuation, leasing, sales, and due diligence.

Due diligence can be especially daunting to navigate, with services and standards varying greatly between report types and consulting firms. Understanding the options and differences between available due diligence options can help you determine the level of investigation that best fits the specific needs of a transaction.

Since buyers, investors, and other stakeholders take on substantial risks in commercial real estate transactions, there are specialized due diligence services tailored to supporting acquisitions. One of these services is an Acquisition Property Condition Assessment (APCA). This service goes beyond the ASTM standard Property Condition Assessment (PCA), which is intended solely for lender financing purposes.


PCA or APCA: What’s the Difference?

PCAs are most often required by lenders for approval of commercial real estate loans. The typical scope requires a building generalist to perform a visual inspection of the property, usually under half a day, and provides a report with general documentation of the inspection. Data is gathered and the property condition report (PCR) is written to ASTM standards.

While the PCA is entirely appropriate for lenders, it is not intended to provide in-depth analysis and the more thorough information that investors acquiring property can leverage most. Lenders want to see that certain liability standards are met, while acquisition stakeholders need to understand the unique challenges and opportunities of a potential investment. There are a host of concerns primarily affecting stakeholders that do not come into consideration in a standard PCA.

An APCA, however, expands the standard scope to provide extra detail on all building components, roof conditions, façades, systems such as heating, cooling, electrical and/or plumbing, and structural components, to name a few. The greater level of analysis provided by an APCA gives stakeholders more comprehensive insights into a property’s needs, and can help in both the price negotiation and capex budgeting process.

 

What’s Special About an APCA?

The APCA offers an entirely customizable property analysis, providing stakeholders with in-depth insights that help drive business decisions and negotiations. A team of senior staff specialists collaborates early on with clients to develop and implement a project scope and fine-tune recommendations, focusing on specific areas of interest or concern.

Within a broad suite of services geared specifically toward acquisitions, clients can tailor an APCA scope of work to fit a property’s specific needs, which typically aren’t included in a standard PCA:


  • 100% Interior Survey

This service includes comprehensive reporting of the overall condition of interior elements. Most commonly used in acquisitions of multifamily properties and hotels, a team of specialists completes an interior survey with on‐site coordination.


  • Accessibility (ADA) Surveys

Accessibility surveys provide reporting specific to a property’s compliance with applicable accessibility regulations, most commonly the ADA and/or FHA. These surveys range from a short-form compliance checklist designed to capture the more basic, common aspects of non-compliance to detailed, extensive assessments that go beyond basic observation. More detailed surveys cover the nuances of accessibility compliance and provide an in-depth assessment of accessible design features related to items such as interior and exterior accessible pathways, parking, signage, and public use areas, such as restrooms or swimming pools. Accessibility assessments help buyers understand the liabilities of accessibility non-compliance and the costs associated with mitigating those liabilities.


  • Mechanical, Electrical, and Plumbing Survey

One or more specialists conduct all mechanical, electrical, and plumbing (MEP) surveys. They provide specific reporting regarding the condition, type, capacity, and maintenance of existing systems through detailed on site analysis and selected testing. Specialists know and understand the components, inter-relationships of systems, and real costs to cure faults, replacements, or deficiencies. MEP surveys can identify how well maintained building systems are and make determinations about their useful life expectancy. Properly maintained systems may be determined to outlast their expectancy, and vice versa for poorly maintained systems.


  • Façade Survey

For façade surveys, one or more specialists conduct the investigations, starting with a Level 1 review of exterior system documentation, interviews with personnel to discuss defects or issues, and visual observations. A Level 2 review goes further, involving specific tests to address any concerns from the Level 1 review. Level 2 surveys are conducted utilizing a Rope Access Team, Drones, or boom lifts. A common example is with curtain walls, which are designed to keep water out, but can sometimes fail and result in leaking. If evidence of leaking is found, Level 2 testing can confirm it and provide recommendations on repairs and estimates of associated costs.


  • Roof Survey

Roof surveys go beyond identifying the age of the roof, a quick visual assessment, and a review of warranty information. A specialist inspects the roof membranes, insulation, and deck section-by-section using infra-red thermal scans and, potentially, analysis of core samples. A detailed summary is provided for each roof section, as different issues could be found in different sections and/or roof types. This survey also addresses costs of immediate repairs and deferred maintenance.


  • Elevator and Escalator Systems Survey

Surveying and reporting of elevator and escalator are conducted by a specialist and involve a special scope of work crafted by EBI. Rather than basing the useful life expectancy and condition of the systems solely on numbers, the specialist physically inspects the pit, the shafts, cables or lifts and rails, gears and motors, and completes an analysis of the controls.


  • Structural Survey

Conducted or assisted by a structural engineer, the structural survey more thoroughly investigates known or potential problems observed over the course of the investigation that a general engineer may notice. A structural engineer provides a thorough report after an investigation which provides detailed analysis of the issue and options for solutions.


  • Parking Garage Survey

The parking garage survey scope of work is conducted by a specialist who performs a review of existing structural drawings and observations of structural systems, sealants, and travel surfaces to determine the effects of water and waterborne salts and corrosives.


  • Mold Survey

A specialist conducts mold surveys through visual observations and investigation of mold in typically affected areas. Often stakeholders request these surveys for multifamily properties, hotels, or units left vacant. Depending on the scope of work, the surveys may include sampling and laboratory analysis provided in a separate report.


  • Asbestos Survey

A specialist conducts asbestos surveys through visual observations and/or sampling of building components typically containing asbestos. Varying levels of reporting are available based on the stakeholders’ risk tolerance and plans for the property. Depending on the scope of work, the surveys may include sampling and laboratory analysis.


  • ALTA Survey

ALTA surveys are conducted by a licensed surveyor in accordance with 2016 Minimum Standard Detail Requirements for ALTA/NSPS Land Title Surveys and are stamped by a licensed professional surveyor. ALTA surveys identify legal property boundaries, easements and encumbrances, and locations of improvements and utilities, among other functions. One of the top reasons to obtain an ALTA survey is because it can enhance title insurance by eliminating the “survey exception” on the policy, giving more accurate coverage based on the existing property legalities.


  • Drone Services

Utilized in many of the above surveys, drones save time and money while effectively capturing data. They can fly over large or small properties, providing accurate, real-time views of an entire site or multiple sites. In less than 5 hours, drones can survey over 100 acres of land and fly to vantage points that are inaccessible to humans or would pose serious risk of injury. With drone technology, we are able to complete high visibility aerial photography in an accurate and more efficient manner.


  • Cost Segregation Studies

Cost segregation is a type of engineering analysis used in determining asset classifications and allocating depreciation for commercial real estate investments. EBI’s licensed building professionals perform a systematic, engineering-based analysis of all aspects of a property. The goal of this analysis is to properly allocate asset costs into real property or personal property, and to classify each asset into its most optimal asset life in accordance with the Internal Revenue Code and most recent United States Tax Court case law. An EBI cost segregation study will maximize the depreciation allowed by current tax code, reduce tax liability, and thereby increase cash flow for the owner.


With so many options, stakeholders want to understand which services offer the best information for their investment. APCAs begin with client consultation to determine budgets, needs, and concerns, and a review of the property to make custom recommendations for the scope of work. The best APCAs are truly collaborative, and the scope entirely dependent on the property, transaction, and parties involved.

Once the scope is determined, expectations for timelines, services, and the schedule for site visits and work completion can be set. EBI’s professionals consolidate all reports—including those from our specialists—into one high-quality report at the project’s end, providing a single source document for easy review.


Why Invest in an APCA? 

While standard PCAs are geared more toward lenders and utilize underwriting models structuring the items and costs of recommended repairs or replacements, APCAs provide insight into the real-world costs of ownership or management of a property. They help the purchaser understand the property condition and what to expect in terms of repairs and maintenance, enabling them to plan and budget for those costs. Additionally, this can be invaluable to prospective owners of new buildings with warranties about to expire.

Each service provides a different value to the client. ADA reports, for instance, are a powerful negotiating tool if it’s found that a building is not in compliance. This not only ensures that the purchaser understands the work required to make the building compliant, but can also mitigate potential ADA lawsuits.

Perhaps the greatest value gained from the APCA is just that: it’s a compelling negotiating tool. The costs inferred from an APCA can be used to re-trade, potentially shaving tens or even hundreds of thousands off a purchase price, greatly mitigating the costs of rigorous due diligence reports. If a report indicates issues with a property, the seller is more likely to negotiate than to risk other potential buyers receiving that information. In “best and final” scenarios, the Acquisition Property Condition Report (APCR) is beneficial to purchasers wanting to understand any potential issues or costs that may be incurred for repairs or maintenance as they calculate their budget. A potential buyer might determine that costs of maintenance or repairs reported in the APCR are too cost restrictive or outside of their capital expenditure budgets and walk away from a deal.

No matter the reason for requesting an APCR, the value of the information gained can lead to spending much less on a deal, or avoiding a property that has major issues. This peace of mind far outweighs the costs of the investigation.


In Our Experience…

In one recent instance, a client worked with another due diligence firm, requesting a standard ASTM PCR as part of the due diligence process in the acquisition of a property. Under that scope of work, no concerns were reported, and the client proceeded with the purchase. Unfortunately, shortly after the transaction closed, serious issues with the plumbing systems were discovered that took six weeks to repair. During that time, the plumbing could not be used.

In addition to the unforeseen repair costs, the client had to manage the headache of business interruption. In a subsequent acquisition, the client retained EBI Consulting to perform the more in-depth APCA having learned the hard way that the upfront cost was well worth the potential savings down the road.

Another scenario involved a client looking to purchase a multifamily property with 5 levels of subterranean parking built on land with a high water table. The dedicated EBI Acquisition Services team determined that the seller recently completed extensive work to the parking garage. Furthermore, the seller spent roughly $700,000 annually in addressing the issue.

As such, EBI worked with the client to develop a project scope addressing the client’s specific concerns. In this case, the recommended scope included MEP, roof, and parking surveys. The investigations revealed that the parking garage needed a great deal of immediate work—work that would require shutting down the garage. The estimated cost of repairs was $6.5–7 million, not including the cost of implementing a valet service or other measures to accommodate residents.

With this knowledge, the client determined against proceeding with the transaction. While walking away from a deal isn’t optimal, the client was happy to do so knowing that it would be an unwise investment. For this client, the knowledge gained from the APCR was worth millions.


EBI’s Commitment to Quality

Considering what could be at stake by purchasing a property without thoroughly understanding its condition, it makes sense to invest in high quality due diligence reporting up front. At EBI Consulting, we know every transaction is important and unique, which is why we work to first understand your needs and ideal outcomes. An APCA will deliver actionable information to help you make the best investment decisions and customized solutions that are relevant and unique to your property. When you want a dedicated team of senior staff specialists collaborating with you to meet your goals and needs, you want EBI’s Acquisition Services team. Our quality reporting and experienced team of acquisition specialists are best-in-class. Our team is responsive from day one and we communicate frequently throughout the process. Contact us to find a local consultant and learn more about how EBI can support your property acquisition.


About the Author

Dave StewartDavid Stewart, AIA, National Technical Sales Account Executive

Mr. Stewart is a registered Architect in Massachusetts and New Hampshire, and a Certified Environmental Inspector. With over 35 years of experience in architecture, construction consulting, and building design, and 25 years of experience in conducting commercial real estate Property Condition Assessments for investors, owners, and financial institutions, he is a respected expert in the space. David is also a Certified Environmental Inspector, a Certified Commercial Inspector, and a Certified HUD 203K Fee Consultant, as well as a member of the American Institute of Architects, and Boston Society of Architects, and holds NCARB Certification.

At EBI, Mr. Stewart developed EBI’s Property Condition Reporting program, and manages staff training in addition to Property Condition and Environmental Site Assessment due diligence for financial institutions, commercial lending clients, and property owners. He has personally completed over 800 Property Condition Assessments nationwide, and managed well over 10,000 total assessments. Previously, Mr. Stewart created and led EBI’s Acquisition Services Group and has completed and managed thousands of Acquisition Property Condition Assessments, Forensic Assessments, and Special Service Reports. Mr. Stewart is now EBI’s National Technical Sales Executive for Acquisition Services, leveraging his decades of experience to create custom solutions for owners and investors across the country.