Buyer Beware: Due Diligence Do’s and Don’ts

October 29, 2014 – Multi Family Executive.com
By: Peter V. Dessau and Eric C. McAllister

Inadequate property inspections can lead to serious, and costly, repairs after the purchase.

With historically high rents fueling the apartment market, sellers are once again demanding top dollar and buyers have become increasingly aggressive in their pursuit of available inventory. During this process, the prevalence of defective construction in the apartment industry over the past several decades should not be overlooked.

Amateurs and professionals alike have purchased properties that were economic disasters because they were fraught with undetected construction defects. As a consequence, conducting thorough “due diligence” investigations is essential in avoiding the substantial repair and maintenance costs that can result from latent construction defects.

Understanding Apartment Construction
As owners and operators know, apartments are hybrid commercial/residential projects that have a history of problems unique to their classification. Making sure that a buyer, or a buyer’s inspection company, understands these problems, and where and how they manifest in apartment construction, can make or break a due diligence investigation.

Even reputable commercial inspection companies focus their due diligence investigations on interior systems, such as mechanical and plumbing systems, and generic sources of water intrusion common to all construction (roofs and windows). It’s doubtful, however, that these inspectors will discern hidden points of water intrusion such as handrails, deck edges, and stair stringers. Thus, it’s important the investigator be aware of not only how and where water penetrates, but how evidence of that water penetration—even when hidden behind finish materials like concrete and stucco—manifests itself on the finished surfaces of the building.

Forensic investigators who provide support to attorneys can be an excellent resource for buyers, too, during the due diligence process. They can, for example, review a building’s architectural plans for common architectural details that can allow water intrusion. They can also walk a project and identify areas that have a high probability of leaking, without conducting destructive and costly testing. If destructive testing is necessary, the forensic investigator can perform the testing and provide estimates the buyer can then use in soliciting bids for the repair work. The investigator’s findings can also help the buyer evaluate the economics of the purchase and renegotiate the sale price, if desired.

Understanding the Construction Team
An apartment building’s original construction documents are commonly made available as part of the due diligence process and should contain design drawings, subcontracts, and prime contracts, at the very least. These files can answer many questions you, as a buyer, may have, including the following:

First, ask whether the builder built the property for the builder’s own profit. Some extremely reputable developers occasionally function as their own general contractors. This is a red flag that should trigger caution, because the economics of development can be in conflict with the time and cost requirements of contractors. When developers act as their own general contractors, there’s an increased probability that quality control will suffer for the sake of maintaining the development pro forma and schedule. This is particularly true if the developer didn’t “hold” the asset for a significant amount of time after it was built.

Second, ask about the design professionals who worked on the job. Different firms have different reputations. Some architectural firms are better at generating plans that are more subcontractor–user-friendly than other firms. If the plans are too complicated, it’s common for subcontractors to ignore them.

The late John Griffiths, an attorney who specialized in mediating construction disputes, kept a photograph in his office of a bunch of sticks assembled at a jobsite where several walls were supposed to tie together. It’s obvious the framer had no clue how to build the relevant detail, because written on the sticks were the words, “I tried.”

Third, ask about the subcontractors who were retained to perform the construction work. Among the major trades, such as framing, waterproofing, sheet metal, and lightweight concrete, how many of those subs are still in business? What was their reputation when they worked on the project?

Trade contractors have a tendency to use the same means and methods on every project they work on, often despite the requirements of their contract documents. It would astound the common consumer to learn how frequently trade contractors ignore essential contract drawings and specifications. As a consequence, a builder’s habits have a tendency to carry over from project to project, good and bad. Attorneys and inspectors who work with apartment owners in your region should know who they are.

Understanding the Maintenance History
Because purchase and sale agreements commonly have limited representations and warranties, buyers should seek to gain as much “actual knowledge” about the function of the project as possible. Maintenance records are often the most important records for ascertaining this information, yet they are commonly ignored.

Patterns in maintenance records can provide valuable insight into which, if any, of the building’s systems aren’t performing. For example, is there a history of complaints of water coming through door thresholds or windows? Are there particular units with multiple maintenance requests for mold abatement? Is there a correlation between maintenance requests in a particular place (such as on a certain floor, or facing one particular orientation)? The problem may lie not with the tenants but with the system itself.

Talk to the maintenance personnel. What do they think works well and not so well at the property? On one occasion, a client of ours was horrified to learn that a team of painters did nothing but caulk and paint siding, because of installation errors in the building envelope. The buyer never bothered interviewing any members of the maintenance staff, some of whom freely volunteered to lawyers in subsequent litigation that the project was referred to as the Golden Gate Bridge because the asset was perpetually being painted.

Understanding Claims Preservation
Besides the building, its construction team, and the maintenance staff, there are three important legal theories apartment buyers should be aware of prior to closing escrow on a property.

Ten-year defective-construction limit. There is an absolute bar against suing a builder for defective construction more than 10 years after the project was completed. As a consequence, when a purchaser fails to identify defective construction in older properties, there can be no recovery against the builder to help offset repair costs, making thorough and effective due diligence inspections all the more important.

Three-year potential claims limit. For projects less than 10 years old, claims for construction defects can nonetheless become time barred if not pursued within three years of when an owner knew or should have known that the defect existed. Moreover, when a buyer purchases a piece of real property, the buyer is charged with the knowledge of the prior owner. Thus, if a prior owner discovers or should have discovered defective workmanship, the statute-of-limitations period commences as to that owner and all future owners.

Limits of transference. The right to sue for defective construction is a personal property right that does not automatically transfer with the sale of the real property. To the contrary, if a seller is aware of defective construction prior to the close of escrow and does not specifically transfer the legal right to sue for that defective construction (through a document called an “assignment of choses in action”), the right remains the personal property of the seller, and the buyer will have no recourse against the builder.

By conducting a thorough review of the project file, maintenance materials, and any prior sales documents, an apartment buyer should be able to determine whether the seller discovered or should have discovered any defects at the property. However, as a matter of course, purchasers of property less than 10 years old should demand that assignments of choses of action be included in the closing documents.

Good due diligence requires patience, hard work, and professionals who possess the expertise to correctly advise their clients. A proper investigation yields a thorough understanding of the building’s construction and maintenance history as well as the available rights to be conveyed.

You can read the original article here.

Advertisements
This entry was posted in Multifamily and tagged . Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: