Trust, but verify.
When it comes to due diligence on a multifamily acquisition, you can drop the trust and solely focus on verifying the information you’ve received. On every deal we’ve done, we’ve found financial “inconsistencies” during the due diligence phase. Verifying and projecting future income is a fairly straightforward process, but doing it for the expenses, including utilities, always seem to take a little more work.
When we purchased our first multifamily property, the seller only provided written confirmation of water expenses, citing the tenants paid for gas and electric. We confirmed that the tenants paid for those utilities, but stopped short of asking who pays for common areas. Unfortunately, we found out a month later when one of the tenants asked if she would still receive a small rent reduction for covering the electric in the common areas.
Since then, we’ve treated the due diligence phase as the real estate version of CSI. It’s your one shot to learn everything about the property and correct any theories or assumptions before you close. And as a former financial auditor, my partner and wife, takes great joy in discovering and confronting these “inconsistencies” that appear.
However, the due diligence is less about how the current owner manages the property, but to inform your purchase and management decisions. Knowing that utility costs are high doesn’t help you much if you don’t know why or have a plan to address it.
The TV crime shows always feature a team investigating a case and you should have one looking into your utilities as well. Ideally, your team would feature a financial auditor, but if you need to do it yourself, we’ve laid out some tips to help you perform due diligence on the utilities.
1. Ask the Seller
One of the first and easiest steps is to ask the seller for the past 12 months of invoices. It’s important to get the last 12-months to adjust for seasonality. Even in warmer climates, there is usually some seasonality that impacts utility usage. I prefer to start with the owners to get a read on how they’ve managed these expenses and see what additional info they’re willing to provide. Some owners won’t have well maintained records, which alone can serve as a valuable data point. However, there is a much more accurate way of getting this info.
2. Call the Utility Companies
Reach out directly to the utility companies and let them know you are under contract for the property and want to confirm utility costs for the last year. This is a great time to ask if you can expect any increase in expenses and see if they will tell you how usage compares to other properties nearby. In addition, some offer rebates or flat monthly rates so utility costs won’t spike throughout the year.
3. Check Existing Vendor Agreements
For larger properties, find out if there are existing agreements with gas, phone, cable, or internet providers. Do some research on competitive rates and see when you can renegotiate terms. Some cable and internet companies may even offer a kickback for getting a certain number of residents to sign up for service.
4. Ask the Experts
Ask your property manager to confirm if the costs are in line with other properties they manage in the area. Ask them for tips on reducing the bill, but don’t stop with the property manager. Reach out to a plumber about tips to reduce water expenses. Do the same with an electrician and HVAC technician on electrical and heating/cooling costs. Use the team of experts to uncover common problems and find solutions to reduce these expenses.
5. Confirm All Tenant Agreements (Written and Verbal)
On our 8-unit, we were told that all tenants paid their own utilities and this was written in the leases. However, one of the leases made a curious reference to the tenant’s Section 8 agreement with the subsidized housing agency. In this agreement, it stated that the tenant was only responsible for cooking gas, but the owner was responsible for electric and heating gas. This cost had to be factored into our expenses going forward to honor the agreement with the subsidized housing agency. In addition, make sure there are no verbal agreements such as the previously mentioned small rent discount for common areas electricity. Have the seller sign a waiver as confirmation.
6. Talk to the Tenants
Ask the tenants about their utility bills and how it compares to what they would expect. This is a great way to identify and solve problems for the tenant, while improving the financial operations. They may inform you of energy issues, competitive offers, energy programs, or suggest that there is an opportunity to implement a RUBS (Ratio Utility Billing System) program, which allows you to bill residents back for their portion of utility costs.
These steps help identify utility costs and opportunities during the due diligence phase. Verifying utilities and determining how you will drive efficiency can go a long way to optimizing a property and delivering strong returns. This is the time to investigate, confirm the current performance and finalize your plans to improve operations. With that in mind, here are a few more tips on how to reduce utility costs.
Bonus Utility Saving Tips
Install low flow toilets
Use a low flow toilet hack – place a half gallon jug of water in the toilet tank
Install low flow shower heads and faucets
Reduce water heater temperature to 120 degrees
Use motion lights for common areas
Swap incandescent light bulbs for CFL light bulbs
Open all air vents (more energy efficient than closing vents in unused rooms)
Replace air filters regularly