Buyer Beware! The Importance of Due Diligence in NYC Multi-Family Real Estate Acquisitions

Failing to conduct thorough due diligence prior to acquiring a New York City residential or commercial property is one of the biggest mistakes that real estate investors make…

Failing to conduct thorough due diligence prior to acquiring a New York City residential or commercial property is one of the biggest mistakes that real estate investors make. While it can be tempting to act quickly to close a hot deal, failing to do your research can cost you valuable time and money in the long run.

What Is Due Diligence?

Many first-time real estate investors are surprised to learn that finding a suitable property and negotiating the key terms of the acquisition are just the first steps in the process of buying a property. The due diligence process, in which the buyer gathers and analyzes information about the property prior to consummating the sale, can be the most complicated and time-consuming. Nonetheless, it is critical to minimizing your risks.

Conducting Your Own Research

The nature of the due diligence process will be informed by the nature of the property you are interested in acquiring, as well as any unique risks that it may have. When it comes to Multi-Family properties,  There are several important sources of information:  

• Title report
• NYC Department of Buildings  
• NYC Department of Finance  
• NYC Department of Housing Preservation & Development
• Division of Housing & Community Renewal  
• Airbnb listings
• NYC Landmarks Preservation Commission
• Litigation (while most filings are public records, there is no central database of all cases)
• New York Sex Offender Registry
• Local town clerk & land use boards

Consulting With Professionals

Depending on your situation, you may want to call in a range of experts to provide feedback about the property. For instance, a structural engineer can validate the integrity of the building and flag any potential construction defects or other concerns. Similarly, a termite/pest inspector can determine if the building is clear. While this may involve upfront costs, failing to thoroughly inspect a building pre-purchase can lead to expensive maintenance and repair costs down the road. If you are considering improvements to the building, it is also advisable to consult with an architect who can confirm that your plans are feasible and/or within your budget.

Environmental due diligence is also important, particularly given the potential for successor liability. Environmental due diligence is a formal assessment of the property for potential risk of environmental contamination. A Phase 1 site assessment determines the likelihood that a site is contaminated through visual observations and a review of public records.  A Phase II site assessment is more invasive and evaluates whether contamination in fact exists.

Obtaining Seller Disclosures

Once you begin the negotiating process, you should be able to obtain certain disclosures from the seller. Below are several examples of the information you will want to obtain:

• Financials (i.e., payroll, tax filings, operating statements)
• Rent roll and leases, including security deposits. You will also want to find out if there is a land lease.
• Vendor and service contracts
• Permits for any work in progress
• Certificate of occupancy
• Complaints/open violation notices

Under the Property Condition Disclosure Act (PCDA) (N.Y. Real Prop. Law 460-467), sellers are required to make certain disclosures or pay a credit of $500 to the home buyer at closing. The PCDA applies to 1-4 family residential properties; it does not apply to condo, co-op, or vacant land, and certain other exceptions. It may apply to leases that have an option to buy.

The PCDA mandates that sellers disclose (using a standard form) environmental, structural, and mechanical systems information, including all known defects. The law does not create any further liability for a seller’s non-compliance other than the $500 credit. Accordingly, many Sellers seek to “opt out” of the disclosure requirement by agreeing to the $500 credit in lieu of the disclosure statement. It is important to note that the $500 credit may not protect the Seller from willful fraud or misrepresentation regarding material defects, which could lead to actual damages. Still, buyers still must do their due diligence.

Seller Representations

Sellers may also make representations about the property during the course of negotiations. It is imperative that any such representations are included in the final written agreement, as oral statements are generally unenforceable.

There are many representations to include (a good lawyer will include as many as appropriate). Examples include:

• Seller corporation is in good standing
• Seller has authority to sell the property
• No legal actions pending/threatened, or court orders affect the property
• All the disclosures are true and accurate and will be at time of closing (leases, rent roll, financials, etc.)
• No liens or encumbrances at time of closing
• All required government filings have been filed on time

The contract must also specify what representations will “survive the contract” and for how long. This gives the purchaser the right to seek a remedy post-closing if the seller’s representations turn out to be false or misleading.

Key Takeaway

When contemplating a New York City multifamily real estate acquisition, you should truly “trust no one.” Instead, it is imperative to conduct due diligence and ensure that any seller representations are properly memorialized in your contract.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Bruce Feffer, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.