Due Diligence Example for Self Storage Business Investing - Storage Unit Business and Real Estate

hey guys Matt McKeever hearing so this is an unusual video it's unlike any other video I've done on my youtube channel in my youtube career what we're going to do today is this is a real-life case study we're gonna dive into this is a store that you storage center so it's essentially one of those centers you know where people store their that they're never going to look at again one of those roll-up door things anyways the seller was claiming if they sold it to us at a 10 cap rate that this property was worth 1.4 million dollars after we dug into the numbers in under an hour of due diligence we determined this property is worth less than $500,000 that's a $900,000 error error if we're being nice and we're giving the seller bath of the doubt otherwise that's $900,000 fraud did this seller tried to pull on us so if you guys enjoyed this video smash that like button hit the subscribe button if you're new to my channel and share this video on social media guides sharing is caring it's the only way I get new subscribers it's the only way my channel grows so please share this on reddit on Facebook on Twitter on Instagram shared on your snapchat I don't really care just share this somewhere if you got value from it if you want to see me make more videos like this share it on social media and if you want me to dive into maybe something you're looking at send me the documents and we'll dive into it the only thing is make sure you don't sign an NDA because that's a non-disclosure agreement if you sign that you're not allowed to share the information thankfully this seller being so sloppy as he is he didn't make me sign an NDA so we're gonna dive into the information right now let's do this so the point of today's video is we're gonna be just kind of walking through a sellers package so what this is is there's a a self storage place or like a u storage place or a public storage type thing the whole thing is there's a whole bunch of little cubicles that people store their in and they rent out that space so we're looking at today a property that has a hundred and seven self storage units or parking spaces that are for rent it's in London Ontario and so thankfully in this case the seller did make me sign an NDA so I can actually disclose any of this information to you guys because they didn't make me sign anything so normally what's going to happen is if you're looking at say buying a business or a real estate property and you want to get a lot of financial information particularly if it's a larger business or a larger property you may have to assign what's called an NDA and so that just simply stands for a nondisclosure agreement so essentially what you're saying is if you if they give you access to their financial statements if they give you access to all the information that shows you whether they're making money or not you're not allowed to disclose it this time I didn't have to sign one so let's walk through it you know I have hidden their information because I wanna be a dick but what you're often gonna find in these situations are that these sellers will really inflate their numbers and in this case this is actually a real estate agent that's selling it so he's the owner and seller and you'll see us we dive into the numbers but this is a great example of how some sellers will try and take advantage of unsophisticated investors and simply try and make a huge promise on the returns or the projected returns instead of actually disclosing what's actually happening so what we have here first of all just so you guys know I kind of a rickety set up here but so we got camera here we got our information there and other information there and your camera one camera two so this is the main document they gave me this is the main document that gave me it's breaking out essentially all the information related to the 2014 2015 and 2016 years as well as a showing 2017 and a projection for 2018 so first of all when you're getting information from a seller always realize that they have a vested interest and betraying their property or their business in the best light so they're usually going to be aggressive with their income numbers and they're going to be they're gonna be forgetful we'll call it forgetful when it comes to the expenses or they're going to be naive when it comes to the expenses so usually what the sellers going to do is they're going to try and inflate the income and they go and try and decrease the expenses which will make it look like the property or the business is earning a lot more money and since it's earning a lot more money the business or the property is worth more money because most sophisticated investors are going to value a proper an investment property or business on the valuation of the income so it's really important that we actually understand if this income number here is actually legit because otherwise we're buying a bill of goods so just a little bit background on myself none of this is auditing or accounting advice that we're about to dive into I'm just gonna be sharing my experiences in my personal approach when I'm looking at this sort of information I may use words like auditor review but that's not actually what this is first things first when you get this financial package from the seller take a look and find out whether it's been prepared by an accountant if it has been prepared by an account to the CPA have they done what's called a notice to read have they done that's actually just a compilation or a notice to reader have they done a review or have they done an audit and so it's important to understand these different terms simply because a compilation or an oyster reader means they've done no due diligence they're providing no assurance that the information provided there is correct if it's a review they're essentially providing negative assurance so they're saying so so real Coles notes version they're kind of saying we didn't notice anything that looked too crazy and an audit is where they're actually diving into the numbers and they're getting support and confirming the validity of the information to a certain degree of probability kind of then this is not a technical video I'm not going to dive really deep into all the accounting terms and if you're really looking at a business or a property and you're concerned about the financial statements I'll get a review or an audit done by a professional CPA that'd be my biggest recommendation but I'm gonna walk you through just kind of how we approach things and at least I'm gonna walk you through how I approach things so first things first is you just wanna get organized so get all your information together in this case what the seller provided me was they provided me an appraisal report there's only really one page of that appraisal report that it aims to any financial information so I have that page here as well they provide me a two-page summary that simply is a revenue and direct expense report is what they're calling it essentially what it is is it's a four year essentially why this is it's a four year summary on the income and expenses and net income as well as showing the 28 tene projected income statement so there's gonna be there's gonna be a long video guy so fall off his chair get comfortable we're gonna get into some numbers so like I said the first thing we want to do is just get organized so what you want to do is label your different documents so in this case this is gonna be my primary document so I'm going to just call it a and just to remember that I'm gonna put an A up here in this corner so this is a and so just to say extra organized I'm actually gonna number the pages of this as well so this is a one and this is a to this page here this page directly from the appraisal so I'm gonna call it b1 so now I have my two documents a and B and the reason I'm gonna label these you'll see in a minute but we're gonna want to cross-reference the information here and one thing I forgot was my trusty calculator but you need a calculator for this stuff and so the very first thing we're gonna do here is simply we're gonna confirm the validity of all these different numbers so first things first is we're just gonna use the information we already have to figure out what we have versus what we don't have so on page a2 here we can see here's the current rent roll and here's the rent roll with the building 2018 so a little bit background on this property as I said it's a self-storage unit but what happened was in 2017 they built a new building and so if we read through this summary here subject property is improved with a6 building self storage complex with a total of 97 indoor unheated units as well as 10 outside vehicle storage spaces the villain contains a total area of approximately sixteen thousand seven hundred square feet and were constructed in 1980 as well as one recently pre-constructed steel building there are also two washrooms in one small office a breakdown of the size and quantity of the self storage units is as follow blue highlighted units are in the recently constructed rear building so this is the new building here just so we're all on the same page that's the new building I'm just right to new just to remind myself while we go through this exercise but so we can see there's on b1 we have 107 units that stated on this property so then jumping over here we can see 107 here so the very first thing we're going to do is we're simply going to confirm that these number of units agree that the units that the units on this page agree to the units on this page what we're going to do is we're going to assume that nothing the salary tells us is the truth and so we're going to double-check everything for ourselves so in this case we're just going to simply add up all the different units and boom we have a hundred and seven now so since I have agreed that this hundred and seven adds up I'm simply going to foot it here and so foot just means that I've actually added it up so in accounting what law of cameras will do is simply have an arrow here and that means that this this actually adds and so since we can see twelve eight thirty six fifteen eight twelve six ten I know that that adds as well so boom we have that adding then what we're going to simply do is we're going to take a look at so then what we're going to simply as confirm that all these units tie out so twelve nineteen ten twenty nine sixteen ten fourteen 10 10 8 9 5 10 and outdoor and we got 12 8 36 15 8 12 6 10 so that agrees so this document in this case this is from the appraiser so this this piece of paper I can trust more than what the seller provided me because the seller has a vested interest where the appraiser has to stand by certain code of conduct so in this case I can rely on the appraisers information more than I can the sellers so I'm going use this as one of my source documents so all I'm gonna say here is that all this information agrees to this and that since this is my source document I'm gonna put a two on it so that means this this 12 here this 12 I've confirmed over here so when I'm looking at this my main document I'll be able to remember that Oh am i positive that there's 12 units oh well I'll double check be one and I go be one then I'm going to look for something that references a two so in this case a two so essentially we're just gonna do that for everything so a 2 a 2 and then just to remind myself that these were actually new units I'm just gonna put a one beside it and then down here I'm just gonna make a note to myself and on this note I'm simply going to say yes so essentially I just have my ones here I'm just gonna say new building 2017 so the only reason I'm marking this is just kind of a note to myself that these are the new units that may come in handy later I don't know for sure but the key is I kind of want this a document to contain all the relevant information I'm going need to make a decision and everything else is just gonna be supplementary info that I've already vowed to here so essentially now we're essentially done with this b1 there's really nothing else that I can take over from this document to vouch to here so I'm just gonna set this aside that over there and now what I'm gonna do is simply confirm that all these numbers cross multiply so in this case what I'm gonna do this they're saying there's 12 units price of 150 equals 1800 so 12 times 150 equals 1800 since that multiplies I'm just going to put a little arrow here telling myself that yeah I crossed cross multiplied that that was cool this 21 600 I'm gonna do this 20 1600 I'm gonna do the same thing so that should simply be 1800 times by 12 21 600 and now I've already gone ahead and double-checked all this math so all this is fine some people will use check marks some will use these arrows it doesn't really matter guys I'm just gonna use checks here just to speed it up so boom all these are good sometimes you're not gonna be able to make a decision right away you might need more information and so you don't have to set this document aside and so if you've set it aside and the seller doesn't get back to you for let's say a couple weeks or even a month with more information you'll forget what you've already done and you don't want to keep picking it up and putting it down and redoing the same work because what ends up happening is you get fatigued and when you get fatigued you get sloppy so we don't want you getting sloppy so essentially we've confirmed that this is all good here so what I can see here is 137 400 is what the total max occupancy would be so this essentially if every was fully rented out at these prices so we're essentially done with this page for a little bit so we're gonna come back to this one in this case what we we've got here is we've got what their actual rents were so first thing you're gonna notice is these actual rents aren't the total rent so that means they either have bad debt or vacancy that's occurring which is resulting in them not fully renting out the properties now what we're going to do simply is we know that 110,000 400 is our max rent possible but we only collected 94 500 so what we're going to do is ninety-four thousand five hundred divided by 110 thousand four hundred and that gives us approximately eighty five point five nine percent so I'm just gonna put over here occupancy to remind myself with what this percentage is now I've done it for the other ones so I'm just gonna fill them in here but feel free to do it yourself if you want I'm not gonna dive too far back into 2014 that's kind of stale dad's as far as I'm concerned I'm just gonna look at the three most recent years you can do whatever you want when you're doing this it's always better do more information but just for brevity sake um that's all I'm gonna do on this guy and so what we're gonna do now is we're gonna add up the expenses and confirm these subtotals because again we can't trust the seller because they have a vested interest in presenting this data and the most and the best light possible so because of that we want to make sure that we're being accurate so because of that we'd wanna make sure the accuracy and the validity of this information and of course my batteries don't die goddammit so as we can see this added up so we're going to put our little foot again saying that this added up now now that we have our subtotals and we've confirmed them now we're simply going to take our our total rent subtract the total expenses to get our net income and we're just going to confirm that again so simply we're going to take our 94501 USA hmm all right so we've already noticed one strange thing and that in this case is that this doesn't add up our net income doesn't equal rent subtract our total expenses so it's not a big difference but it's still very strange so right now our different stands as a hundred and sixty four dollar difference so why why would this be different well obviously that they weren't using Excel or a formula to calculate this number so what we'll often find is sellers will play around with their expense of the rent number potentially to make it look nicer and what they forget to do is if it's not automatically linked as a calculation here it's not going to auto-update so what they do is they'll play around with these numbers or this number and then we can tell that these numbers don't add up the moment you find a number the doesn't subtotal or add up the way you'd expect that's a huge sign that something's wrong here that's a giant red flag right there so that the moment you discover something like this you need to be extra cautious with the numbers you're using so what we're going to do now is we're going to dive deeper into all these other numbers and make sure that they work out as well and so simply here to remind myself that this is what it should be I'm just going to put an S be beside it should be and this should be thirty three thousand two seventy seven six nine so again we have another discrepancy here that's a really bad sign that makes me believe that no one really proof read this and that they were probably playing around with the numbers at some point and that's why we're getting different totals so let's let's look at 2017 and see what sort of crazy kookiness the heavens store for us on this one so take my ninety four five hundred subtract forty seven 100 of three point nine five I get forty seven thousand three nine six oh five so they under sold themselves by fourteen thousand one hundred and eighteen point three six so that that seems crazy that they've they accidentally didn't show enough income here but again this is probably someone that was playing around with the numbers and that's why these totals don't add up there's no reason why a seller would be under estimating their net income and this presentation to us because that means we're going paid because that means we're gonna pay less for this property so why why would this all happen so what you're gonna find is a lot of people in real life really focus on taxes in their day to day operations of their property so what they'll do is they'll maybe inflate their expenses for tax purposes and then when they go to sell the property they try and deflate those expenses when they're presenting it to the seller so my guess in this situation would be that odds are that they probably underreported their rent or over reported their expenses for taxes then when they took their taxes and tried to build out this report for us they forgot to update this income line so I would bet that this is probably what they actually report for taxes but this is what they think actual expenses for closer to an actual rent or closer to so this is something important to just to notice yeah because as you can see right now obviously this doesn't give me a lot of faith in what's going on here um but we're gonna set that aside for now we're gonna come back to this later but for now let's focus on these 2018 projections so as a note to ourselves remember we have this new building in 2017 which added these these three new sets of units so just a reminder that brought 22 new units as a percentage of what they used to have I'm going to take this 85 divided by I'm going to take the 22 new units and divide by 85 and that's gonna give me approximately 25 26 % so I'm gonna say approximately twenty-five percent more units in 2018 because these were built right at the end new building end of 2017 and so we have 22 new units or approximately 25% more units in 2018 so the reason that this number is important is I'm gonna use it as a basis when I'm looking at their expenses because now since they have more units I'm gonna expect them to have higher expenses because it makes sense if we have 25% more units to take care of I expect to see a proportionate increase in things like wages utilities and property management and/or repairs and maintenance so let's let's take a look at it when we're looking here when we're looking at the year-over-year change here nothing too drastic this looks pretty reasonable to me so I'm not gonna mark it up when I look at telephone this looks pretty reasonable to me the only thing that's interesting is all these even numbers so one note guys is if you see too many even numbers usually that's the sign that someone's playing around with their numbers or they're making estimates instead of actually portraying the actual expenses incurred so if we see a lot of even numbers a lot zero zeroes that's a sign that probably these are estimates or best guesses rather than the actual expenses incurred so that's maybe a red flag we're going to want to note otherwise when we look year-over-year these are all seem relatively similar so I don't see any major red flags this all looks pretty reasonable the way that these numbers have increased or decreased over the years so nothing too major going on there again when we look at our total expenses things seem reasonable now what is interesting is in 2017 our occupancy increased drastically so we went up to eighty five point six percent occupancy versus seventy two and seventy percent so now since now that I've noticed that this looks a little bit different I'm gonna think to myself maybe I should go back and look at this 77 so that's seventy seven four three four divided by 110 thousand four hundred gives me a seventy percent and so what may have happened just they may have been increasing the rents over the years and so maybe our potential rent in 2014 2015 2016 that may not be an accurate reflection and so that's probably gonna be something we're going to ask them for additional information in the future if we decide to proceed with this deal but for now we're just gonna keep moving on with this one so I'm just going to take the last three years as an average so in this case I'm just gonna put a one beside it again and I'm gonna make a note to myself up here and that simply is that three-year average occupancy equals seventy six point two percent so what I'm gonna want to do here is now for my 2018 projections when I'm looking here I'm gonna want to take our total potential income are 137 400 and times that by my average three-year occupancy so first thing I can tell right off the bat is this 178 500 this number looks really weird so I'm just gonna put a question mark too because I really want to highlight that to myself in the future to come back and double-check this number because that just seems so crazy to me what I'm going to do is just try and keep my page relatively clean so what my actual expectations of this is gonna be I'm gonna expect this to simply be I'm gonna make the assumption that my actual rent should be a hundred and thirty seven thousand four hundred at a seventy six point two percent occupancy and in that case that's gonna give me approximately a hundred and four thousand six hundred and ninety nine for gross rents I'm almost seventy five thousand dollars difference here that's that's ridiculous that's insane this is a big red flag so that we're already off to a really bad start here for there 2018 projection so I'm really not expecting this number to come together but one thing I should do is I should just confirm all these expenses so again I'm simply gonna go eighty four hundred so that adds so that's good then I'm going to take my 1 7 8 500 subtract by 42 6 3 2 1 35 8 6 8 so that adds so that's good so let's take a look let's compare these expenses the estimated 2018 expenses now to what my actual expenses in 2017 2016 2015 work so wages they're showing essentially and in fact no change year over year so I'm just gonna put a little column here year over a year and I'm gonna say that approximately this was no change so this little squiggly line just means approximately so all I'm saying here is approximately no change year over year then I'm gonna look at this 700 again we're saying approximately no change utilities 4500 again approximately no change and so the reason that this is kind of strange for me is we can remember that we have 25 percent more units in 2018 and again we're expecting more units rented out so that seems very strange insurance it looks like they're a small increase in insurance so I'm gonna say that the so I'm gonna say the change here was approximately $400 so the triangle just means change or a difference so change approximately $400 my common elements huh common elements I didn't have that before so that's interesting so I'm just going to put a little question mark here why all of a sudden do we have common elements now so that's something I'm probably gonna want to follow up with the seller with and be like why all of a sudden in 2018 do we have common elements but we didn't have in 2017 2016 or 2015 so this is a change of $500 or this is a change of $5,000 so I'm just gonna mark that for myself repairs and maintenance now they have repairs and maintenance going down by thousand dollars and I should probably just put an arrow up there to remind myself with that and now what we have is our change is approximately a thousand dollars down that seems really unreasonable seeing how we're renting out more you it's 25% more we have 25% more units we have one whole new building but our repairs and maintenance is actually going down now they may have simply put some of the repairs and maintenance under common elements for their 2018 projection so that's kind of hard to say we're we may have to give them them for the dead on this one but we still just want to mark it as a note so then property taxes this is where things look really strange for the last four years we can see that we're around 21 to 23 thousand dollars a month in property tax however we drop by nearly ten thousand dollars without any explanation so that's very strange that's that's a big question mark here so what I'm simply going to do is 23:05 3.95 subtract 13 8 3 2 so that's a decrease or that's a change of 9220 $1.95 now this is really strange there may be good reason for this but at first blush I see no reason they didn't explain it to me so that's highly suspect so some reasons that this might be a reasonable decreases maybe there was a special assessment and that special assessment is over maybe there was some sort of water did maybe there was some sort of debenture on the property from the city so maybe they hadn't paid so maybe they done a water upgrade or some sort of upgrade to the services to this property and that's been fully paid off now as of 2017 that could be another good reason for why this is dropped so much but right now this looks highly suspect and I don't trust it so what I'm going to want to do actually is I'm gonna want to increase these so in general I'm going to a 25% increase year-over-year simply because I have 25% more I'm gonna sue him a 25 percent year-over-year increase simply because I have more units now so instead what I'm gonna want to do is I'm gonna take these numbers here and increase it by 25% and that's what my actual expenses are going to be and that's what my actual expected expenses are going to be so in this case instead I want to take the AB I'm going to take the average of these three years so I'm simply gonna go put a two here a two here and two here now I'm gonna make a note to myself down here at the bottom to average 3-year expanse equals divided by three means I'm expecting forty six thousand five hundred and $36.63 if nothing changed but if I assume assume a twenty five percent increase then I would actually expect my total expenses to be fifty eight thousand one hundred and seventy dollars and seventy eight cents so in this case I'm gonna say my expected expenses I'm just gonna put it that three here and three here and so the reason I'm putting them three in front is that's from here so that's that's all that that really means is that's the source information so in this case expected expense equals fifty eight thousand one hundred and seventy dollars and seventy eight cent so my actual expected net income now is my hundred and four thousand six hundred ninety nine dollars in gross rent subtract fifty eight thousand one hundred seventy dollars and seventy eight cents or forty six thousand five hundred and twenty eight dollars and 22 cents in that income so what the hell happened here we're going from one hundred and thirty five thousand eight hundred and sixty eight dollars in income to forty six thousand this is a difference difference of eighty nine thousand three hundred and thirty nine dollars let that sink in the net income we're expecting versus the net income they're expecting we're only getting approximately thirty four percent this is thirty four percent of this number that's that's ridiculous this is this is beyond this is the stuff that infuriates me this this is just insane this this is so wrong that someone's trying to take advantage of buyers out there like ah you know it's really hard to give them that for the doubt in this situation simply because these numbers these numbers look so bad they looked so incriminating when we look over it and we haven't even been able to confirm any of these yet so imagine if we keep diving deep or what we're gonna find so but before I even go any further into these numbers let's just simply talk about what else would we do if we were still interested in this deal so if we were still interested in this deal we're gonna want to see their income tax filings for a couple of years ideally so we're gonna request that so that we can see if we can vouch the income tax filing numbers to these numbers because again that income tax filing it's more like a trusted third party source simply because it's something that they told the government is true and a lot of people are more scared about lying to the government than they are about lying to a potential buyer so that's one thing we're going track otherwise what we can do is we can ask to see some of these expenses so for you tell these we can request their utility bills for the last year we can add those up and see if it adds up to 4200 same with insurance we could either ask for a statement from their insurance company or simply get their insurance policy and see whether it cost them twenty eight hundred dollars a year repairs and maintenance we could ask to see those receipts and property tax we could confirm with the city or the municipality whether it's twenty three thousand and more than twenty eighteen it's expected to go down by almost ten thousand so what we would do is we'd get more source document similar to what we got from this appraisal and we'd call it you know let's say we get our property tax bill from the city we're gonna call that c1 for the property taxes and we'll vouch that there and we'll put a c1 here if we're able to confirm the expenses otherwise let's take a look at this again remember we were saying if if this was true the 135 thousand eight sixty eight if that was a ten cap rate we'd be willing to pay it means we'd be willing to pay out one point three five million for this property whereas for this number at a 10% cap rate we'd be willing to pay four hundred and sixty five thousand dollars so if we were solely buying this property based on a ten cap rate based on the changes we've made for the net income statement here that's almost a nine hundred thousand dollar difference in purchase price nine hundred thousand dollars in purchase price let that sink in it's completely unacceptable how sloppy this financial statement appears to be from the seller especially since their realtor they should know better this is this isn't fraud this is so close to it this is so misleading this is terrible this is completely inappropriate the out-and-out lies that some sellers will tell buyers in order to try and get maximum price and that's why you need to do so much due diligence yourself that's why you need to dive into this so at first blush based on the income statement they provided us in the future projections we'd be willing to pay almost 1.4 million dollars whereas once we've ran the numbers and actually dug a bit deeper into them it looks like we don't be willing to pay under five hundred thousand dollars that's nine hundred thousand dollars in difference nine hundred thousand dollars and literally this was with what you guys saw it this was under an hour of due diligence I was doing here and I determined that I'd be want to pay nine hundred thousand dollars less because I spent an hour digging into the numbers imagine once we started digging further into these numbers what what other secrets are we gonna find whether the little white lies and black lies are we gonna find anyways hope you guys enjoyed this video this is a very unusual video I don't think there's a lot of it out there on the youtubes yet the following this sort of format where we dive into actual real numbers this is a real-life case study guys a real-life case study where I'm showing you nine hundred thousand dollars in difference between what the sellers saying and what we're saying the property is worth simply because we did an hour's worth of due diligence ridiculous absolutely ridiculous what they're trying to get away with here so hopefully you guys enjoyed this video I'm joined walking through it with you guys and this just a high-level due diligence you need to be diving even deeper than when I showed you in this video you need to begin those utility expenses those property taxes the insurance cost all that before you before you go firm on this sort of deal so if you enjoyed this video smash the like button and hit the subscribe button if you can use my channel check out the other videos YouTube wants you checked out and please please please please please guys share this on social media sharing is caring that's the only way I get new subscribers so please share this video with your friends your family your dog I don't care just get me more subscribers until next time remember making mine's a team sport there's more than enough money out there first I'll make it but if you're not saving it I mean what's the point thanks guys

Channel: Matt McKeever

Views: 12,177

Rating: 4.973856 out of 5

Keywords: Due Diligence, Due Diligence Example, Self Storage Business, Self Storage Business Investing, Business Investing, Storage Unit Business, Real Estate, Matt MCKeever, real estate investing, income property, cash flow, buying a business, grant cardone, graham stephan passive income, investing, financial independnece, financial independence retire early, financial freedom, financial education, m&a, accounting, finance, financing

Id: G9t-m4BaJEI

Length: 36min 15sec (2175 seconds)

Published: Sat Feb 10 2018