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The Secret of the Mattresses: How a Lack of Due Diligence Can Steamroll Your Acquisition
The Secret of the Mattresses: How a Lack of Due Diligence Can Steamroll Your Acquisition
While reviewing a property prior to acquisition, the extra mattresses didn't seem too strange, probably an over-occupied unit. However, nighttime investigations showed secrets a daytime inspection didn't reveal, and as Alex Jackiw was touring the property that night, she noticed an unusual number of cars parked in the grass in front of one particular building, the same building where a unit had been flagged for mattresses on the floor.
Looking up the stairs, she noticed something different about this particular hallway - a red light, and a man in the window intently watching the street. It was then she realized the extra mattresses were not an over-occupancy story.
Wendy Dorchester
Senior Vice President of Sales and Strategic Initiatives
Pegasus Residential
Alex Jackiw
Chief Operating Officer
Hayes Gibson Property Services
Alexandra Jackiw of Hayes Gibson Property Services, and Wendy Dorchester of Pegasus Residential teamed up to share "Do's and Don'ts of the Due Diligence Process," a session packed with tangible takeaways at Apartmentalize.
Due diligence is the formal investigative window between signing the purchase and sale agreement and closing the deal, usually 30 to 90 days. Strip away the checklists and the process is really one thing: an honest assessment of risk. Am I buying what I think I'm buying, and what am I taking on if I'm wrong?
The primary goals of due diligence:
- Catch financial misrepresentation.
- Find gaps in documentation.
- Quantify true repair costs.
- Verify revenue stream, rents, and property value.
- Identify potential sources of liability and legal exposure.
- Evaluate current management operations.
- Determine opportunities for value creation.
At their Apartmentalize session, Jackiw and Dorchester walked through due diligence as a seven-step process.
Before step one: get the agreement and build the team
The work starts before the inspections do. Understand the buyer's goals for the asset, verify the timeline, assemble a team that actually knows what it's doing, and line up the third-party experts you'll need for inspections and estimates. As Jackiw put it, this is not the moment to draft your administrative assistant to fill a staffing gap.
And get the purchase and sale agreement first. Jackiw put it bluntly: a lot of buyers act like the PSA is a classified document only available to people with security clearance. It isn't. It should be the very first thing you request, and if the seller won't hand over the whole thing, ask for the sections that govern what you're about to do. The agreement tells you exactly how long your due diligence period is, and the clock starts the moment the ink is dry. It also dictates the work itself: what documents get produced, the scope of physical inspections, what personal property transfers (and what's excluded), restoration and indemnification, and confidentiality.
That personal property detail is easy to wave past, but it is critical. One buyer was thrilled his deal included a big red Ford extended-cab pickup the maintenance supervisor drove around the property every day. At closing, the shiny truck was gone, and what transferred was an ancient 1964 model up on cinder blocks behind the maintenance shop. The supervisor's daily driver had been his own all along. The buyer never specified a VIN and never photographed the actual thing he thought he was buying. Swap the truck for a rent roll or a set of maintenance records and the same gap costs real money. And watch the deadline closely, because once the due diligence period expires, your earnest money typically goes "hard," meaning you forfeit it if you walk.
Step 1: Verify the financials against independent sources
Never accept a rent roll handed to you as an Excel spreadsheet, Jackiw stressed. Demand the version generated directly from the property management software. Owners get creative. She has seen dummy rent rolls, fabricated move-ins, and ghost residents, all of which fall apart the moment you cross-reference against your own unit inspections and the actual bank deposits.
The subtler trick is concessions buried inside the lease term. On a property in Louisville, the concessions were spread out to land in months four, seven, and nine. Looks clean on paper. But if you close in month six and nobody flagged it, you inherit the month-seven and month-nine hits, and somebody has to fix that on the closing statement so the buyer isn't the one absorbing them.
The same independent verification applies to everything else in the financial file. Two that pay for themselves:
- Taxes and assessments. Missing a covenants, conditions, and restrictions detail once cost one of Jackiw's clients a million dollars in value. A planned-unit-development property had a retention pond in the middle of it carrying a special assessment of $5,000 a month. That's $60,000 a year, and at a 5% cap rate, a million dollars in value, sitting in a document nobody read closely.
- Insurance claims and code violations. Verify whether insurance proceeds were already paid and whether the work was actually done, because a new buyer places a new policy and won't inherit the old one. And ask about code violations: Jackiw once took over a portfolio carrying 1,970 of them, and a new code inspector will be on your doorstep fast.
Step 2: Investigate the management and maintenance history
This is where the units with no service requests become the most interesting thing on the property. Those are usually the apartments nobody wants to let you into, and there is almost always a reason. Sometimes it's a hoarding situation, which Dorchester noted is a mental illness that requires a deft response. Sometimes it's worse. Jackiw walked into one no-service-request unit and found an attorney who had been hoarding his own urine in glass jars stacked around every room. The hazmat cleanup ran $15,000 for that single unit.
Patterns in the service-request data cut the other way too. A friend of Dorchester's flagged units less than two years old with a suspicious volume of requests, which turned out to be improperly installed equipment that would have cost $72,000 a year had she not dug in. And the maintenance shop can tell its own stories: Jackiw didn't ask why the maintenance superintendent kept a jackhammer on site, and only learned afterward that he'd been jackhammering slabs himself to fix deteriorating water lines across the property rather than pay a plumber.
If the property is affordable or rent-assisted, the management review gets its own layer. Ask for the Regulatory Agreement or LURA, the Housing Assistance Payments contract, the Tenant Selection Plan, and the most recent MOR and NSPIRE inspections, and confirm whether any findings remain unresolved and whether approved rents are actually being charged.
Step 3: Conduct a hands-on physical inspection
Walk every unit. Every single one. No exceptions. If there is one line to take away from the entire session, this is it. Dorchester told the story of a 400-unit twin-tower high-rise she took over in downtown Baltimore. The lease files showed leases, the rent roll showed rent being paid, and everything pointed to about 95% occupancy. Nobody walked all the units. A few months after takeover, the real number was 80%. The seller had furnished empty units, paid rent on them, and invented fake resident names in the files to make the rent roll look fantastic. It wasn't. There is no such thing as a locked door you skip. As Jackiw told an owner who asked how many units he should walk: only the ones he was buying.
Don't assume the unit mix and dimensions the seller handed you are correct, measure and photograph everything, and bring specialists when building infrastructure is beyond the skill set of your inspection team. A structural engineer for foundation or visible settling. A roofing contractor for a remaining-useful-life estimate. A licensed plumber if the property has galvanized or polybutylene piping. An electrician if you spot Federal Pacific or Zinsco panels.
Step 4: Analyze the local market
Start with the homework you can do before you ever arrive: the employment base and where residents actually work, population trends, crime data, resident and prospect reviews, school district rankings, walkability scores, the new construction pipeline, and the regulatory environment. Where people work tells you who you can market to and whether the income is there to support your rents.
Then go be there, because neighborhoods are not a desk exercise. Visit the area at different times of day, walk the infrastructure, and talk to the people who already know it. Be sure to take the time to visit after dark to assess adequacy of lighting and resident activity when the management office is closed. When sizing up a neighborhood, Jackiw's favorite sources are cab drivers and bartenders, not necessarily in that order.
The piece buyers get wrong most often is the rent comps. Establish what's called the effective market area, the real geography the property competes in, and map it visually so you can see where the true comparables sit. Do not use the comps the broker handed you in the operating memorandum. Those are built to make the rents look aspirational, not to reflect reality. Jackiw took over a property in Henderson, Kentucky where the site had been comping itself against properties in Evansville, Indiana, on the other side of the Ohio River, which made little sense. She remapped the comps to what the subject property actually competes with in Henderson and ran the comparison from there.
Build a real rental comparison off the right comps, adjusting base rates for any concessions and accounting for the amenities and features on each property, and line them up by unit type, square footage, market rent per square foot, amenities, and incentives.
Step 5: Stress-test the operational performance
The financials tell you what happened. The stress test tells you what you can do with it. Know the difference between physical and economic occupancy, the occupancy trend over the past three years, the operating expense ratio, the payroll-to-revenue ratio, and the trend in net operating income. And ask the question that reframes a deal: can rents and amenity charges go up, and if so, how much and how soon?
Rent-to-income ratio is the tell, and it reads in both directions. On a 110-unit mid-rise in downtown Indianapolis, the ratio came in at 19%, which told Jackiw every resident had room to pay more. On day one, with no renovation and without touching the property, they raised rents $100 to $150 across the board, and turnover after the increase was under 20%. Run the same math in a heavy-concession deal and the warning flips: if you qualified residents at concession-discounted rents, those people may be hundreds of dollars underwater at renewal, and your occupancy is about to fall off a cliff.
Step 6: Cross-check everything and reconcile
This is the unglamorous step where the whole exercise pays off. Compare the P&L against bank deposits. Verify that each lease in the file matches the corresponding line on the rent roll. Cross-reference the lease file audit against the unit inspection reports, and the delinquency report against the credit screening in the files. Compare utility costs against actual bills, and pay particular attention to how utilities are billed, especially RUBS. Reconcile the security deposit liability from the lease files to the security deposit list.
None of it is exciting. All of it is where the numbers either hold up or come apart, and it is the only way the stories above stop being anecdotes and become evidence you can take into a negotiation.
Step 7: Close, renegotiate, or walk away
Everything funnels to one decision. You move forward if the property meets your underwriting and the risk profile fits. You renegotiate if the findings give you reason to, and the common levers are concrete: a price reduction based on actual versus stated NOI, seller credits for deferred maintenance, a holdback escrow for known repairs, or a longer closing timeline. And you walk away when the property has problems a price cut can't fix, environmental contamination, structural failure, a declining market, or a seller who won't negotiate in good faith.
You earn the right to make that call honestly only by verifying everything you were handed against something independent, and by being willing to open the door nobody wants you to open.
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