Apartment investors that are looking to purchase a property often ask me:

Which is Better: An Offer to Purchase or Letter of Intent?

First, let’s define the two, then I’ll discuss when to use a Letter of Intent.

1. Purchase Offer, or Purchase Agreement – A legal document that describes the price, terms, contingencies, and other details of how a buyer would be willing to purchase a piece of real estate.

2. Letter of Intent (LOI) – A preliminary document outlining the price, terms, and other transaction details that a buyer would be be interested in purchasing a piece of real estate.

Note that the definitions are not too far apart, but the documents themselves are. The biggest difference is a Purchase Offer is a formal legal document, that once signed by both parties becomes a legal and binding agreement. If you are working with a real estate agent or broker, this is usually the document they will have you sign if you are interested in placing an offer on a property.

A LOI is typically used as a “starting place” for negotiations on a property. Generally a LOI will be followed up by a formal Purchase Agreement after the terms are settled on. This may or may not be the case in your area, but is a good use of the two documents.

The difference is a Letter of Intent is basically a letter stating the kind of offer you are contemplating in making. Usually it contains what I call the GENERAL items of price, terms and closing date. Most of the other legal STUFF is left out.

It is good to use an LOI to gauge the viability of purchasing the property based on the price an terms you are considering. IN other words, it is good to use to gauge whether or not the offer you have in mind is even going to come close to making sense to the seller.

I use LOI’s a lot when I am trying to buy a property for much less than what the seller says they want, more flexible terms than the seller says they want OR if I am unfamiliar with the property and area I will use the LOI to start the negotiating process while I do my due diligence work in the background.

Remember, most of the time an LOI is not a formal offer but mainly a point of understanding between you and the seller.

So, use an LOI as a method of exploration of a property and to get the ball rolling. Based on the sellers reaction and response to your LOI will tell you to move ahead with a full purchase agreement or not.

Revenue

Your initial analysis should consist of researching other apartment buildings in the area you are interested in. You can begin this by calling similar apartment buildings and inquire about the rates of the units they have available. It is necessary to know what your competition is commanding for the amenities they provide.

There are competent brokers available who should be able to provide information such as the average rent per square foot and occupancy rates. You can then then compare this data with similar data of the apartment building you are considering. You can then determine if the current owner has kept up with the market and whether you can justify raising the rent without offering further improvements. There may also be the opportunity to convert excess storage space into rentable living area. This would increase the rental income and add value to the property.

You must inquire whether the rent plan of the building is “all bills paid” master-metered environment or whether the tenants are responsible for their own electricity bills. Converting a building and passing the costs onto the tenants can have positive results to the income stream.
* The action will require an offsetting decrease in rents on a per-unit basis.
* The tenants will be more conservative and thinking more about conserving energy if they are aware they are now responsible for their own power usage.Another way to generate additional income is to provide vending services such as laundry, pay phones, and soft drinks to the apartment complex.

Depending on the number of units, you may contract a laundry service that provides washers and dryers. The service will pay you for the right to offer its services on your property. You can negotiate with cable TV and satellite services for the right to provide your tenants with television services. Cellular phones are big business and phone companies are regularly looking to lease a site to locate their communication equipment on the rooftops of buildings.

Expenditure

There are quite a few ways to minimize the operating expenses of an apartment building.

* The cost of building repairs and maintenance will vary with the age of the apartment building.

* Management fees and salary costs can be cut especially if you are going to self-manage the property and assume many of the management and maintenance duties.

* It is a good idea to pass the utility costs over to the end user. Sub-metered apartments can reduce the electricity costs. You can cut the cost of the water bill by simply repairing any leaks in the faucets and toilets and by replacing the flush mechanism in the toilets with one with a water saving feature. You can also install water-saving devices in showers and bathrooms.

* Look for an insurance agent who specializes in providing commercial services. You will find that costs vary widely among agents so shop
around for the best deal.

* You can employ a tax advisor to protest the assessed tax valuation of a prospective building based on the taxes paid by similar buildings in the area and possibly have the amount lowered.

Searching for the right property can be difficult but nothing worthwhile is ever easy. Fortunately by examining the variables there are many ways of adding value in an apartment building. By considering these variables you should be able to determine the overall condition of the property and the potential monetary returns on your investment.

Rule number one? Buy properties that will have positive cash flow from the start, based on the current income and all of your projected expenses including management. If the current owner doesn’t have management, that is his problem. You are an investor, not a manager, and a good income property should pay for management and still produce positive cash flow.

Do your due diligence? Here’s a simple definition of the term: “Investigation and verification of the details of a particular investment.” You can start this process before you make an offer, but you should also have clauses in the offer that allow you to have inspections done, and reviews of the books and certain documents.

Look at the files, to verify income. There should be rental agreements signed by tenants, and rental histories showing if there are any problem tenants or late payments. Look for rental deposit documents also, to see amounts and where the deposits are kept.

Ask to see service contracts and agreements. Do they transfer, or are you free to seek better deals? These can include property management agreements, landscaping, snow plowing, pool cleaning service, and cooling system maintenance agreements.

Get the last 24 months income and expense statements, and look for anything unusual, like expenses that are too low or income that seems too high. Review the rent roll, and find out if the rents are over or under the market rates for the area. If there are employees, look at the payroll records for any surprises, like accrued vacation time that you’ll have to pay.

Do an interior inspection to learn about the place, the tenants, and any problems that you will have to fix in the coming months or years. Look for pests, water and fire damage, as well as obvious “problem tenants.” Are there any empty apartments that are listed as occupied? Use professional inspectors as needed for pest inspections and safety inspections. The local Fire Marshall may do a free inspection to verify that the building meets current codes.

For the exterior inspection, you will want to first walk around and take notes. Watch for anything that looks unusual or in need of repair. Then you can get professional inspections, if necessary. You want to verify that the electrical and plumbing systems are up to date and meet current codes. You also want to get an estimate on how many years of use the roofing has left. You’ll look at driveways, landscaping, and exterior paint condition.

Call local authorities and check for any permit problems or zoning or encroachment problems. If there have been fire code violations, were they corrected?

Get the help of an accountant to decipher the books. Have a lawyer review your offer and any documents. Ask what other things you should be doing.

Take notes, and list problems, and estimated costs to correct them. You can use these notes during subsequent negotiations. The problems investors run into when buying income properties are usually not unforeseeable. They can be avoided or resolved if you just do your due diligence. Use a checklist so you won’t forget anything.

When buying an apartment building, you should make sure that you will get more income coming in than the total money you’ll be paying out each year and this cash flow is enough to justify the cash you invest. So, some investors will look at the “cap rate” of a property to determine if it is a good investment at a given price when they buy apartment buildings because prices are often based on income.