PHOENIX—The most recent Real Capital Analytics report on the multifamily sector, published in mid-November, showed a 65% year-over increase in dollar volume for the sector to $19.6 billion. That's a lot of apartments changing hands, and many lender requirements that needed to be satisfied. When it comes to doing due diligence, a frequent question among buyers is what considerations to keep in mind, especially when those due diligence requirements may differ among different types of lenders—or loans.

"This seems to be one I get asked and answer frequently," Dan Spinogatti, Phoenix-based SVP with EBI Consulting, tells GlobeSt.com. The answer depends in part on how the buyer plans to use the Property Condition Report (PCR), and also on whom the buyer asks.

"In our world, it's true: you get what you pay for," says Spinogatti, who oversees client management and new business development in Burlington, MA-based EBI's Western region. "If you are doing a PCR for buyer due diligence, a higher degree of expertise and detail is often appropriate."  Acquisition or Equity PCRs are more complex than lender scopes and often involve multiple expert consultants, for an overall 'deeper dive', appropriate for equity ownership and management of that asset. 

"And, If you've got a contractor out there looking at your property for free, he'll give you an opinion (and good documentation of that opinion is typically not their expertise) but the info he gives you might not be an unbiased, third-party opinion." On the contrary, that opinion might be geared toward ensuring that the contractor gets the fees for maintaining or replacing that equipment or property component.

If it's going to be an agency loan, as multifamily financings frequently are these days, "we have to approach it based on their scope of work," Spinogatti says. "They have very specific requirements for the qualifications of a property condition assessor."

Freddie Mac's scope is more explicit than Fannie Mae's on certain criteria, and Freddie may reject the application if a few of those details are missed. So in talking with the borrower, Spinogatti tries to make it clear up front who the lender is likely to be, and thus use "the most conservative scope," i.e. one that would meet the agencies' requirements.

On a property condition report, he says, "Some of the little things will impact it: if you didn't look at enough of the property, if you didn't survey it to the level of their data sheets; there's still more detail that they want you to go into. The Freddie Mac environmental requirements are very explicit: on radon, you have to test one sample per residential building or 10% of the ground-floor units. A lot of other lenders don't spec it out to that degree, so you don't need to do as much." Beyond Fannie and Freddie, HUD is "even more explicit" on its requirements.

That being said, "there are commercial banks that are getting more involved in multifamily financing and competing with Fannie and Freddie, which as a consultant I like to see because they're easier to deal with." On a Freddie deal, the ESA and PCR reports go through a double or triple review.   During the acquisition process, we often are hired by buyers to complete the lender scope of work (well ahead of the financing) and they may have questions. Then later, their mortgage broker or internal underwriter will review, and additional comments or questions often result. If it's a Freddie Mac deal, eventually Freddie Mac will review it and have their own comments." A report thus may go through three iterations before it's finalized.

Another issue: will it be a CMBS deal? "If we know that up front, there are certain things that we're focusing on." This consideration also affects how lenders view due diligence.

"Historically, on a PCR for a CMBS deal you have downward pressure to keep costs and capital expenses contained," says Spinogatti. The longstanding adage in property condition reports was to allot $250 per unit per year for replacement reserves. Nowadays, $300 per unit is more the norm, in reality if not in people's expectations.

"It could be a good-looking property, well-maintained, but let's say it's now six years old," Spinogatti says. "While the property condition looks very good today, consider that this analysis requires us to look out 12 more years on the replacement reserve analysis, for a loan term of 10 years".  The reserve analysis is used by lenders to escrow for capital improvement and larger maintenance costs over the loan term.  "In 12 years from now, it's going to be 18 years old," which means a lot of maintenance expenses and capital improvement investment is often needed on the back end of the loan term.

Often, Spinogatti says, "If I'm being engaged by someone on the financial side, I ask the underwriter, 'given what you know of this property and transaction, what is your early assumption of what the reserve amount is likely going to be?' If I sense a misalignment between expectations and reality, I will talk about that up front."

When it comes to per-unit reserve requirements, there's "a kind of inflation taking place," says Spinogatti. Fannie Mae had a meeting a couple of years ago for engineers, architects and consultants specifically to go over the GSE's updated Physical Needs Assessment scope, which took effect in February 2013. "That was the first time they had something specifically for the consultants. Before, they would just go to the lenders and say, 'Here's the new scope, it's up to you guys to communicate it.' In doing this, they made it clear that they expect to see more conservativism on the way certain things are handled." Accordingly, most of the Fannie Mae lenders are now accustomed to seeing replacement reserves of $300 or even $350 per unit.