Real Estate Investing Real Estate Due Diligence 2 — Questions and Answers
Question 1: What is the primary purpose of a Property Condition Report (PCR)?
- To determine the market value of the property
- To document physical condition and estimate current and future repair costs (Correct answer)
- To verify the property's zoning classification
- To assess the creditworthiness of existing tenants
Correct answer: To document physical condition and estimate current and future repair costs
A PCR provides a comprehensive assessment of a property's physical systems and components, including estimates of immediate and long-term capital expenditure needs.
Question 2: What does the term 'deferred maintenance' mean in real estate due diligence?
- Maintenance scheduled to occur in the next fiscal year
- Repairs and upkeep that have been postponed, leading to cumulative deterioration (Correct answer)
- Preventive maintenance recently completed to avoid future issues
- Capital improvements completed in the prior ownership period
Correct answer: Repairs and upkeep that have been postponed, leading to cumulative deterioration
Deferred maintenance refers to necessary repairs that have been neglected over time, which can signal larger underlying issues and significant future capital expenditures for a new owner.
Question 3: What is the 'effective age' of a building?
- The number of calendar years since construction was completed
- The age reflected by the building's condition regardless of its actual chronological age (Correct answer)
- The estimated remaining useful life of the structure
- The age at which a building qualifies for historic tax credits
Correct answer: The age reflected by the building's condition regardless of its actual chronological age
Effective age is based on a building's physical condition and maintenance history; a well-maintained older building may have a lower effective age than its actual construction date suggests.
Question 4: Which property system typically represents the largest capital expenditure when it requires full replacement in a multifamily property?
- Interior flooring and carpeting
- Roof and HVAC systems (Correct answer)
- Landscaping and parking lot striping
- Interior paint and light fixtures
Correct answer: Roof and HVAC systems
Roofs and HVAC systems are among the most expensive capital items to replace in multifamily properties due to their scale, complexity, and materials cost.
Question 5: What is a 'capital expenditure reserve' (CapEx reserve) in real estate investing?
- Funds held in escrow for future property tax payments
- Money set aside specifically for major repairs and system replacements (Correct answer)
- Emergency funds to cover unexpected long vacancy periods
- Reserves required by lenders to ensure debt service coverage
Correct answer: Money set aside specifically for major repairs and system replacements
CapEx reserves are funds an investor sets aside to fund periodic major expenses like roof replacement, HVAC systems, or parking lot resurfacing that occur infrequently but are predictable.
Question 6: What does a boundary survey reveal about a property?
- The exact legal boundaries, dimensions, and any encroachments or easements (Correct answer)
- Underground utility locations and easements beneath the surface
- Soil composition and its load-bearing capacity for construction
- The presence of environmental hazards and contaminated soil
Correct answer: The exact legal boundaries, dimensions, and any encroachments or easements
A boundary survey establishes the precise legal boundaries of a parcel, identifying property lines, encroachments from neighboring properties, and recorded easements.
Question 7: What is 'functional obsolescence' in the context of real estate due diligence?
- Physical deterioration caused by age and normal wear and tear
- Loss of value due to outdated features or poor design that reduces market appeal (Correct answer)
- Reduction in value caused by negative factors in the surrounding neighborhood
- Depreciation calculated using straight-line methods for tax reporting
Correct answer: Loss of value due to outdated features or poor design that reduces market appeal
Functional obsolescence is a loss of value from outdated design features, inadequate floor plans, or inadequate utilities that make a property less competitive, even if it is physically sound.
