BBG News

A Buyer’s Nightmare – Acquiring a Building Without Performing a Due Diligence Review

Sep 26, 2022

Purchasers of New York City real estate occasionally feel that they have negotiated such fantastic deals that they are willing to waive their right to a due diligence period. The misbelief is that the price of the building is so good that it does not matter what kind of records the seller can provide with respect to the building. This is how we end up with a buyer’s nightmare.

For illustration purposes, let’s imagine a theoretical 6-story 24-unit pre-war walk-up building in which all residential units were allegedly deregulated more than twenty years ago. The purchaser believes that he is acquiring twenty-four free market class “A” apartments at a steal of a price. So, the purchaser waives his due diligence review period. What could go wrong?

Well, if just one tenant in the building decides to challenge the regulatory status of his/her apartment, this could open up a Pandora’s Box of issues. If the purchaser is left to defend the regulatory status of a unit, the apartment could be found to be regulated if the purchaser cannot produce documentation substantiating the deregulation, even if the deregulation occurred more than twenty years ago.

Furthermore, if the deregulation is found to have been fraudulent in nature, the purchaser could be assessed treble damages, despite the fact that the purchaser did not even own the building at the time of deregulation.

Thus, if the tenant was paying $3,000 per month in rent when the legal regulated rent should have been $2,000, the purchaser could be left to pay $72,000 in overcharge damages (this does not take into consideration the permissible rent guidelines increases) plus $72,000 in treble damages, for a total of $144,000 in damages. And if all tenants in the building were to file similar claims, our theoretical purchaser would be left to pay a minimum of $3,456,000 in damages. So, unless that amount was factored into the purchase price, the purchaser has, in fact, emphatically not gotten the bargain (s)he expected.

This analysis also ignores the possibility of outstanding rent reduction orders. A rent reduction order is detrimental to a purchaser’s asset as it results in rent being frozen at the amount charged at the time the order was issued. Further, an outstanding rent reduction order prevents lawful deregulation. Even if the rent is restored, a purchaser can no longer deregulate the apartment now due to the 2019 enactment of the Housing Stability & Tenant Protection Act.

The attorneys at BBG regularly perform due diligence reviews so that our clients are made fully aware of the potential liabilities associated with the acquisition, financing or sale of a building. Any potential purchaser should avail him/herself of our expertise.

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