How to Perform a Compliance Audit of your Real Estate Assets
Part 1 - Introduction to Methodology
Why should you be performing a compliance audit of your property?
Compliance audits are the bread-n-butter of a healthy, well-performing portfolio or asset and they are crucial for two simple but powerful reasons. They help ensure:
that a property is safe for its residents and end-users, reducing the risk of accidents, injuries, and/or legal liability, and
that a property is operating efficiently and effectively, which in turn contribute to reduction in operating costs, increase in profit and optimization of market value.
When building trust with stakeholders, investors, tenants and regulators, becomes a priority for a property investment company, compliance audits help improve transparency and accountability as part of the business strategy.
Compliance audits for properties and portfolios are also a vast undertaking, so this series will be split into parts. Each part will focus on different asset classes and steps specific to those asset classes. This piece, Part 1, will focus on methodology.
To make a complex audit manageable, it can be split into the following steps:
Instruction
Inspection
Observation
Documentation
Action
Instruction
The first and foremost step is to be clear on the instructions. What is this audit being performed for? Who needs this information? Who will benefit the most? What is the scope of the audit? What are the different roles and responsibilities of the persons involved with performing this audit? What is the timeline? Who will sign off on the final report? What sort of compensation and fee structure has been agreed on? Is there a contract or Terms of Business in place?
These questions provide clarity on the objectives of the audit and the specific requirements that need to be met.
What impact does not having clear instructions from a client have on a portfolio audit?
Without clear instructions, the asset manager or surveyor may not fully understand the client's expectations, which can lead to confusion, miscommunication, and ultimately, an incomplete or inaccurate audit report.
Potential impacts of not having clear instructions include inadequate scope of work, misinterpretation of expectations, incomplete data collection, inaccurate or incomplete reporting, and inefficient use of resources.
To avoid these potential impacts, it is important for clients to provide clear instructions to the chartered surveyor before the audit begins. This should include a detailed scope of work, clear objectives, and any specific areas of concern. It is also important for the auditor to communicate effectively with the client throughout the audit process to ensure that expectations are being met and that any issues or concerns are addressed in a timely manner.
A clear instruction and scope of work document helps to ensure that the audit is conducted efficiently and effectively. It provides guidance to the auditors on what is expected of them, and it helps to ensure that the outcomes of the audit meet the requirements of the stakeholders. By establishing clear objectives and requirements upfront, the stakeholders can have confidence that the audit will deliver value and identify any issues or risks associated with the property.
Top tip: Instruction is key. Whether you’re performing an internal audit or for a client, understanding the exact scope of works, using assumptions and methodologies approved by the instructor, will lead to a successful result. Get the instruction right, in written form (signed Terms of Business, in case the audit is for a client) and don’t be afraid to ask as many questions as you can think of at this stage.
Inspection
Inspection is the main body of work, and may include:
Property Inspection
The purpose of a thorough property inspection is to assess the physical condition of a property and identify any defects or issues that may require remediation, or affect its value and performance. These inspections may range from a visual examination of the property's exterior and interior, a general overview captured in photos and videos or detailed inspections performed by chartered building surveyors such as dilapidations reports, structural and/or M&E surveys, as a way to do thorough review of the building’s condition, prepare a planned maintenance program and put a capital expenditure budget in place.
Standards for property inspection have been addressed extensively by industry regulators such as the Royal Institution of Chartered Surveyors (RICS) and the Association of Residential Managing Agents (ARMA), that should be referred to during a property inspection, especially when it comes to conducting specific inspections for specific areas of the building (M&E, doors & windows, fire safety requirements, decorative elements, façade and glazing, damp damage, Japanese knotweed, structural settling etc).
Accounts Inspection
Accounts inspection is an essential part of a property audit as it provides valuable insight into the financial health of the property and its operations. Here are some of the main key things to look out for during an accounts inspection:
Rent Roll: The rent roll is a list of tenants and the amount of rent that they pay. It is important to review the rent roll to ensure that it is accurate and up-to-date.
Arrears: Check for any arrears in rent payments or service charges, as this can indicate potential cash flow issues.
Service charge accounts: Review the service charge accounts to ensure that all expenses are legitimate and that they have been accurately apportioned among the tenants.
Budgets and forecasts: Check the budgets and forecasts to ensure that they are realistic and achievable. This will help to identify potential areas of overspending or underperformance.
Bank statements: Review bank statements to ensure that all transactions are legitimate and that there are no unusual or suspicious activities.
VAT records: Review the VAT records to ensure that they are accurate and up-to-date. This is particularly important for commercial properties where VAT can have a significant impact on cash flow.
Internal controls: Review the internal controls in place to ensure that there are adequate measures to prevent fraud, errors, and mismanagement.
Observation
For most audits, observation is treated as optional or a second-thought, but this needs to be included as a crucial element of a holistic property or portfolio audit. This step is different from inspection or inquisition on documents. It includes gathering observational evidence on how the building is operated. Questions like, are the building manager’s aware of all the issues the building is facing? Are the concierge and help desk associates on site on time? Is everybody aware of their roles and responsibilities? Do tenants know what to do during an emergency fire drill or what the emergency fire exit plan is? Do they have sufficient information on where the call-points are? Is the property manager and facilities managers and consultants sufficiently qualified to do their jobs? How do users generally use the building - have they been given training on use of sophisticated machinery and equipment, do they know where to wait and whom to contact?
Observation is also helpful to identify the inclusivity and sustainability of the spaces included in the audit. A lot of the times, companies will have ESG and inclusivity as part of their business strategies, and not know hot to actually go about achieving successful results in these categories. ESG (especially in Europe and UK) and inclusivity extends beyond just having EPCs and fire action plan for handicapped users in place. Observation can report on lack of ramps for accessibility in the building, height of call bells, lift buttons, fire extinguishers, locking mechanisms for main doors and communal doors, odours in communal spaces, general housekeeping, residents’ and tenants’ feedback on comfort levels on a day to day basis, and so on.
A good checklist of these observations will help you convey to the stakeholders, where the building is lacking operationally and how notes on usage, regular interaction with tenants, circulation of essential information, and help improve the life-cycle and quality of the asset.
Documentation
Documentation is a critical component of a property compliance audit, as it provides evidence of compliance and helps to identify any areas of non-compliance or potential risks. A thorough compliance audit will involve a review of all relevant documentation, including the following:
Planning permissions: Planning permissions are issued by local authorities and specify what types of development are permitted on a property. They can be reviewed to ensure that any modifications or changes to the property comply with the relevant regulations.
Building regulations certificates: Building regulations certificates confirm that a property has been constructed in compliance with prevalent building regulations.
Health and safety documents: Health and safety documents, such as H&S risk assessments, fire risk assessments (FRA), Legionella tests (LRA), asbestos surveys, Electrical Installations Condition Report (EICR), Gas Safety Certificates (GSC) and others, provide information on potential hazards and risks associated with a property. It is essential that records of these are maintained and fresh ones produced on a regular basis to ensure a compliant building and chartered surveyors should review these documents regularly to identify any potential risks or non-compliance issues.
Environmental reports: Environmental reports, such as Energy Performance Certificates (EPC) and Contaminated Land Reports (CLR), provide information on the environmental impact of a property. For larger portfolios, ESG (Environment, Social, Governance) impact surveys and reporting should be part of the compliance strategy.
Tenancy agreements and leases: Tenancy agreements outline the rights and responsibilities of tenants and landlords, and provide information on rent payments, rent reviews, repairs and maintenance, property/premises ownership, usage rights, and other matters. These should be reviewed during an audit to ensure that the lease is being administered as per its legal covenants, that it complies with relevant regulations, and that tenants are aware of their rights and responsibilities.
Contracts and invoices: Contracts and invoices pertaining to service level agreements, minor and major works, consultant appointments, managing agents, utility supplies, maintenance works, and so on, should be kept on record and be reviewed during an audit to ensure financial transparency with regards to the property and fund management. These records are also essential to be referred to, during legal disputes.
Insurance policies: Insurance policies provide protection against potential losses or damages associated with a property, and should be tailored to a portfolio or asset’s specific requirements.
Documentation also includes the actual audit report that is to be submitted. A simple, clean layout that makes evidence and information easy to understand is key here. The template that I use for my audits will be released as a downloadable with the next post.
Action
The final Action step is the culmination of the full exercise, wherein a thorough report of your findings and observations is submitted to the client, and the road ahead is charted out.
Review the report: The first step is to review the report in detail. This will help to identify any areas of non-compliance, risks or issues that need to be addressed.
Prioritize action items: Once the issues have been identified, prioritize them based on their level of risk and potential impact. A register can be created using the RAG or traffic-light system to track issues, follow-up with relevant parties, and mark the end of works when these issues/risks are mitigated. I have included a very simple version of an Issues Register in Excel, that’s free to download, below.
Develop an action plan: The action plan should outline the steps that need to be taken to address each issue and this should ideally include timelines, responsibilities, budget, and resources required. The action plan also needs to be inline with the urgency of the works (especially anything that is related to fire, H&S or structural in terms of physical issues, and arrears affecting operational cash flow in terms of financial issues) and the operational goals of the client’s business/portfolio strategies.
Implement the action plan: This step is subject to approval of the client, and will include instructing consultants, experts, contractors, sub-contractors, negotiating on contracts, detailing scope of works, and mobilisation of relevant teams.
Monitor progress: Monitoring progress to ensure that the action plan is being implemented effectively is part of project managing the processes and requires an asset manager to be regular with follow-ups to have control over the flow of works. Regular monitoring also helps identify bumps on the road and any issues that may arise during the implementation process and allows the asset manager to make adjustments to the plan as needed.
Document actions taken: Document all actions taken to address the issues identified in the audit report. This will help to demonstrate compliance and due diligence if there are any future audits or inspections.
Regular monitoring if the action plan being implemented, also helps identify bumps on the road and any issues that may arise during the implementation process and allows the asset manager to make adjustments to the plan as needed.
Overall, the action plan developed based on the findings and recommendations of the audit report should be comprehensive and tailored to the specific issues identified.
I am always interested in hearing from readers and fellow asset manager’s on what they focus on while auditing and in practice so I will be looking forward to your comments.
While this Part 1 was a general overview of the process, the upcoming posts will go into more detail on conducting audits on specific asset types and areas to focus on based on business goals. Also stay tuned for the release of more editable templates and checklists to help make your work easier.