You learn early as a real estate investor that there are no shortcuts to success and no guarantees. The same is true of due diligence. Investing involves a lot of hard work and some degree of uncertainty.
Due diligence requires time and effort, but it does serve to reduce your risks. That makes it well worth the upfront time investment you make on any property you are considering. The majority of costly mistakes investors make could have been avoided through proper due diligence. Maintaining a profit is difficult in any economic climate, and it is more difficult when you have a lot of unanticipated costs.
Determining property value
There are a lot of moving parts to any real estate transaction. Investment properties have even more factors affecting the value. If a property is making money for the current owner, why are they selling it? Something must be motivating them. One of the first things you should assess is why they are selling. It could be because there are some upcoming costs associated with the property that will derail its profitability and throw it into the red.
Be sure that any contract you sign provides ample time for due diligence and a clause that allows you to renegotiate the terms of the contract or exit the transaction if necessary based on what is discovered during the due diligence period. Use a due diligence checklist and begin all inspections as quickly as possible.
Do your footwork
In addition to personally inspecting the property, you should also make an effort to speak with as many tenants as possible and interview employees. They can be greatly informative and provide you with some insight as to your possible upcoming role as landlord.
Financial due diligence
This is a tedious and time-consuming process. You do not want to learn as you go. You should engage the assistance of an experienced investor or mentor in your specific real estate investment niche. You also should be using a CPA who specializes in investment property.
Call upon them for this phase of due process.
This can involve reviewing available operating statements, property financials and leases. Be sure there are no special clauses in any lease that may lower the monthly rent for some tenants. The seller should be able to provide a full accounting of security deposits.
Review existing insurance policies and check for lower cost options. Ask for information about any insurance claims made in the previous five years. There should also be a complete inventory of all property being transferred in the sale. And be sure to obtain copies of the trailing financials covering the past two or three years. These financials are also know as Annual Property Operating Data (APOD), or Profit and Loss Statements.
Proper due diligence takes patience, effort, and utilizing a team of knowledgeable professionals. It provides you with an understanding of the property’s construction, maintenance history, and potential for profitability.
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