As many seasoned investors know, due diligence is an essential part of any real estate transaction. In fact, some would say it’s the most important part of each transaction. In a day and age where technology makes investing as simple as a click of a button, many investors don’t take the time to dig deep (both financially and physically) into properties they are interested in.
Before we go any further, we must understand one thing:
Sellers (and their agents) are looking out for their best interest, NOT yours. Makes sense, right?
This doesn’t make sellers bad – in fact, it makes them smart. They are doing exactly what you would expect a seller or investor to do – to look out for their best financial interest and make the highest return possible. They are doing exactly what you would most likely do in their situation. However, you must remember this when you are a potential buyer in a transaction and take the necessary precautions to ensure your interests are being represented as well.
Here are four “due diligence” steps (out of many) in which you can take to help make a more educated decision:
- Conduct an inspection – contact your agent to have a third party inspection of the property. It is crucial that you have this done to give you a “snapshot” of the current condition of the property. Even if the property is being sold as-is, it is always best to get a general overview of what is working and not functioning properly. If you were traveling across the country, would you drive to your destination blind or would you use GPS? Use these tools to help you make a smart decision. The cost of an inspection is very small compared to the problems that could arise from you not knowing about hidden problems – trust me.
- Ask for a pro forma – this is an estimate of returns for a property and should contain terms such as Cash on Cash, Cap Rate, Cash Flow, etc. While some sellers or companies may provide them, you need to look close for additional costs that tend to be left off such as property management, maintenance and repair allowance, vacancy, taxes, etc. A property that shows positive cash flow on a pro forma can quickly turn into a negative cash flow once you factor in true costs.
- Ask for a Profit and Loss Statement (P&L) from the past two years – most investors keep a P&L statement for each property they own. This document should contain all the items in the pro forma – the only difference is that this document will show how the property has historically performed based on its actual numbers. Beware of phrases such as “last year was a fluke year – it won’t be the same for you” or “rent is really low but you can raise it up to market rates and the returns will get even better.” While some of these statements may be true, you need to verify them with facts.
- Work with a licensed agent that specializes in real estate investing – just as you would hire an inspector to evaluate a property, hiring a real estate agent whose #1 job is to represent you is essential. Agents who focus on investment properties should be able to assist with the items above in addition to coordination between parties, negotiations, compiling market data, supplying invoices from contractors for possible work, and much more.
Please keep in mind that this is only a small picture of real estate investing. By keeping your focus on the four areas above and seeking guidance from a team of professionals, you will be on your path to becoming a more educated real estate investor – congratulations!
DISCLAIMER: Jason Reynolds does not provide legal, tax, or investment advice. All information herein is general in nature and should not be considered legal, tax, or investment advice. Consult an attorney or tax professional regarding your specific situation. Nothing contained herein should be relied upon as a promise or representation as to the future. Recipients should conduct their own investigations and analysis of any real estate transaction that they are involved in. No warranty is given concerning the suitability of this information for any application.