Often Overlooked Due Diligence

Tiny 1399472294 avatar mikeytm

By Mike Morrison
April 11 2012

Due Diligence is near and dear to my heart. In a nutshell, due diligence is 70% of an agent/brokers/investors job. Some are good but most I run across are really bad performing due diligence for their clients. We as agents owe our clients the “F” word. Fiduciary duty to protect our client in a transaction.

What is at the heart of due diligence is asking for information to provide a clear picture of the transaction. In my opinion, it’s not asking too much for information no matter who you represent. If providing relevant information regarding the transaction is a problem for either party (Buyer/Seller) then it’s time to re-evaluate your position.

As an aside due diligence is more important for the Buyer/Seller who is not represented by an agent or advisor.

To my point. I am currently representing a Seller of multiple income producing properties. Since there are multiple buildings, the transaction becomes a Commercial one. Please note, this concept of due diligence bleeds over into all realms of real estate

I have 3, that’s correct 3 pages of document and information requests. This list fits Buyer or Seller, Commercial Sale or Lease, Residential Sale or Lease. Before I accept a listing, I request all the documents that are germane to the type of listing. This accomplishes 2 objectives. A clear picture of the deal and speed of the deal flow.

Here are overlooked questions to add to your list, whether Commercial or Residential Income Producing Sale/Purchase:

Is the property under 3d party management? If so do you have a management contract in place? Please provide a copy of the management contract. Why is this important to a buyer? I have seen management contracts that survive a sale. I may not want to be compelled to use XYZ Management Company. Key; this point may be a contingency written into the purchase contract. No surprises after closing.

What type of lease document do you use when you lease a property?
I want to inspect the document. You need to know what you are committed to after the purchase of the property. Any free rent? Any repair deductibles? Promised future repairs during the lease terms?
I take this further and request an Estoppel Certificate from each tenant. Black’s Law Dictionary provides a good description of an Estoppel Certificate. KEY: can effect cash flow.

Do you have any tenants that are Month-to-Month? If yes, why? Has their rent increased after the lease expired? If no, why? How long have
they been tenants? Is it possible to get them to sign a new lease. KEY: again can effect cash flow.

A Physical Inventory of any Fixtures, Equipment and Furniture.

If you want a simple way to check the validity of Income Numbers request the last 12 month’s bank deposits. If the Seller balks, RED FLAG. While on the subject, I personally place no stock in PROFORMA Numbers. Try and get a bank to lend you money on proforma numbers. They’ve been down that road. Besides, we all have seen what the Real Estate Always Appreciates got us. Proforma = Throwing Darts at the Wall. I want Real Numbers.I can figure the up or downside to the property. If you don’t have them, I Pass.

If the property has employees, request a Payroll Register; employee name, position, pay rate, benefits. Key: cash flow.

All service and advertising contracts. Trash, HVAC, ect. Key: cash flow.

A copy of the property insurance policy. For all you know the property is under-insured. Your expenses just rose. KEY: cash flow.

To summarize, these are just a few of the important questions a buyer should have. I see them missed at every turn. Some of these questions are REAL DEAL BREAKERS. For a buyer you have every right to ask for this information. Heck, you’re taking the RISK. If the Seller balks at any of these requests I walk away. There is never a good reason to withhold information in a transaction. Hence, we have the Greater Fool Theory. There is always a fool who will purchase blind or overpay for a property.

Sellers, think how much faster the transaction will go if you have this information ready to go for a solid buyer. I want to see a deal warts and all. Buying & Selling Income Property is all about CASH FLOW.

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