You do realize there is nothing you can’t check up on with a real estate investment deal, right? It doesn’t matter who tells you something is a good deal, whether they are a saint or a crook, you can decide for yourself whether the deal is legitimate or not.
Real estate investing is, unfortunately, an industry that has had a lot of scams and bad deals in the past, and a lot of shady gurus, so it is very easy for anyone to assume the worst when it comes to who is in this industry. I know that is often the case because when I first got started in real estate, I assumed everyone was out to scam me. That was the only basis I knew to go off of. It actually worked out great to assume I was always getting scammed though because it forced me, in a way, to make people and companies prove themselves to me before I’d move forward. I would go into any opportunity as a total pessimist, and stay that way, until I was convinced otherwise. That actually sounds a little more dramatic than it was… what it really translated to was that I was skeptical going into anything with anyone, and skeptical about anything anyone tried to tell me, but that did not stop me from continuing to dig in. My skepticism did a great job of teaching me to do due diligence.
Investopedia defines due diligence as:
1. An investigation or audit of a potential investment. Due diligence serves to confirm all material facts in regards to a sale.
2. Generally, due diligence refers to the care a reasonable person should take before entering into an agreement or a transaction with another party.
My First Real Attempt at Due Diligence
My first real estate investment ever was for a pre-construction development in another country (right? kind of the reverse way of getting started- starting with the hard stuff!). It all sounded good and I didn’t see any obvious holes in the pitch, but once I was presented the sales contract all sorts of skepticism popped up in me and I barely even knew what I was looking at much less what should or shouldn’t be in a contract. I scheduled to meet with one of the guys behind the opportunity and I planned to ask detailed questions then, assuming I would catch the scam. Picture it- brand new investor, no idea what I was talking about or how to act in one of these meetings, didn’t even know if I was going to have to pay the guy for meeting with me. In I walk with a copy of the sales contract, but not just any version of the contract. This version of the contract looked like it had been taken straight from a crime scene with how much red was on it. In red pen I had gone line by line and noted questions I had, which was a lot of questions! It took us quite a while to hit each line, but we hit them all. It was funny because once we were done with all the questions, and all the answers he gave me seemed to make sense, I remember sitting there thinking “hmm, now what…” I hadn’t expected all of my concerns to be taken care of and now that I didn’t have any more unresolved ones, I almost wasn’t sure what to think.
Deep down, I think asking all those questions (although they were good and legit questions I needed answers to) was to see if I could catch these “guys” in some kind of shadiness. I’m of the mindset that you can usually corner a scammer pretty easy and get him to a point of not being able to answer something. On the other hand, a legit guy or company who is for real can answer everything you ask. Unless the scammer is one of those who can talk their way out of everything, but even then you can oftentimes pick up on that being what they’re doing because they actually don’t answer your questions but rather dance around them. In this case, all of the answers were given calmly and made complete sense. I was quite impressed, and semi shocked. This guy might not be a scammer!
To this day, me and that guy still joke about how many questions I showed up with. Especially because I talk to so many new investors now and so many apologize when they ask “too many questions” and I always respond the same way- “The day you show up with more questions than I asked on my first go at this, I will be impressed!” Joking with them aside though, I commend people for asking questions because I would have to think you aren’t a very good investor if you don’t ask anything.
Realizations about Due Diligence since that First Meeting
What I had no idea about back when I started meeting people and companies in the biz, and what I’ve learned in the few years since then, and what I’m going to tell you in this article so you don’t have to take as long to figure it out as I did, is there is nothing you can’t check up on when you are setting off to buy an investment property. You don’t have to trust one word anyone tells you. It doesn’t matter who pitches you a property, whether they are saints or crooks, because who they are has no bearing on your investment. The seller of a property could be a complete jerkwad felon and it doesn’t matter if the property is a good one. Or you could buy a property from your church-going neighbor with a perfect record and a flawless-looking life and end up with a bad property. Who pitches you a property or who sells it to you doesn’t matter. Who gives you advice doesn’t matter.
When I was a beginning investor, I was completely focused on the credibility of the person who was telling me something. I cared more about whether I should trust them than anything else about the investment opportunity or the quality of education I was receiving because I thought it mattered. I know now, however, that it’s not the person pitching you something that you need to check out. It’s the investment opportunity itself that matters. It is the only thing that matters!
For the Newbies
This concept will be harder for you because you likely have no idea what questions to ask or what due diligence to do on a property in order to figure out if it’s a good (and safe) investment. That’s okay, I totally understand. So you will be more reliant on the advice of others in order to figure those questions out (hopefully you’re looking for advice at least, instead of trying to figure everything out on your own). So in that regard, it would be helpful to make sure you are dealing with someone legit. Just know with that though, ultimately, that person still doesn’t matter. The facts about the property you are thinking of buying are what really matter, and that is what you need to be seeking to find out- what are the facts about the property, what facts should you look for, where do you find out those facts?- rather than putting all of your focus on that person or company.
What I do recommend as far as the person or company goes is asking for referrals from other people who have worked with them about their experiences. Customer service is the main thing that does pertain to the person or company directly, so see how that was for them (nobody likes dealing with a jerk), but then ask about the investment they bought. Did everything pan out as expected? Is it producing returns? Were there any unseen complications? Notice those questions, the ones that matter, are about the property and not about the person or company. Or if it is a person or company providing you education rather than an actual investment, you can ask others what they thought of what they learned. Be careful in this case and understand that everyone has different beliefs and personalities and goals, so just because one person thought the advice was horrible doesn’t mean it’s bad advice, it may just not fit them. For instance, I am always a huge advocate of not landlording your own properties but if you are someone who feels like they want or need to landlord, then my advice, of course, will sound horrible to you, whereas it might be great advice for someone else. Everyone is different, so be sure to understand that. For the gurus especially, you are likely to find more negative reviews than positive because a large majority of people who sign up for those courses are ones who want to get rich quick and when it doesn’t happen, they blame the source of the information. It’s likely the information was totally on par, they are just ticked it didn’t work as easy as they wanted it to.
The one time that I do recommend treading lightly is if a person or company is trying to charge you for services or education. It doesn’t mean it’s bad, just move slower getting into it and do follow-up more. Do a little more research before you start forking over dollars (especially since we have free info now on BP and so many companies offer to help for free!).
The famous name that comes up in real estate debates. Is he legit? Who knows. Who cares! All I know about him is that I have avidly followed his advice, after reading several of his books, and his advice has worked for me. His advice is the reason I am where I am today (typing this as we speak from my beach apartment, in my pajamas that I’ve been in all day, and not having to worry about being at a job in the morning). I think Robert is totally legit, but let’s say he isn’t. Who cares, because his advice has worked for me. Hypothetically he could be the biggest con artist on the planet but it doesn’t matter because his advice has gotten me where I want to be.
My theory has always been, take advice from someone you’d trade shoes with. Remember the guy I asked all those red-inked questions to? When I met him, we met on his rooftop pool deck at his downtown LA high-rise, he was wearing flip-flops, and he worked for himself on his own schedule and time so he had no problem meeting me whenever worked best for me. Now was I inclined to take advice from this guy? Absolutely! I wanted that life. Would I take advice from a guy who landlords 25 properties of his own and has to deal with tenant and plumbing issues? No. Not because he doesn’t know what he’s talking about, but because I don’t want that life. Same for Kiyosaki, I’ve always wanted his life (the freedom aspect at least), therefore I take his advice.
It’s not about needing to trust Kiyosaki so I know whether to take his advice or not, it’s about whether the advice works for me or not. I was able to figure out his advice works for me for a very small price tag, just the cost of cheap paperback books and one small weekend class. Easy. As long as no one is trying to make you spend a lot of money with them, keep listening to them. See if what they say makes sense. See if it works for your life. Their advice is what matters, not them. Kiyosaki doesn’t resonate with a lot of people but that doesn’t mean he is wrong either.
Note: Of course a lot of this is an over-dramatization because it’s doubtful that some sociopathic con artist is going to give you stellar investing advice, but the premise holds true. If the advice the sociopathic con artist works for you, take it! Who cares about his life if what he tells you makes your life awesome. Think about it.
Do Your Due Diligence on What Needs Due Diligence
There are two major components to a most investment property deals: 1. the person or company pitching you the property (where it comes from), and 2. the property (what it is). Not all deals have someone pushing it, but for the purpose of this article let’s focus on the ones that do. This person or company may be a real estate agent, a seller, a guru, a company or promoter of some sort (common with turnkey properties), a wholesaler, or in some cases it might even be a friend or family member trying to drag you into an investment with them. Understand that any of these people can tell you anything they want, but at the end of the day it is up to you to verify everything. I hate to say it, but if someone gives you bad advice about an investment property and you just go off what they say, it’s technically your fault if something goes wrong.
You, as a real estate investor, are 100% responsible for doing your own due diligence.
That means, the person giving you the advice doesn’t matter. Have I said that a few times? In no way whatsoever do I say that to condone anyone taking advantage of you, giving you bad advice, or misrepresenting themselves or even that I know of any people or companies who are actively doing this. The takeaway from me saying the person or company doesn’t matter is only to tell you that you should never go off of what people say and therefore you shouldn’t put so much focus on what they say, but rather take their advice and go verify it for yourself. Stop worrying so much about digging into the person or the company and focus more on the opportunity. You’ll get to know the person or the company plenty well if you keep moving forward with the opportunity, trust me. How that person or company responds to you while you check out the opportunity will tell you everything you need to know about them. If someone is shady, you’ll figure it out. But even still, if they turn out to be shady it still doesn’t matter if the investment opportunity is awesome! I personally have bought a property from a convicted felon. Did I care? Absolutely not, it was a rockstar property that turned out to be just as advertised. What do I care about that guy’s history? Of course, seek to find the good people and companies who are fun and easy to work with and have good reputations because it’s just easier that way. There are enough of those people out there where you should never have to work with someone who makes you uneasy or miserable. But focus on the properties more than anything else.
If you know how to do proper due diligence on a property, you will catch someone trying to scam you.
Since I’m in turnkey world, the biggest thing I hear from the naysayers is about how turnkey companies have notoriously scammed out-of-state and out-of-country (i.e. long-distance) investors and sold them crap properties but since the investor wasn’t local to check it out, they wouldn’t find out. Well guess what, I don’t condone those companies doing that at all (most of those are out of business now) but at the end of the day, it was the long-distance investor’s fault that happened because they didn’t do their due diligence. Had they done it properly, they never would have bought the property. It baffles me as to why people slam those companies who did that. Yeah, they suck for doing that and I’m the first person to call that unethical and not nice, but it’s still the investors’ fault! No one elses.
What Due Diligence to Do?
Here is a list of the critical items involved in an investment property and how to verify each item, so ultimately it doesn’t matter who tries to convince you the property is awesome, you can know for yourself.
- Condition. This one is so huge, especially for flippers, but for everyone. One of the fastest ways to get duped is to buy a property with a severe maintenance issue you didn’t know about. Do not let this happen to you. Always hire a 3rd party, reputable, home inspector to do a thorough analysis of the property. If you don’t trust one inspector or doubt any of his findings, hire another inspector to do a 2nd inspection and compare the two. You can do as many inspections as you want. Even if they are $300-600 each, you could pay for 10 of those and the money would still be worth it to ensure you won’t have any hidden maintenance issues that will sneak up on you. This will help you in getting contractor quotes for the work as well, which you should get before you purchase the property so there are no surprises on that side either.
- Title. Get title insurance.
- Contracts. There are a lot of cases I think using a lawyer is a bad idea, but know that you always have the option to hire one to look over contracts or any other legal documentation you are presented about a property, most importantly being the sales contract and the closing documents. I do recommend making sure the lawyer you use is well-versed in real estate investing or they could hose up deals for you unnecessarily. If you don’t want to pay for a lawyer, you can also shoot a copy of any contracts you receive over to someone you know who is decently versed in real estate and see what they say about it. You’d be surprised at how much even doing just that will help. A real estate agent, a property manager, other investors, anyone.
- Purchase price. Back in the day I would say order an appraisal but those have proven to be half-worthless more and more in the last few years. You certainly can, but rather than doing that (your lender is going to order one anyway if you are financing) I would call a 3rd party real estate agent to run a Comparative Market Analysis (CMA) for you. That report will look at comps in the area and recent sales and come up with what sale price range you should be looking at. Keep in mind condition of the property you are buying versus the comps though too.
- Returns/cap rate. Always run these numbers for yourself, don’t just go off what someone tells you it will be. Ask what numbers the person or company used and make sure they used what they should have, which includes actual numbers whenever possible instead of estimates. For some reason people love using estimates when actuals are easily accessible. No idea why this is.
- Expenses. As I just mentioned, find out the actuals. There is no reason you should estimate your monthly property tax payment, for example, when you can go on the county’s tax assessor website and find the actual amount for yourself. Insurance, call and get an actual quote. Utilities, do you have to pay them or does the tenant? If you have to, find records of what those expenses will look like.
- Monthly rent. The other number to not take someone’s word for! Even if a tenant is in the property paying a certain amount when you buy it, that doesn’t mean that amount is realistic. Call a 3rd party property management (PM) company and ask their professional opinion of what they would expect the rent on that property to be. If it matches what you were quoted or what the current tenant is paying, great! You can even call more than one PM company and get multiple quotes if you’re really paranoid. I do recommend calling a PM company over a real estate agent though because the agent is only going to look at listed rents nearby whereas the PM actually places tenants on a regular basis and will know the ins and outs of each neighborhood a lot better so they can give a more accurate assessment of what they predict the rents should be.
What else am I missing? Anything? Focus on learning how to do proper due diligence on an investment property and you will be much safer throughout your investing career, regardless of who is around you.
I know for me, all of the things about my properties that didn’t pan out correctly were most definitely things I did not do proper due diligence on. For any of the experienced investors out there, is there anything that went wrong with any of your properties that you could have avoided with more thorough due diligence?
Photo Credit: Juan Felipe Rubio
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.