After the purchase and sale agreement has been signed, it’s time to start reviewing the documents. If you are buying a single-family home that has not recently been used as a rental, the documents you receive may be minimal. However, if you are buying a rental house, a multifamily property, or a commercial building, you’ll likely have a lot to review.
As I mentioned at the beginning of this chapter, the purpose of the due diligence process is to make sure you are actually buying what you think you are buying. Inspecting the paperwork is a good way to do that. The seller may claim that the property’s tax bill is $1,500 per year, but how would you know for sure if you don’t investigate? They may say the property rents for $675 a month, but how would you know if you don’t check to confirm this?
The following is a list of documents you may receive from the seller. Keep in mind, not all of these will be used in every situation, because it largely depends on the type of property you are buying. However, I’ll list the most common possibilities here so you can know what to keep an eye out for.
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10 Seller Documents You May Need to Review When Buying a Rental
1. Seller Disclosures
Most states, if not all, require that the seller disclose any known defects in a property before selling it. Therefore, in most deals you purchase with the help of a real estate agent, the seller will give you a pile of forms in which the seller lists anything that might be wrong with the property. You’ll want to read this document carefully, so you’ll know immediately about any issues with the property that the owner knew about. Of course, the large loophole here is that the owner must know about the problems, so this should not take the place of your doing your own investigation on the property’s condition.
2. Seller’s Tax Returns
One of the most powerful tools you can use to determine the truth about a property’s financials is the seller’s tax returns. A seller will not likely make a property look extra “cash flow-plush” for the IRS, so tax returns will likely be the most accurate representation of how the property really performs. To get these, simply ask for them! Look for any discrepancies between tax returns filed and the financial information provided by the seller, but also recognize the difference between aggressive tax write-offs and deception. If you find inconsistencies between the numbers they provided and the numbers on the tax returns, you’ll want to dig further into this.
3. Current Leases
If the property is an existing rental property, be sure to dig through the lease(s) with a fine-tooth comb. After all, a lease goes with
the property, so that lease between the seller and their tenant will become the lease between you and the tenant. Be sure to pay special attention to the rental rate, the length of the agreement, and any special, out-of-the-ordinary terms written into the lease.
You don’t want to discover after you buy the property that they had a 20-year lease for $1 per month!
4. Current Rent Roll
The rent roll is a list of all current tenants, their rental amount, and other information (such as move-in date and lease term length). In essence, it’s a summary of what you’ll hopefully find in their leases, but double-check that anyway. Make sure the numbers add up to what you think they should.
5. Tenant Estoppel Certificates
If you are buying a property that is already rented, and especially if you are buying a property with multiple units, I highly recommend getting estoppel certificates from all the current tenants. An estoppel certificate is simply a form that the existing tenant fills out, letting you know what the terms of their current lease are. This can help you verify that the seller did not change the lease agreement without the tenant’s knowledge or create a fake one, just to make the income seem higher (trust me, this happens!).
6. Current Year’s Tax Bill
Be sure to verify that the tax amount you ran your numbers with is the actual tax bill. You can usually verify this online through your local assessor’s office.
7. Recent Utility Bills
Utilities are a major expense with real estate, so verify that the numbers you used for your math homework are accurate. Either ask for specific bills or call up the local utility companies and get the information directly from the source. Also verify who pays for which utility, especially if you are purchasing a multifamily property, and always check to make sure the utility bills have all been paid. When I first got started investing in real estate, I discovered several days after closing that there was a $400 garbage bill that the previous owner had not paid, and the debt was now mine. Now, I check to make sure all bills have been paid before closing!
8. Security Deposits
If the property is already rented, make sure you verify the security deposit amounts to ensure you are given the correct cash at closing.
9. Recent or Current Maintenance on the Property
Again, this is most helpful when a property is already rented. You’ll want to get a good idea of what work has recently been completed on the property and what still needs to happen. This can also help you determine whether the owner has simply been deferring maintenance to make the expenses appear less than they really are.
10. HOA Documents
If the property is governed by an HOA, you’ll need to review the HOA’s declaration of covenants, conditions, and restrictions, more commonly referred to as the CC&Rs. This document explains all the things you can and cannot do according to the HOA. For example, an investor I recently talked with told me that he bought a condo in Chicago, only to find out a few months later that the HOA would not allow the property to be used as a rental! Don’t fall into that trap. Review the CC&Rs!
You may also review other documents, depending on the property and the rules or customs of the location in which you are buying. I simply could not list every possible document! The important thing to remember is this: verify everything.
Any documents I missed?