All investments require a certain amount of due diligence on the part of the investor before signing on the dotted line. It’s smart to know as much as possible about the investment and where one’s money is going before taking the plunge, and private real estate is no exception.
Private real estate investment is different from stocks and bonds in that one is investing in a real physical asset versus a share of a company or an abstract financial concept. As a result, those investors who are new to private real estate may wonder which questions to ask and the proper way to go about due diligence for these assets.
Below is a primer on what to ask and how to assess the results.
Private Real Estate Due Diligence
What to Ask
The type of due diligence required for a private real estate transaction can vary according to the property’s asset class: multifamily, office, industrial, retail, hospitality, land, etc. How a property is used, or planned to be used, affects its value and what an investor needs to know before investing in it.
However, there are some forms of due diligence that are recommended for every asset class.
One of the first questions investors should ask is why the property is on the market. This will steer the direction of the rest of their due diligence efforts. If the property is being sold by the developer, due diligence related to the age of the property is probably unnecessary.
However, if the property was constructed several years or decades ago, that leads to other questions including its method of construction, material makeup, maintenance schedule, seismicity issues, ADA compliance, and environmental assessment history.
Further, they should request property condition reports that address structural aspects and building systems, such as HVAC and plumbing. They should also complete legal due diligence on the title and ownership via a trusted attorney.
Owners may be motivated to sell an older property for a variety of reasons, including irreconcilable differences among the owners, a quest for liquidity, maturing loans, impending tenant lease expirations, or even market fundamentals. Investors should find out if any of these reasons apply to the sale of that property and if there are any other reasons why it is being sold.
Other questions potential investors should ask regarding older properties include who the tenants are, what their businesses are, and their creditworthiness. They should also look at current leases and determine when leases expire to seek out opportunities to increase the property’s rental revenue.
In addition, investors should look into how the property was managed, the potential or necessity for upcoming renovations, and other opportunities to increase the asset’s profitability.
How to Use the Results
The answers to the above questions, as well as the assessments and evaluations performed previously or at the request of the investor, will yield a more complete picture of the asset—its pros and cons.
Proper due diligence will help investors determine if the investment is worth the risk and what the potential costs might be to either bring the property into compliance with required codes and standards or to increase its ROI.
While it may not prevent all future concerns an investor might encounter with an asset, the due diligence process will do much to assist investors in understanding what they are really buying before making a commitment and can help them avoid undue risk in private real estate investments.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.