We often talk about due diligence but what does it mean to you
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
Due diligence is an important part of real estate investing. I have invested in single family homes for years and have a good idea of what is involved.
What areas to you look st when in investing in a residential or commercial properties?
Please share why it is important to look at each area because I think sometimes new investors fail to see the importance of such things as location, condition, demographics, books and records, market saturation, supply & demand, cost of repairs, what to inspect, etc.
Good points Jesse, but due diligence to me is property specific and Charles was including generalized areas that certainly influence a buy decission, but, to me are issues that are considered as a business consideration. Demographics such as employment, average incomes, average home prices, rentals vs. owner occupied are all aspects that should be evaluated before you ever look at a property.
My due diligence is first property inspection, the condition and needed repairs, then to comps..what's it really worth in the market...then costs to repair to bring up to that market comp level,...then costs of the transaction and offered price.....then and before I make an offer.....what are the legal aspects of ownership? This is where it gets down to cracking the nut, is there a sewer comming through, any factories proposed down the street, any external obsolesence that has not been disclosed, rezonning issues...if I see several for sale signs in a neighborhood I'm concerned! Any school rezonning, is the neighborhood going to lose it's highly rate school and be changed to a less desirable district...any new tax issues? After that type of thing I'll look to title, construction done in the past six months or any work done on the property? If so, do you have lien waivers? Any liens of record, any easements that are obvious, but not filed?
Now there is a good one! ...Easements. Story- Looking at a corner commercial property that has a back alley to one street and homes behind the alley. There is a big RV parked in the back yard, an old one and the back neighbor has a double gate to the alley. The subject property has a vacant lot at the other end that adjoins the alley. OK, so how did the guy get that RV in ther and how does he get it out? He drives out the double gate across the alley onto the vacant lot and to the front street over the trail path that has been beaten down on the vacabnt lot. Looking at the building, its a great space to add on two more commercial spaces or kick the building around in an "L" shape and double the space! Ooops, maybe not! Is there an easement filed? Nope, ok, is there an easement,? Probably so! It's an easement by presription and adverse possession, the public, obvious and known use, without objection of the owner, with such use being continious over a period of time set by state statute. That neighbor can probably and effectively block any future building on that vacant lot by claiming the easement for the purpose of ingress and egress to his property. It has been used in the past, it is the only way he can get in and out, so after a period of time, and from time to time which meets continuious, he has driven that big RV (kinda hard to do that secretly) over the subject property as evidenced by the path, so....assume he has rights to it!
That's an example of due diligence, paying attention and looking for ways you can get the short end from something that is usually overlooked through the normal course of actions taken in a real estate transaction.
Bill,
I think it's really easy for newbies to get lost or overwhelmed while doing due diligence.
To me, what matters most is whether this a good deal today? I take into account whats sold recently, what's on market now, and if it's a good deal for the area.
Why overanalyze a deal? You can spend days or even weeks sitting on a deal running numbers and looking at trends and charts.
Why spend so much time looking at statistics when you can be out on the streets picking up more deals?
Good points Jesse, but due diligence to me is property specific and Charles was including generalized areas that certainly influence a buy decission, but, to me are issues that are considered as a business consideration. Demographics such as employment, average incomes, average home prices, rentals vs. owner occupied are all aspects that should be evaluated before you ever look at a property.
My due diligence is first property inspection, the condition and needed repairs, then to comps..what's it really worth in the market...then costs to repair to bring up to that market comp level,...then costs of the transaction and offered price.....then and before I make an offer.....what are the legal aspects of ownership? This is where it gets down to cracking the nut, is there a sewer comming through, any factories proposed down the street, any external obsolesence that has not been disclosed, rezonning issues...if I see several for sale signs in a neighborhood I'm concerned! Any school rezonning, is the neighborhood going to lose it's highly rate school and be changed to a less desirable district...any new tax issues? After that type of thing I'll look to title, construction done in the past six months or any work done on the property? If so, do you have lien waivers? Any liens of record, any easements that are obvious, but not filed?
Now there is a good one! ...Easements. Story- Looking at a corner commercial property that has a back alley to one street and homes behind the alley. There is a big RV parked in the back yard, an old one and the back neighbor has a double gate to the alley. The subject property has a vacant lot at the other end that adjoins the alley. OK, so how did the guy get that RV in ther and how does he get it out? He drives out the double gate across the alley onto the vacant lot and to the front street over the trail path that has been beaten down on the vacabnt lot. Looking at the building, its a great space to add on two more commercial spaces or kick the building around in an "L" shape and double the space! Ooops, maybe not! Is there an easement filed? Nope, ok, is there an easement,? Probably so! It's an easement by presription and adverse possession, the public, obvious and known use, without objection of the owner, with such use being continious over a period of time set by state statute. That neighbor can probably and effectively block any future building on that vacant lot by claiming the easement for the purpose of ingress and egress to his property. It has been used in the past, it is the only way he can get in and out, so after a period of time, and from time to time which meets continuious, he has driven that big RV (kinda hard to do that secretly) over the subject property as evidenced by the path, so....assume he has rights to it!
That's an example of due diligence, paying attention and looking for ways you can get the short end from something that is usually overlooked through the normal course of actions taken in a real estate transaction.
Bill,
Without thorough Due Diligence, how can you possibly negotiate a deal in your favor? I would much rather be safe than sorry! You may luck out once or twice but that third one, could cost you the other two!!
There is a big different IMHO, between a due diligence done for the purpose of buying a property to live in or buying it as an investor.
When I started, I used to use home inspectors. I don't do it anymore. It is a waste of money for me. I hire a general contractor who not only tells me what's good and what's bad, but also tells me how much would it cost to fix.
I don't care if the roof is "in marginal condition ahd shows signs of wear" that is a language of a home inspector. I want to know, how long this roof will last, what do I need to do if a fix is needed, and how much would it cost me.
I don't care about doors hinges, but if every door in the house does not shut properly, I want to know if I have a foundation problem.
Due diligence is less complicated for single family residential properties, but not any less important.
Here is a short list of things I like to cover in my due diligence of a SFR.
My investments are rental so I find it more important to use an income approach rather than using comparables.
A thorough inspection of the property by a competent home inspector. I always do my own walk through as well and take pictures.
I want to know the area well. What is the area demographics, what are surrounding homes selling for, what is the mix of owner occupied to rentals, what is the vacancy rate in the area, what are the typical rental rates for similar homes, what is the job market like, proximity to schools and other consumer resources.
If repairs are needed I want to be sure that I have a conservative repair cost.
Review the assessors information, are there any easements, encumbrances, liens or outstanding taxes. What is the likelihood of an assessment for sewer, sidewalks or other improvements.
I also like to review a property for other potential uses. Is the property over or under built for the neighborhood. What is the zoning?
This is a start for a residential property due diligence.
Jesse, I think your argument has some merit. I do also think in matters what you intend to do with the property as well. If you are buying to hold you want to insure that their is a market for quality tenants, you want to be sure that rents are going to work out in the long run, and it is important to know there is not a lot of deferred maintenance.
If your wholesaling property you may not be as concerned about all of the details. You do want to know the market though.
A developer will need to do far more due diligence in my opinion.
Great point Eddie, I would want to know that my contractor/inspector knows there stuff. Not all contractors are created equal. A general contractor that is knowledgeable in all areas of home construction and is experienced in remodeling different kinds of homes might be a good choice. In some cases they might be willing to come in at no cost and prepare a bid based on the work they suggest needs to be done.
There is far more due diligence involved in commercial properties. What kind of things have you learned to watch for?
Due Diligence to me means "Do Everything Possible Not to Get Kicked in the Groin After the Deal Closes." And that involves different things for different markets.
From an office or multifamily perspective, we get a property inspection report to help determine deferred maintenance or major rehab, we do our own market study, rents, occupancy, sales, etc. Usually, we also determine cosmetic improvements that will freshen up the property, paint, landscaping, etc., as well as what improvements to management are needed to increase occupancy/rent. Prior to acquistion, we determine our exit strategy. Who is the typical buyer for this type of product. What do they demand of these properties in order for a successful purchase.
I'm currently doing my due diligence on a 46 unit apartment complex.
The location is good and the property has good curb appeal and is in the heart of a downtown Bremerton.
I've been reviewing the books and records and finding some anomalies. I have been reviewing existing maintenance records, a phase 1 that was done 2007, a property condition report from 2005. A structural engineering report accessing the integrity of the building done in 2005.
I have found some contractors and consultants that I will be working with so that I can assess the current condition of the building. I have already determined that this is some deferred maintenance.
I will be doing a market study. I am looking to determine what the rental market is like now and might be like in the future. The location of the building may have a higher and better use than what is currently being used for. There is some evidence that some low cost renovations could be done that would allow for better rents. As I study the market, I will know the answers to more of these questions.
I have been going online reading comments made by former tenants of the building these have been quite revealing. I plan to spend the night in a motel nearby to get some idea of how safe the neighborhood is and take a look at the building and what is going on.
I will be paying a visit to the city to see if any violations have been recorded. How have the fire inspections gone. Any police calls. What is the neighborhood crime like. What kinds of crimes are committed. How safe is it to park on the street.
How much has the apartment advertised? Where have they advertised? Determine actual vacancies and expected vacancies. Have rents been gradually increased and what effect has this had on vacancies. What are neighboring apartments doing? What do these units like. What is the makeup of neighboring apartments?
There are other issues to be addressed. As a buy and hold investor, I want to make sure my investment will do well now an into the foreseeable future. I also look to add value to the building and know enough about the community to bring the highest price for the property if I do sell in the future.
Hi Charles, I think you touched on alot of what I mentioned in another forum...pretexting in the neighborhood will get you alot of information. The best intelligence is human intelligence, pretexting is role playing or posing as another. If you're an interested prospective tenant from out of town and you walk the neighborhood, you might learn alot. Ask too at the C-store, gas station, flower shop, what ever businesses there are. A gift of gab is required. Business owners usually know what's going on around them, especially if they have had problems.
If you're think of changing use, one of my favorite things to do, better start with p&z office and see if the change is permitted and if not, how long and what is required to change. Zonning changes can be a bear to impossible, it's political, and it is very time consuming and can be very expensive. See what is required if you are buying with a change in mind. A change of use, say an apartment to assisted living can take a couple of years, If most neighbors must agree. I did a house that was changed to retail/office with a residence, mixed use, the guy ended up having to make improvements to a neighboring house to get them to agree and stop throwing up road blocks..... Good luck, Bill
Apart from the broad stroke strategies; viz., 50/50, entry/exit, REO process; it can mean overlapping a business strategy to a vision, and the associated lifestyle questions.
David, I like to think creatively as well. One of the things I look for in a property I buy is other potential uses, what is the zoning, what might the area need, how large is the lot is their room to expand.
When buying a single family home, I often give higher consideration to a property zoned commercial or multi-family especially if the lot is large.
That being said, I won't consider paying anything in today's market that goes beyond it's current use.
I like to have a number of exit strategies and future development to a higher and better use might be a good strategy.
So i like to spend some time looking at this possibility while I insure the current numbers and factors make sense.
Charles,
The exit strategies are crucial and surely rest on your experiences and accounting background. It's humbling to have this means of learning from such competent investors.
Many focus on the emotional acquisition (especially seen with 1031 exchanges) so heavily it obscures that - depending on the type, eg. multi which you referenced - some have a much longer "hold" period.
Being enamored is not a business strategy.
The biggest DD issues I see are people not hitting the REAL value. The first thing you have to do is determine the value (not the price).
After that you have to see if big brother has any reason to ruin your day.
The rules don't change much over time, but the struggle always seems new to the newcomers.
It is unfortunate that some fall in love with a property and fail to seriously review the pros and cons of a deal.
Jeff, understanding what the real value is the crux of what the due diligence process is all about. Without digging into the numbers or other property attributes how can someone really know the value of the property.
I also believe that it is important to consider to real values. The real value of how the property is currently used and its current performance. I also consider the value I will bring to a property. The value I bring is not the value I am willing to pay for though.