Financial Due Diligence?

Question

Can someone explain a little bit about the financial aspect of Due Diligence?

Bill Gulley · Answer

I have obtained Schedule E pertaining to the property, but IMO it should not be used alone as a verification since you'll never know if that was indeed the schedule that was filed. You can get blank forms by the dozens at the local IRS office!

Occupancy and lease terms can be verified with your estoppel letter, verify occupany with utility records, sellers will usually provide their books on a property. This is a basic audit where you want to match up income and expenses to verify claims made by the seller. If you find utility usage drop but no drop in rents claimed you could have a story teller....

Mbei Enoh · Answer

@ Jack Lee: As a private money lender, I usually ask for all data on the property including rent rolls, income statements, and property photos going back 2-3 years. While I usually don't ask for tax information, I do ask for credit scores, individual assets and credentials. Again that's what I ask for because I play in the distressed commercial property space and others may have different criteria.

Jack Lee · Answer

So if I just ask to see their Schedule E, most sellers will refuse?

In addition, what if the owner does not use an accountant?

Daniel Doran · Answer

As Dale stated, I have specifically advised client's not to release their tax returns.  It's overkill and similar to giving someone the keys to your house when they ask to borrow a cup of sugar.

What I have done instead is have the client's accountant send a certified statement of the financial health of the property in question which obviously includes NOI.

Hope that helps.

Dale Osborn · Answer

Many people have asked for tax returns - I have never seen anyone willing to provide them to strangers.

Jack Lee · Answer

Thanks guys. Would asking for the sellers' past 3 taxes forms be standard procedure?

Dale Osborn · Answer

You need to evaluate the "money in" and the "money out" to see if the property will support itself without you having to dump additional money into the property. Is there enough left over to save to invest into another property later? Sometimes the Sellers pad the numbers so part of your financial due diligence is to verify that the amounts coming in and going out are correct. Some ways of doing this involve asking for mortgage payment history, insurance policy with premiums for past 2 years, telephone, water, sewer, electric, & cable bills for at least a 6 month period. Copies of repair bills as well as supplies purchased would be other items to look at. Without good numbers, you are unable to determine if the property will work for you or not!

Bill Gulley · Answer

As a buyer. Equity financing would be seller financing.

Why do you need to use it and how sure are you that you can meet the obligation when it comes due? Can you afford the payments, say keeping around 36% DTI, there is usually no appraisal in these deals, are you sure you're not overpaying or paying a premium for financing...you should not. What's the rate, is it lawful? Is there a servicer involved, there really needs to be to count and deposit payments in a timely manner. I'd say don't do seller financing without a servicer.

Debt financing would be a mortgage from a lender. Big difference between a hard money lender, private lender, bank and mortgage entities. Here, appraisals are usually made to ensure lending risks but also that the buyer is not overpaying. Points (1 pt=1% of the loan amount) and interest rates need to be assessed as the APR to compare loans, inclusing fees and other charges. Who are you dealing with, an individual or a bank and look to how servicing will be accomplished. Again you need to know you can qualify for any obligation made in the future as well as the ability to repay the debt.

There could be other issues, but generally that's about it......due diligence much deeper as the lender, not so much as a buyer/borrower. Good luck

Jack Lee · Answer

For buying a simple SFR or Multifamily with equity and debt financing.

Bill Gulley · Answer

Can you narrow that down a bit? The world of finance is a big place. 
RE selling or buying, seller financing, installment contracts, assumptions, assignments, note purchases/sales, subordinate financing.....

Financial Due Diligence?

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