Preventing earnest money deposit loss?

Question

Hello everyone,

So I found the one, the property I have been looking for. It's a 4 unit multifamily. This would be my first real estate investment, worth $450,000. Quite expensive for my first investment and I am bit nervous and wanted to get some advice.

My questions:

How do you go about making an offer to prevent earnest money deposit loss if you are skeptical about initial financials (income and expenses breakdown) received from the seller. Like what can I include in my contingencies so that if during my due diligence period I discover that the numbers don't work out or seller fails to support it with proof to prevent myself from losing my deposit?

My situation details:

So, I requested the financials from the seller, past 12 months of income/expenses breakdown but only received past 3 months of info. Three out of the four units are currently vacant, seller is saying he has applicants for two more units but is holding since it's easier to show the property to prospective buyers, last time these two units were occupied was a month ago. Location is great and based on what I know about the area renting out the units shouldn't be a problem. However, I am skeptical about the financials I received (Property was built in 1926). I want to make an offer with 1% earnest money deposit, but as I said the I am skeptical about financials. It's just a one page hand written document that has utility bills, lawn, snow, & capital repair saving and that's it. Reason, I am not 100% sure about the financials is because I talked to the owner and he owns multiple other properties and has done deals worth millions of $ but the financials I received does't look like a work of an astute owner. Plus, it took him more than 1.5 weeks to provide this info since I made the request and then when I did receive the info he was like we have 3 offers in hand and want to make a decision within next two days. With the financials provided so far the numbers workout but I don't think I have all the parts to complete the puzzle. I have seen the property it's in decent shape and offer will definitely include inspection. What are your thoughts?

Will Barnard · Answer

Some of the info you provided would give me some skepticism as well. In the most simplistic form, an "inspection contingency" or "due diligence phase" contingency of X amount of days would suffice. Upon receiving all disclosures and documentation from seller which you requested, if it does not pencil out how you thought upfront, you get your EMD back so long as you cancel within the contingency period.

Be careful - landlords will often place crap tenants in just to make the financials look better and then you are stuck with them. If you can actually get tenants in easily for this area and this property, you may be better off taking it with just the one tenant and filling it yourself with your own approvals and check points.

For small multi units like a quad, it is often common for the landlords to not have accurate or complete records as most are going to be mom and pop operations. Getting them to turn over actual tax returns and records of these deals is often problematic so you need to be confident on the rental rates you think you can get and use those numbers, then use all the necessary operating expenses, vacancy factor and cap ex to complete your costs.

Yashasvi Soni · Answer

Thank you guys for the insight! This helps alot!

Basit Siddiqi · Answer

@Yashasvi SoniYou can put anything in as a contingency to be able to back out of the deal. Just clearly write out what you are looking for.Just some things to be mindful of, the seller has to agree with your contingency for him to want to sign the contract and sell the property.An offer with more contingencies is less attractive than other offers.

In my opinion, the trailing 12 months of income/expenses holds weight but not too much. Numbers can be inflated. This document should not be your research whether this is a good investment or not.

Talk to your agent or other investors in this area.
Does the rent seem accurate?
Does his expenses seem accurate?
check with the home inspector, will there be a lot of items that you need to fix up in the near future.
etc.

Erik W. · Answer

Due diligence clause in the contract should cover your right to inspect the rent rolls, leases, structural and mechanical integrity of the premises, and perform any and all other work to verify the property is what the Seller says it is. Trust nothing. Verify everything. I also require the Seller's Schedule E, which lists all the rents and expenses for tax purposes. That document will tell you quite a story, because they're always trying to inflate expenses to get more of a tax deduction. If you discover a deficiency in the building(s) or problems with financials, you should be able to either make the Seller correct those, adjust the sale price to compensate, or you have the option to cancel the contract and receive a full refund of your earnest $.

I also require all tenants to sign an estoppel letter stating the terms of the lease are correct and that there are no other promises made or unfulfilled between them and the Seller, and that there can be no additional promises made between the them once the letter is signed. Keeps them from claiming the Seller promised them a new double oven as a parting gift.

Preventing earnest money deposit loss?

Preventing earnest money deposit loss?

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