How to Perform Due Diligence Thoroughly and Properly

Investors throw around the word due diligence too easily, and most do not grasp the importance of performing a thorough due diligence. The consequences can be devastating to an investor if the investment is not carefully analyzed, and all aspects of the investment need to be scrutinized, including the formation of partnerships.It only took me one big mistake to realize the importance of due diligence, and I am writing this for you today so you can avoid the mistake I made.

I have included a detailed due diligence checklist below for you to follow.The checklist may seem overwhelming, but it is imperative to look at every item.Once you have done a couple of deals, the checklist will become automatic, but we still refer back to it to make sure we don’t forget any items.Overlooking even one item can put your investment in jeopardy.

1 collect rent roll and all current leases

2 verify income and expenses (profit and loss statement)

3 verify security deposits

4 year to date rent collected

5 last 2 years of tax returns

6 current year budget

7 vendor contracts (landscaping, garbage, etc)

8 payroll ledger

9 loan documents

10 insurance documents

11 outstanding work orders

12 utility bills, including sewer, cable, gas, phone, electric and garbage

13 3 years of capital improvements

14 property taxes

15current payroll

16copy of any warranties

17 liens and liabilities

18 check with police department for building activity

19 check with town for any code violations

20 Maintenance records for equipment, such as boilers, roof, elevators

21 Check town records to see if any building permits have been issued in surrounding area.Good idea to familiarize yourself with potential neighbors

In this article, I am going to discuss the first 4 items on the list.It is critical that you understand how to collect and analyze every piece of information.

The first thing that a seller should provide is a copy of the current rent roll and current leases.You have to match the leases to the rent that is being collected.Once you assume ownership of the property, those leases become binding.You do not want to buy a property with a lease that the seller created with his cousin who has a 10 year lease that is 300 per month under market.That crappy lease will transfer over to you once you become the owner.If the leases do not match the rent roll, then ask the seller why.It may be an honest mistake where he forgot to update the information.If the income on the rent roll is less than the amount the seller furnished initially, then this is a retradable offense. You can go back to the owner and ask for a concession on the price, but the owner may decline to adjust the price.Should you go through with the deal or should you walk.It all depends if the deal still works at the current price.

Let’s move on to verifying income and expenses.You need to be able to arrive at an accurate Net Operating Income for the property to be able to estimate the value of the property.To verify income, you can ask for tax returns or bank statements.Sellers usually understate income and over report expenses, so analyze each expense carefully.Our rule of thumb for expenses is either approximately 50% of gross income or 3,200 per unit.To calculate Net Operating Income, take gross income and subtract total operating expenses.

If the seller has been collecting security deposits, then there should be a separate escrow account that holds these deposits.The security deposits do not belong to the landlord, they are property of the tenant and returned to him once the unit is vacated and returned in its original condition.Match the security deposits to the amount stated on the leases, and expect the security deposits transferred to you at closing.Every state has its own laws pertaining to security deposits, so become familiar with your own state.

.Year to date rent collected is a good barometer to see how the property is trending.Are they collecting rent at the same pace as last year? Or is there a dip in collections?Ask the seller to furnish a schedule of rents collected year to date, and if the amount is considerably less than last year, you may consider going back to the seller and asking for a price concession.

In the next article, we are going to describe the next 4 items on the due diligence checklist.Let us know what you use to help you perform your due diligence.Do you have any additional items that you look for in the due diligence process

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