“Every battle is won before it’s ever fought”.
The ubiquitous Sun Tzu quote from his famous treatise on warfare (The Art of War) is touchstone of any real estate investing strategy. Anecdotal evidence seems to bear out this wise general’s a observation applies to real estate investing. Example:
- Purchase a property during the right phase of the market cycle and you will see your prosperity flourish.
- Fail to identify a serious defect like asbestos and feel a MAJOR strain on your budget plan.
- Buy the wrong time or with inappropriate financing for the strategy you will at least lose a fair amount of sleep and age rapidly. At worse you may end up in court: bankruptcy, divorce or civil. At a worse you may get a visit from men in black (SEC…Not Will Smith or Tommy Lee Jones).
Therefore, a solid acquisition plan with increasing phases of financial commitment will maximize your chances of success. In this article I will attempt to share a common sense plan that you can utilize to meet your financial objectives.
Notice the following observations:
- While it helps to have a great team around you remember the great Ronald Reagan quip: “Trust, but verify”. The investor pays the heaviest price if anything is missed in the acquisition process.
- The key assumption after every step we have a choice to proceed to the next step or to return to an appropriate prior step depending on market conditions and changes in our capabilities as investors.
The simple plan…Mindset then Strategy
How to Analyze a Real Estate Deal
Deal analysis is one of the best ways to learn real estate investing and it comes down to fundamental comfort in estimating expenses, rents, and cash flow. This guide will give you the knowledge you need to begin analyzing properties with confidence.
1.) Investor Gut Check/Suitability:
What is my vision and mission?
- What do I want to accomplish with real estate investment?
- What Impact will I make in the life’s of those around me?
What are my limiting beliefs?
- Do I believe it can be done?
- Do I believe I can do it?
- F.E.A.R…False Evidence That Appears Real.
- What is the fear within trying to do? What strategies are most effective in countering it? Measure risk and MASSIVE action perhaps?
What are my Resource constraints?
- How much time do I have to devote to this?
- Loan committee questions: what is my cash, collateral, credit, capabilities, character profile?
- How will I alleviate the constraints?
- Can a paid coach fill in the knowledge gap? Can I partner with someone?
- Is a private money campaign right for me? Do I recognize the value I offer?
What vehicle and strategy appeals to me most? What am I passionate about?
- Single Family Residential
- Risk Appetite and Strategy Selection
- Appreciation vs cash flow target?
- Buy and hold?
- Reposition with varying degrees of management and capital intensiveness
- Ground up construction
- Do I know anyone who has achieved my outcome?
- Where do I meet them?
- Is coaching cost beneficial?
2.) What are the Market Conditions for My Favored Strategy
Single Family Data Research: ex Zillow local market trends for broad overview
Commercial Real Estate Market
- Click here to download Urban Land Institutes research resources
- The emerging trends report from Urban Land Institute
- Loopnet.com to get a flavor for cap rates/vacancy
- Contact a good mortgage broker
- Scottsman guide for a good general overview
- Note some pose as lenders when they are just brokers FYI
- Be wary of firms with unreasonable upfront diligence fees
3.) Generate a Project Proforma to Evaluate Feasibility
Apply your Market Research:
- excellent opportunity to get very specific on what a good deal will look like
- crucial to narrow our focus
Opportunity to stress test your project
- What if scenarios to clarify how much margin for error the project offers
- Better to kill a marginal deal and live to fight another day
What are the best exit strategies?
4.) Market for Deals
Direct Mail Marketing
- ex Listsource: (I recommend following Sharon Vornholt)
- Farm List from a friendly title agent
- Apartment Associations
- Real Estate Brokers
- A note about Loopnet: generally great for data but rarely a great deal!!
5.) Market for Dollars
Zone of influence
- Friends and Family if you so chose
- Chamber of Commerce
Private Money Campaign: Stay SEC compliant my friends!!!!
- SEC v. Howey established the Four Pronged Test to decide if its a securities offering:
- 1. Investment of money due to
- 2. an expectation of profits arising from
- 3. a common enterprise
- 4. which depends solely on the efforts of a promoter or third party. If it meets that test need to exercise extreme caution in compliance. Generally a mortgage note is not a security unless it is fractionalized. Active management by all participants in LLC/TIC is not a security. Seek legal counsel if this aspect interest you.
6.) Make Offers: We Don’t Win if We Don’t Play!
- Great deals require persistence
- Be shameless in offering a favorable deal: the answer to unasked question is no.
- Have your loan documentation ready to go
Is the Seller really MOTIVATED?
- Only through practice can we learn what a motivated seller behaves like
- Enjoy the process!
7.) Pre-Contract Due Diligence
- Financials: Does the property appear to meet your proforma model?
- Is the property physically challenged? Differed capital expenditures almost a hallmark of a great opportunity. Does the physical condition exceed my time constraint? I am able to manage the renovation process given my other obligations?
Is the seller distressed?
- Tired of tenants toilets trash?
- Code violations
- Did they buy on proforma and FALL SHORT?
- Financing unfavorable?
8.) Going to Contract: Key Considerations.
- Earnest Money: Should be no more than 5% of the contract price
- Contingencies: Make sure your contract allows a penalty free exit!
- Financing – Is the LOI from your lender appear to meet your needs? Are my private money efforts far enough along? Do I need to wholesale/assign to another deep pocket buyer?
- Physical Condition – Are the undiscovered or undisclosed defects a deal kill? Re-trade: negotiate a seller credit for differed maintenance?
9.) Due Diligence: Trust but Verify
(Legal Counsel worth every penny here!!)
- Rent Roll
- What is the term structure? Are all the leases coming due?
- Expenses: do they make sense? Did I uncover an opportunity to save money?
- Utility Metering: Landlord or Tenant paid?
- Why buy on proforma? Should you pay the seller for your sweat equity?
- Any bad juju? Radon? Lead? Asbestos?
- Mechanical Systems
- Any Storage tanks
- Any toxic neighbors (Other than the Kardashians)
- Is the property in compliance with zoning laws?
- Highest and Best: Are their opportunities to reposition in a different purpose?
- Any defects in the title that are problematic?
- Any issues with the legal description?
Real Estate Taxes
- Are they paid up?
- Are they reasonable? Worth targeting this assessment to reduce operating expenses?
- Any construction liens?
- Other disputes??
- Whats included in the sale?
10.) Close the Deal
Sit on the beach and collect your mailbox money…LOL. Just kidding. Passive real estate can be at very low time investment but its a business after all. In next weeks article I will talk about the four disciplines of execution and how it can help focus on the key metrics that drive success.
In conclusion, this ten step process demystifies the risk associated in purchasing investment real estate. It allows you to gain progressively more knowledge about your project and make several go no go decisions. Most importantly you can proceed with confidence you have MEASURED the risk.
Resources for Further Study:
- Visionary Leadership Skills or/and Beliefs: Pathways to Health and Well-Being by Robert Dilts (Mindset)
- Real Estate Market Analysis by Deborah Brett and Adrienne Schmitz (Urban Land Institute)
- Its A Whole New Business by Gene Trowbridge (Outstanding overview of SEC compliance in private placement)
- Principles of Syndication by Samuel Freshman (SEC compliance and private money)
- The Complete Guide to Buying and Selling Apartment Buildings by Steve Berges
- Intent to Prosper by R. Kym Harp (The gold standard in Due Diligence)