In my recent podcast here on BiggerPockets, I advocate that when you’re new to real estate investing you should strive to save your money up and partner with an experienced investor.
The word vet is a derivative of veterinarian. People first started using it as a verb to describe verifying that a horse was in peak condition before a sale or race (usually done by a veterinarian). When you’re determining if you should entrust a person with your capital, the phrase “vet an investor” couldn’t be more apt.
When you vet a horse you don’t make a decision because the horse is a “good guy.” No, you examine every inch of that animal and if anything is wrong you move to the next stall. Use the same approach to vet an investor. Don’t get emotional. Don’t be afraid to ask probing questions. Dig into what they’re doing, how they solve problems, and how they plan to grow. There’s a strong chance you’ll have to retire on the money you put in their care. Don’t throw it away because you didn’t do your homework.
So, what should you look for? What’s a red flag? How do you know that an investor isn’t horsing around? (if you’re not a fan of horse puns, you should stop reading this article now).
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I’m starting with transparency because it’s the most important thing. Any investor you’re considering should have no secrets. Every one of your questions should be answered on the spot or they should get back to you as soon as possible. Does the investor change the subject? Do they lie or exaggerate? Maybe they give a vague answer and never get around to sending you the details. When you vet an investor, if they’re not entirely transparent, trot away and find another stallion.
We have two ears and one mouth so we can listen twice as much as we speak
A week ago I had an initial call to vet an investor. I was on the phone with him for 20 minutes and he allowed me to say a grand total of 2 sentences. At no point was there any interest in what I was hoping to accomplish, my goals, or if we would be a good team. Instead, he chose to spend the time explaining how awesome he was.
Under no circumstances will I ever give this bloke control over any money. Why?
He sounded like a used car salesman. The person responsible for my retirement needs to be a cynic. He needs to be able to doubt himself. He needs to seek out the worst that can happen and see what can be done to mitigate it. This is the opposite of the stereotypical salesman who is optimistic, overly confident, and adapt at sweeping concerns under the rug.
Think about it this way: there are plenty of rich salesman. However, the richest people in the world are never in sales. People like Buffet, Gates, Walton, Rockefeller, and Helu focus on business principles, creating products, and building an empire…sales are secondary and always a means to an end.
As you vet an investor, ask yourself: What type of person do you want in charge of your money?
Any investor you’re considering partnering with is claiming real estate experience. Make them prove it. Get property addresses and start digging:
- Pull the tax records. Does the investor own what he says he does?
- Seek out sales prices. These should be publicly recorded at the courthouse or accessible online. Do they match what he told you?
- Drive by the homes. What condition are they in? Are they vacant? Is the investor a slumlord?
To fully vet an investor, it’s imperative you get detailed financial statements for ALL of their deals over the last few years. Sneaky investors will attempt to cherry pick investments for you. Don’t let them. Get details on everything. If they can’t or won’t provide them, then at best they’re poor record keepers. Move on.
Once you receive the statements, here are specific items to explore:
- Are expenses high enough? For a landlord, a general rule is that “non lending expenses” should be 50% of the potential rent. By “non lending expenses” I mean vacancies, turnover, insurance, maintenance, property management, etc. Everything except loan payments. If these expenses are 25%, find out why.
- Is the income too large? If they rent properties, research the market and see if their rental amounts are in line with the area. If they’re flippers, you should already have pulled the publicly recorded sales prices to compare with.
- How much was invested? Grab their balance sheet and figure out how much capital was contributed. If you divide one year’s profit by the contribution, you’ll get the annual return. Does that match the investor’s claim?
Be mindful that anyone can exaggerate returns and doctor financial statements. To vet an investor, let the tax returns tell the real story. Nobody in their right mind will lie and tell Uncle Sam they made MORE than they did. That would just cost them money.
Add back in the depreciation they’ve claimed to get an approximation of their income. Does it match what the financial statements showed? There are a plethora of reasons there could be a discrepancy, but it’s imperative you dig into it!
If there is a large difference they can’t account for, that means they’re lying to you or lying to the government. Either way, move onto the next stall.
Wrap It Up: Vet an investor
Vet an investor like a horse. Look for a solid track record and don’t be afraid to explore their nether regions. A little probing shouldn’t hurt their feelings.
Remember, you’re goal is to build wealth. Only settle on an investor once you find one who can help you do that. If that person eludes you, sometimes the best trade is to do nothing.