You have an apartment building under contract, which is awesome. Performing due diligence is an exciting part of the buying process because it means you successfully negotiated the deal (which is not easy to do!) and are now ready to start due diligence to determine if it’s something you want to go through with.
But many investors are so eager that they begin spending money during the diligence process before they should, and they unnecessarily put cash at risk that they’ll never get back if they decide not to close.
Don’t make that mistake.
Delay spending money as long as possible.
For example, don’t hire a property inspector to inspect the property (which costs money) BEFORE reviewing the financials (which is free). What if you decide not to pursue the deal after reviewing the seller’s actual financials? Then you’ve spent money on the inspection that you’ll never get back.
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Many investors think that they need to quit their job to get started in real estate. Not true! Many investors successfully build large portfolios over the years while enjoying the stability of their full-time job. If that’s something you are interested in, then this investor’s story of how he built a real estate business while keeping his 9-5 might be helpful.
The Checklist That Can Help You Save Big During Due Diligence
Here is my due diligence checklist in the right order to make sure you’re not spending money until you are 99% sure you’re going to close on this building.
The following checklist assumes you’re doing due diligence on an apartment building, though it can be modified for other asset types. It also assumes you have a 21-day due diligence period — adjust accordingly.
What to Do in Week One
- Send a letter to the seller requesting financial and other due diligence documents
- Informally tour the property and inspect some of the units with your property manager or contractor
- Perform a rent survey
- If you have investors, create the deal package for them
- Request term sheets from your lenders
- Request insurance quotes
Notice that NO MONEY HAS BEEN SPENT YET.
What to Do in Week Two
In Week Two, your goal is to review the documents you received from the seller and to re-evaluate the deal.
Update your deal analyzer with the financials you received from the seller. Incorporate the repair estimates from your initial property visit. Does the deal still make sense?
If so, complete the deal package, and send it to your investors. You’d like verbal commitments from them next week.
If everything checks out and you’re still feeling good about the deal, it’s time to think about spending some money next week to get the property formally inspected.
What to Do in Week Three
By the end of the third week, your goal is have a high degree of confidence that you’re going to move forward with the deal.
- Order the initial title report to see if there are any title issues
- Decide which property manager you’re going to hire
- Get verbal commitments from your investors
This week you MAY spend some money on a formal property inspection.
This depends on the size of the deal and your situation. For example, your property manager may have maintenance staff, and they may agree to do a unit-by-unit inspection for you for free if you hire them when you close on the building. Or you have a contractor who will do the inspections for you if you use them for the repairs.
If neither of these apply to you, then it is prudent to hire a professional property inspector. He or she will inspect every unit and all of the major systems and create a detailed report that you can give to your contractor for a cost estimate.
If you’re in an area where lead paint laws are an important consideration, then you should also order a lead paint inspection.
The main point is this: delay spending money as long as possible.
Even though you may have had to spend some money on a property inspection, you did so only AFTER reviewing the financials and only AFTER touring the property yourself.
If the inspection uncovered significant issues, then it was money well spent. If not, then you can feel confident about going to closing.
And if you feel good about moving forward, there is still more money that needs to be spent before you close: for example, you will need to pay a deposit to the lender or bank to order the appraisal. You may also need to pay your attorney to draft the operating agreement or a private placement memorandum.
Before spending this kind of money, you want to have a high degree of confidence that you want move forward with the deal.
Follow this guideline, and you will minimize the money you risk during the due diligence process.
I’m sure you have some cool due diligence stories yourself and some other good advice for the Bigger Pockets community, so let’s hear it!
Leave a comment below, and let’s start a conversation!