You may have heard this old adage, which is very true when investing in real
estate, as well as other investments. Many investors have a tendency to attribute
it solely to pricing. It’s true that pricing is a major component and is important;
however, it’s not the only important component. There are many other elements
that can play a crucial role in evaluating investment real estate that will have an
effect on its current and future value.
Specifically, what I’m referring to is the investigation or due diligence performed
when looking to put your hard-earned money into real estate. This is a subject
that the vast majority of investors will skim over, relatively speaking, instead of
doing a “deep dive” and giving it the worthy consideration it deserves. Too many
investors are under the influence of “hopeium” when purchasing investment real
estate. They believe and hope that it will all work out in the long term, which may
or may not be the case.
Warren Buffet said, “Risk comes from not knowing what you’re doing.” The
typical investor is usually doing their real estate investing on a part time basis and
is under time constraints to get their due diligence completed. There is plenty to
do during that process. Depending upon the investment genre, you may have to
gather market info, if it’s not in your familiar marketplace. You have physical
inspections, lease reviews, loan application, appraisal, etc. Most buyers are
stressed and just trying to survive to make it through to the close of escrow with a
minimal number of headaches, distractions and hurdles to overcome. The
problem with this scenario is you are counting on no hidden issues popping up
during due diligence, or especially after the closing, that will cause you heartache,
or worse, financial disaster.
There are an untold number of items and issues that can derail an investment
that you will not know about unless and until you uncover them before you close
escrow. The idea of conducting proper due diligence is to minimize the risk and
optimize the value through thorough investigation of the investment. We know
that the seller of the property will not hand you a list of issues and potential
problems when opening escrow. In fact, they are hoping you don’t discover any
issues or reasons not to complete the transaction.
Once you become aware and acquire the skillset of properly conducting due
diligence when purchasing investment real estate, you will feel more confident
making an informed and intelligent decision. You will know, once you have
completed the due diligence process thoroughly, to move forward with the
purchase, or not.
Here are some of the items and issues that many investors may leave to chance
and often overlook:
- Thorough review of the leases and all the provisions that can affect value
- Thorough review of the service agreements
- Not insisting on interviewing the tenants
- Investigating the submarket they are investing in more thoroughly
- Not visiting the property at different times of the day and week
- Not utilizing a skilled real estate attorney to help them through the transaction, including negotiating loan documents
- Not hiring professionals to assist in various aspects of their investigation whether it be legal, financial review, lending, etc.
- Letting the appraisal process go on “auto-pilot” hoping they get to the value they need for the loan they applied for
- Knowing how and what you should negotiate on with the seller to legitimately ask for a credit
There’s a list of other items, tips and strategies that can help to save you money,
headaches and stress, as well as optimize value once you know where to look.
I heard a story from a friend of mine who is in the property management
business. He said he received a call from an investor one day who said they were
referred to him. He was in the process of buying his first office building and
needed a property management company to manage it. He asked if he could help
him with the transfer of management when it closed escrow, which was in the
next two weeks. My friend asked when his due diligence period ended. The
investor asked, “What’s due diligence?”. My friend was taken aback, especially
when he was told his earnest money was already non-refundable.
Yes, that is an example of an investor who was more than “clueless” investing in a
real estate investment he knew nothing about. Believe or not, there are similar
examples of this type of investing process that goes on every day. I see it regularly with people who are in 1031 exchanges, who are hell-bent not to pay
the taxes and “throw the dice” on an investment they know nothing about
because their back is up against the wall and they’ve run out of time.
There is no reason to put yourself in a bad position when investing in real estate.
You need to increase your knowledge in order to reduce your risk. This doesn’t
mean that every time you invest it will work out fine with no problems. There are
always unforeseen issues that can come up or extraneous factors that will affect
the markets. The idea is to minimize your risk as much as possible, while
optimizing your chances of it working out in your favor.
If you’re interested in learning more about properly conducting due diligence visit
my website at www.impactcoachingsystems.com. I have some terrific resources
and tools available, complimentary, to help you with your real estate investing.
Yes, it takes more time, energy and sometimes expense, but learning these
skillsets will pay you exponentially. It works like any other skill you’re looking to
acquire: the more you do it, the better you get at it.
Brian Hennessey is the author of one of the #1 best sellers of commercial real
estate books on Amazon, “The Due Diligence Handbook For Commercial Real
Estate” as well as “The How To Add Value Handbook For Commercial Real
Estate”. Both are available as audiobooks on Audible.com and ITunes.
You can learn more about his books and other valuable resources for real estate
investing at www.impactcoachingsystems.com.