There’s a huge problem in the real estate industry that nobody is talking about: DUE DILIGENCE.
The vast majority of investors and real estate professionals barely scratch the surface when conducting due diligence.
· Investors are leaving large amounts of money on the table by not learning how to properly conduct due diligence
· Real estate professionals are putting themselves at risk for potential litigation
· Most of this is because “they don’t know what they don’t know” which is what can hurt them
· By learning these important skills it reduces stress; makes you feel more confident; makes the sellers of the properties less likely to play games while negotiating with you
· Becoming adept at conducting due diligence ultimately makes you a better investor because you’re more prepared to make an informed and intelligent decision
Having and adhering to a proven system allows you to conduct due diligence faster, easier, more efficiently and you’re less likely to miss something.
Here are the 10 most common mistakes to avoid when purchasing an investment property opportunity:
Mistake # 1: Not Valuing the Property Correctly
It’s always surprising how many investors are willing to buy off on price after negotiating with a seller, just because they arrived at an acceptable purchase price. Do your homework! That means checking for sales comps and other available properties on the market. Empower yourself by contacting the more active commercial brokers in the vicinity and inquire about local property values and sale comparables. You’re constantly adjusting your valuation during your due diligence based on your findings.
Mistake # 2: Not Understanding your Lender’s Underwriting Requirements
Before you spend a lot of time, money and energy conducting your due diligence, make sure you’ve had a preliminary discussion with some lenders about the amount of the loan they would consider putting on the property. Today’s Lenders are very conservative and look at many aspects of the property such as: physical condition; sale and lease comparables; leases in place; intended use; environmental issues; credit worthiness of purchaser; etc. Check with them before you get too far down the road with your due diligence to avoid surprises later.
Mistake # 3: Not Checking If The Property Complies With All Current Municipal Building Codes
It’s a fairly common occurrence that a buyer finds out after purchasing a property that it doesn’t meet the compliance of building or Americans with Disabilities Act (ADA) codes. This comes up when the contractor goes to pull a permit from the city for intended improvements or when the city inspector comes out to inspect the contractors work, discovering the infractions. Be sure to keep an eye out for tenants whose space has been built-out without a permit. It’s a good idea to have a contractor, architect or space planner inspect the property to discuss any improvements and compliance issues during your due diligence period. You don’t want any costly surprises after the closing.
Mistake # 4: Assuming There Are No issues Within Existing Tenant Leases
The leases can have many “trip wires” such as cancellation provisions, contraction provisions, caps on pass-through expenses, fixed option rent, to name a few. You want to be aware of these provisions because if the tenant exercises them, it could put you in a bind and devalue the property. It’s important to have a competent real estate attorney read the leases if you are not familiar with commercial real estate leasing.
Mistake # 5: Assuming Lenders Will Accept All Third Party Reports
Before hiring any third-party vendors to conduct an inspection and prepare a report, make sure that your lender approves them. This goes for the Property Condition Assessment, Environmental Reports, or any specialized reports such as seismic or geological studies. Mistakenly having to pay two different vendors for the same report costs much more than time, it is very expensive.
Mistake # 6: Trusting that the Seller and Their Representative Have Disclosed All Issues
You have to be a detective when performing your investigation and due diligence on a property you’re looking to purchase. Not all sellers are going to be forthcoming when it comes to disclosing the problems of their property. Remember the Latin saying, “caveat emptor”: let the buyer beware. Ask the hard questions and make sure you do that in writing, i.e. emailing them, so you can keep track and record all correspondence in case you need to bring it to court one day. Always ask for back up receipts, lien releases, copies of paid invoices, etc. Remember, ASSUME NOTHING.
Mistake # 7: Expecting the Closing Statement To Be Without Issues
Before you sign the final approval of the closing statement sent by the escrow officer, be sure you have scrutinized all the items listed… as well as those omitted. Many times a seller will load up items to be credited to themselves and “forget” items that should be credited to the buyer. Some commonly overlooked items are: letters of credit or Certificates of Deposits used as security from tenants that the Landlord needs to assign to the new buyer; leasing commissions owed to brokers on leases that have recently been signed; tenant improvement allowances owed to tenants or contractors; vendor billings that need to be prorated or paid in full prior to new ownership taking over, etc.
Mistake # 8: Not Checking Out the Competition
Especially if you’re not familiar with the area, you want to be aware of the subject property’s competitive set. Those are the properties it directly competes with. If you see rent specials or other concessions, you need to know why this is happening in the marketplace. It could mean there is a lot of vacancies in the area, meaning you’ll have to factor that into your financial analysis.
Mistake # 9: Not Spending Time at the Property
Go there at different times of the day. The reason I say that is that you’re going to get a much better idea of what goes on there. That parking lot of the subject property might be a hang-out for kids to party on the weekends. You get a chance to speak with the tenants and see how the property operates at various times. It might even change your mind about the property.
Mistake # 10: Not Walking Each and Every Unit
Even if the seller doesn’t want to disrupt the tenants, which is a ‘red flag’ for me. I want to see every one of them. You don’t know what they’re going to be hiding or what you’ll end up seeing. Maybe one of the units has mold or fire damage issues. Insist on it. Even consider passing on the opportunity if the seller won’t allow it. It’s that important.
What is ‘re-trading’ a deal?
Re-trading means asking the seller for a LEGITIMATE discount. Make sure you document the reasons you’re asking for a discount properly. Write a letter and itemize each and every issue that you uncovered and that needs to be addressed. It’s all in the manner you present it. And if they don’t address it, make sure you have an out. Too many buyers today ‘make up’ reasons for the seller to discount the purchase price, as if it’s just part of doing business today. Don’t get a reputation for that. It’s too costly.
If I were to try to boil it down for you, the key ‘take-away’ from learning how to conduct due diligence properly?
ASSUME NOTHING. If you’re going to assume anything at all, assume that there are multiple problems to discover. Learning how to properly conduct due diligence will help you uncover those problems, as well as discover hidden value enhancers to increase property value.
Brian Hennessey is the author of the #1 best seller 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 as well as other valuable resources for real estate investing at www.impactcoachingsystems.com.