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Due Diligence
Due diligence is one of the most important parts of deal crafting. In my humble opinion, there is no deal until there is a closing and a realized profit. We have all heard the phrase “you make your money when you buy” and nothing could be truer.
The first steps to buying smart and safe are to be a P.I.G (Professional Information Gatherer). We must first get good at gathering information. For that to happen, we have to learn how to be better listeners by using our ears more than our mouth.
The 70/30 principle dictates that during a conversation, we listen 70% of the time and talk 30% of the time. When we speak, we should be asking questions. It is tough for many people to follow this principle in favor of non-stop talking that is caused most often by nervousness and insecurity.
Why do they hide the facts or provide inaccurate info?
Sellers are scared too. As investors, we must understand that what we sometimes do intimidates “civilians” a/k/a non-investors. People fear what they don’t know, and most people don’t understand real estate investing. Fear of the unknown can sometimes be overwhelming, sometimes even crippling.
Some sellers simply don’t know where they are financially in an investment. Being uninformed about the financial health of an investment property is not uncommon. Many people simply don’t have a handle on income and expenses, and they simply don’t know.
Overpaying for a property is also a common problem. Overpaying can result in the seller trying to pass the losses forward to the new buyer. Larry Harbolt often says “Don’t replace the seller in the quicksand” which is solid advice that you should listen to. When sellers overpay, it is tough for them to show a positive cashflow or realize a return. One of the most common reasons that people sell multi family assets is overpaying at the time of purchase. Imagine owning an asset that was a liability.
Sometimes brokers will tend to “pad” numbers for the property to appear more attractive to potential buyers. Using data points such as “Cap Rate” can be deceiving to untrained buyers. The deal analysis must venture far beyond loose fitting metrics such as cap rate.
It's not uncommon for properties to be mismanaged by their owners (and hired managers ). Poor management leads to poor record keeping and lackluster performance. Generally speaking, people don’t like advertising their shortcomings and mistakes. In cases such as poor management; inaccuracy of data is almost guaranteed.
That’s all fine and dandy Tyler, but how DO I get accurate info?
ASK, yes, I said ask. If we assume, we almost ALWAYS assume incorrectly. Based on this very fact, why can’t we simply ask for the correct info and query as to its accuracy? Here is what that conversation might look like: “Hi John, thanks for the info. I will be providing this data to my lending team to prepare the documents for my loan and insurance policies, can you confirm this data to be 100% accurate? Or is this data projected / pro forma?”
Public Records – Search government sites such as the tax collector's office, small claims court, criminal court, eviction records, code enforcements and city planning. Also, search the legal description and company names involved with the property to uncover more detail on the history of the property.
Youtube is noted as the most powerful search engine in the world. Use it to search for video and other data unique to the property and seller. I remember one situation where I discovered a video of a police raid on a property I was researching that was a meth lab. The seller had omitted that critical element from our discussions. On other occasions, I have discovered fire damage, burglaries, various crimes and all sorts of issues documented on Youtube.
Facebook is also known as a robust search engine in addition to being the world’s leading social media platform. An excellent way to learn more about a property is to search the address on Facebook. A search for the owner of the property can also uncover facts about the property that could be useful during the due diligence process.
Estoppel letters are used to verify reported income amounts from tenants as well to document the dues and fees owed to homeowners associations or condo boards. If dealing with an HOA or condo board; buyer beware because they sometimes charge ridiculous fees to obtain these which are often required by many institutional lenders in the loan underwriting process. If buying a rental property outside of an HOA these are a great tool to provide a verification of the actual rents paid by the current tenants and also are used to verify the accuracy of the security deposits being held by the current owner if any.
Side note: on a recent apartment building purchase were obtained estoppel letters signed by the tenant stating there were no security deposits held by the seller. A few months later a tenant was being evicted and tried to demand her “security deposit” back even though she had previously signed the estoppel letter stating she did not have a deposit.
Get face to face if possible: Today we have tools like Zoom.us, Skype and other resources to interact with each other “face to face” or as close to it as possible. Don’t hesitate to use these tools during the fact finding process. There is a certain degree of power in looking someone in the eye and asking them a question. The face to face situation makes it more difficult for the seller or broker to be deceptive.
Our team always reaches out directly to utility companies to obtain the billing records for the property going back 24 months at a minimum. This has helped us discover water leaks and other issues that we were able to quickly correct after closing for added cash flow.