As all real estate investors know, finding potentially lucrative investments isn’t even half the battle. A far greater concern is ensuring that a likely investment will be profitable and not just a waste of time and money. These five steps form a checklist on how to perform due diligence for a property. Check Yourself: managing risks and expectations for real estate investment acquisitions
Quality Checkers – Assembling a team to check your investment
For almost all investment opportunities, performing an accurate analysis of the risks and rewards is beyond the capability of any one person. You will need the services of a full team of specialists to check on every aspect of the potential investment. Odds are you will have already retained the services of many of these people. For the roles that are not yet filled, you may need to hire or find a reliable third party specialist. This will be your first step in Managing Risks and Expectations for Real Estate
You will need an attorney, a property manager, and an accountant. You will also require the services of general contractors and various inspectors. Unless you provide all the capital yourself, you will also need one or more lenders. The lenders’ input at this stage will be absolutely critical because without their support, your investment will not proceed. You will meet many of these specialists throughout your career; it is important to develop a good relationship with them and create an efficient team for future property acquisitions. A team that has worked together many times in the past understands each other’s strengths and knows how to properly communicate with one another. A team that understands each other and works well with one another is vital for the success and profitability of an investment.
Your second step in Managing Risks and Expectations for Real Estate is financial analysis. In all likelihood, you will have performed some sort of financial analysis for the property already. Take a look at the property’s offering memorandum and see if the numbers show potential for profit and match your preferred exit strategy (value-add, buy-and-hold, etc.). If the property didn’t have potential financial gain, then you would not have considered investing in the first place. This step goes beyond back-of-the-envelope calculations; you and your team must analyze every possible aspect of the potential investment’s finances.
A short version of the aspects which will require investigation includes:
- Rent roll – Who is renting and for how long? Under what terms and conditions are the tenants renting? This may vary for different tenants in the same rental property, adding to the complexity of the analysis.
- Market analysis – What are the current trends for similar properties? What opportunities might there be to sell the property down the road? How will this acquisition affect other opportunities?
- Historical analysis – Building off the market analysis, what are the historical patterns for the property? Does an in-depth look at the property’s history reveal disturbing patterns or possible inconsistencies? Are there looming operational costs that might only emerge after your investment?
After the financial analysis comes the property’s physical check. You will need inspectors to verify the condition of the property. Home inspectors search for any defects and possible expenses the asset could incur. After locating specific defects, a home inspector will generally recommend a certain specialist to deal with the problem. You may need specialists like surveyors to ascertain property lines, or environmental inspectors to determine if there are any unusual environmental and regulatory concerns with the property – and if so, how to remedy them. And of course, you may need contractors to give you estimates to fix any problems detected. Don’t skip this 3rd step for Managing Risks and Expectations for Real Estate
Is your team doing their job; this is your 4th step in Managing Risks and Expectations for Real Estate. This part falls squarely on you, proper management is the driving force behind new acquisitions. Are you managing the entire due diligence process appropriately? Have your lawyers inspected the contract? Has your accountant verified the potential profit? Do your advisers expect that property to retain or increase its value over the coming years? Are you listening to the on-the-ground reports from your property manager, inspectors, and contractors as well as your big-picture specialists? Has your team kept you informed on newly-discovered risks or benefits to your potential acquisition?
This step absolutely relies on having assembled a quality team in the first place. Each member of your group plays an important role in maximizing profits and reducing liabilities. Without support from reliable, knowledgeable staff, you will never be able to assess a potential investment accurately.
Checking for Warning Signs
Having done all the steps on this checklist, what should you be wary of now? Here are some quiet deal-killers to look for. And finally your 5th step in Managing Risks and Expectations for Real Estate
- Regulation changes – Tax increases fit into this category and can completely change the profitability of an acquisition. Always consider local and state laws before acquiring property in a certain area. New laws can change tax rates and other crucial factors that must be considered before purchasing property.
- Environmental damage – Some properties will bear the scars of previous industries. Cleaning up former industrial sites or discovering unpleasant chemical surprises at a property can ruin the bottom line and take years to resolve. This is why it’s important to hire at least one thorough home inspector who can accurately assess any expenses the asset may incur.
- Insurance – Acquiring a property is one thing, maintaining it is another. Insuring it can quickly get expensive, yet it is necessary to protect your valuable assets. Buyers must take into account property and liability coverage as well as various other financial risks.
- Maintenance costs – Properly maintaining a property can quickly drain profits. Maintenance expenses could become even more costly if the previous owner of a property deferred much-needed repairs, shifting the responsibility to you. Real estate investors should always have a good estimate of all the expenses required for the upkeep of newly-bought properties. It is important to give yourself a cash cushion so that in the event of your expenses becoming more costly than estimated, the costs would still be covered.
Above all, don’t rush a deal! Pushing forward with unwise acquisitions is far worse than taking some time out of your day to check all aspects of a potential investment. Do your due diligence and reap the rewards in time.