Would you ever consider buying a car without doing any research beforehand?
What about planning an entire overseas vacation to a foreign country without reading any online reviews or consulting a professional travel agent?
You may be adventurous if you said, “Yes” to either of these. But for most of us, it comes down to this: When we’re making a large investment, we want to know exactly what we’re getting into.
It’s the same when it comes to performing your due diligence before making a large real estate investment, like an apartment complex or other multifamily property.
Hey Moguls, Chris Urso here with important reminders about due diligence.
Many people – whether you’re a passive or active investor – overlook due diligence. Bad move!
My company and I make it our goal to educate fellow investors who are learning the craft of investing, but also to inform other real estate marketers and real estate educators – those who are raising capital and doing deals.
Everyone talks about the “glitz and glam” of making money in real estate, and we often make the mistake of focusing on the downside of due diligence (it’s time-consuming and, at times, painstaking), rather than the huge upside (it’s the best way to minimize risk!)
But let me tell you that once you get a “system” down for due diligence, it won’t be as time-consuming as you think, and it’s going to pay off – big time – in terms of minimizing your risk and making your best profits.
“Prepare and prevent, don’t repair and repent.”
~ Anonymous
Why I Do Due Diligence
Let me give you an inside look at how I handle due diligence...
For any potential multifamily property deal, I may have a 65-page booklet for my investors that’s jam-packed with market research, sub-market research, theories behind the numbers, etc.
Not only that, but my business partners and I also walk through every single unit in the property, do an analysis of every appliance, check every roof, examine all scoped plumbing lines... you get the idea.
We’re trying to minimize the risk at all costs. Plus, it kind of makes us feel like we’re detectives on CSI or Law & Order. ;-)
It’s easy to focus on the upside of real estate, but there’s risk with every investment.
I can’t emphasize it enough: You must understand what you’re investing in and get educated.
Ask questions like: Why does the deal make sense? or Why does the investor like the deal? Have they done their due diligence?
Simply put, we (you and I) have to inform our investors and explain why our deal makes sense. Once they understand the amount of due diligence that we’ve put into a deal, they get a lot more comfortable…
Especially because they’ll start to think more carefully about their other pending investment opportunities, which might not have the necessary due diligence completed.
So – now that you have a quick snapshot of why doing your homework is essential, let’s take a quick look at the types of due diligence that you’ll want to implement.
The 3 Faces of Due Diligence
There are 3 types of due diligence that I highly recommend. Each is going to be vital for minimizing your risk:
1. Market: This includes understanding what’s going to drive demand for rentals in your area. It also includes economic drivers, population growth, diversity of employment opportunities, etc.
Practical Tip: My business partners and I will also spend time looking at the rent comps. I often drive around and even tour competing properties in the neighborhood. I want to see what they’re doing right and what they’re doing wrong, so I can position my property to be second to none. Plus, it’s fun to be “undercover” as a prospective tenant at comparable properties.
2. Physical: This is just what it sounds like – walking through the property and checking everything.
Practical Tip: During your walkthrough, take note of:
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How many new rooms you need
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How many units need to be renovated
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How many units need new flooring
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How many appliances will need to be replaced during your 5-year hold period
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Whether or not the underground waste line piping need to be replaced or repaired
These are just a few starting points. As you take on more properties, you’ll learn the ropes and be able to recognize all the aspects of the property that need to be checked carefully.
3. Financial: This includes doing a full-blown lease audit of the property. Full-blown, people!
Practical Tip: During a lease audit, my property management team literally sets up “camp” at the property for several days. Here are a few of the things we accomplish in that time span:
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Review all the leases
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Make sure the leases tie back to the rent roll that was delivered to us by the seller
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Ensure that the rent roll is signed by all parties
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Check that the leases note any deposits, discounts, etc. that we need to be aware of
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Examine any contracts on the property, which might include landscaping, HVAC, or servicing any bodies of water on the property
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Thoroughly read every single tenant file, looking specifically at their credit and criminal backgrounds, employment history, income verifications – the whole nine yards
This isn’t a comprehensive list, by any means, but it should give you an idea, right off the bat, of what you need to be looking for when performing your due diligence.
Key Takeaways
Now, keep in mind that you don’t necessarily have to take all of these steps that I listed above, if you’re a passive investor. But you should be aware of all these details, so you can ask the right questions at the right times.
Remember not to get caught up in “shiny object syndrome,” otherwise known as seeing a potentially good property investment and jumping at the chance to claim it before doing your due diligence.
Bad idea.
It may take a bit more work to do your homework up front, but it’s most certainly worth it.
Plus, your business partners, investors, etc. will be more willing to do business with you in the future – once they see how educated you are, and how your due diligence translates to minimal risk for them.
And that’s a win-win.
Talk to Me
What other due diligence tactics or strategies do you use to minimize your investment risk? Hit me up in the comments section below.
Make of list of rent comps in your area. Get an idea of rent prices in your targeted community. If you want to take it a step further, schedule a tour as a prospective renter at properties you’ll be competing with for tenants. (Wearing your best “undercover” sunglasses = optional.)
Create a walkthrough checklist. You’ll use this when walking through potential investment properties, to determine what needs to be updated or repaired. As you become more experienced, you’ll keep adding to this list.
Talk with fellow investors or business partners. Determine what they like to see, in terms of due diligence on a property. If you’re working with them currently or in the future, you’ll know what they expect.
Christopher Urso
is the founder of URS Capital Partners and National REIS. Chris has been investing in real estate since 2001. Over the years he has been involved in all aspects of real estate, from single-family fix and flips, buy and hold cash flow houses, and finally to apartment buildings. His real estate investment career only took off when he purchased his first apartment building 3.5 years ago. He now controls over $15,000,000 of apartments and has raised over $8,000,000 of private money in just over 3 years. He now structures investment partnerships to acquire large apartment complexes and also private coaches investors helping them purchase their own apartment buildings.