Due Diligence - an Investor Necessity

By: Steve Gillman

You need to do your due diligence when investing in real estate. What is due diligence? Here is a simple definition: "The investigation and verification of the details of a particular investment." You can start this process before making an offer, but in the offer you also normally include clauses that allow you to have inspections done, review the books and look at certain documents.

Due Diligence Guidelines

Your due diligence should always include a look into the books and records. Look at the last 24 months income and expense statements, and watch for anything unusual, like expenses that are too low or income that seems high. Review the rent roll, and investigate whether rents are over or under the market rates for the area. You need to see the payroll records if there are employees. Look for surprises, like accrued vacation time that you'll have to pay.

Verify income. There should be rental agreements signed by the tenants, as well as rental histories, which might show if there are any problem tenants or late payments. Rental deposit documents should show amounts and where the deposits are kept.

Examine service contracts and agreements. Do they transfer, or are you free to seek better deals? These could include property management agreements, landscaping, snow plowing, pool cleaning service, and heating and cooling system maintenance agreements.

Walk around with pen and paper for your initial exterior inspection. Note anything unusual or in need of repair. Get professional inspections, if necessary. Verify that the electrical and plumbing systems are up to date and meet current codes. You may also want an estimate of how many years of use the roofing has left. Look at driveways, landscaping, and the condition of exterior paint.

Due diligence needs to include an interior inspection. Learn about the place, the tenants, and any problems you'll have to fix in the coming years. Look for water or fire damage, pest problems, and obvious "problem tenants." Watch for empty apartments that are listed as occupied. Use professionals as needed for pest inspections, safety inspections, and such. The local Fire Marshall may do a free inspection to verify that the building meets current codes.

Call local authorities to see if there are zoning or encroachment issues, or permit problems. Were there been any fire code violations? Were they corrected?

Get some professional help when doing your due diligence. An accountant can decipher the books and notice any problems. A lawyer will not only review your offer and other documents, but can also tell you what other things you should be doing.

Always take notes, and do something about serious issues (have them fixed, adjust your offer, etc.). Usually the problems that investors run into when buying income properties are not unforeseeable. Most of them can be avoided or resolved if you work through your due diligence checklist.

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