Whether you are looking at a single-family home, duplex, or multi-unit rental property, carrying out comprehensive due diligence in property investment is a risk management strategy that should be conducted by all serious real estate investors.
Due diligence fundamentally means doing your homework before you consider to invest in real estate. It enables you to properly assess the value of a property before making an investment option.
It is not only the most cautious property investors who engage in thorough due diligence before making an offer on a property but business-minded and serious real estate investors who can appreciate the risk that a bad investment could have on their entire portfolio.
The question now is how do investment professionals approach due diligence for real estate deals?
1. Financial due diligence: It’s important to devote a considerable amount of time and energy to researching market assumptions for any potential real estate acquisition before submitting any formal bid on an asset.
Assuming the numbers pencil out and adhere to your investment strategy, this period serves as a time to investigate a property’s cash flow to ensure that income and expenses match the seller’s representation.
When carrying out financial due diligence there is a list of items that would need to be an audit to verify the financial information and market assumptions you are basing your investment on are as reliable as possible. Below are a few of them:
Market analysis: It is important to reaffirm property market assumptions made in your original underwriting. A market study is carried out to estimate the future rents that might be charged by studying similar properties’ location, unit finishes, amenities, and other variables.
Carrying this out would have a significant influence on long term cash flow. It is essential to ensure your market leasing assumptions are supported with real market data and actual property performance.
Historical Analysis: When carrying out an analysis of historical operations you tend to have valuable insight on what expenses that should expect to incur once operating the property begins.
You may feel you have an apt understanding of how the property is currently operating, but it is also important to understand how the property has operated historically when attempting to more accurately project how it is going to operate. when performing this type of analysis, the goal is to look to find areas to save money.
2. Physical due diligence: Physical due diligence is commonly neglected by most real estate investors prior to property closing. While sometimes preliminary property condition details are shared with you, other times they are not.
The purchaser examines the overall condition, compliance, and long-term suitability of the physical property itself, as well as the site on which it sits. After all, the property is most likely for its long-term cash flow, it is only logical you will want to ensure the investment will be around to payout.
3. Operational due diligence: Operational due diligence provides insights which enables you to project and accurately plan and execute based upon the findings uncovered during the bidding and earlier due diligence work.
More focused on the business side of the property, this is an opportunity for you to properly scrutinise the static, in-place operations utilized by the existing ownership, distinguish strengths from weaknesses while identifying potential upside.
4. Conduct a Title Search: The title, which is often mistaken with the deed, is the transferable right to the property in question. Investigate the complete ownership of the property. You may be dealing with one person while visiting the property and negotiating the price but while reviewing the title you realize that there are multiple owners.
You must ensure the seller actually has title to the property and if so, that the title is clear of any liens or other claims against it.
The importance of carrying out due diligence on a property should not be overlooked. To hurry through due diligence is just like closing without a plan of action. In an industry built on margins, any efficiencies gained or disasters avoided can dictate the underlying success of investments.
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