Posted by Kathy (MI) on February 24, 2002 at 18:48:42:
Craig, your information was well appreciated. Printed & saved.
Buying tips & Due Diligence (very long) - Posted by CH
Posted by CH on February 24, 2002 at 13:32:58:
After being called to the mat on what reasonable due diligence is, I?ve decided that it?s so important that I would take my time to put some general big picture items for all to look at before closing on a transaction so that you limit your future surprises. What else am I going to do on this beautiful Sunday morning???
Let?s start of with green light and red light buying tips;
GREEN LIGHT
- Make sure you specialize in one type of investment property. Know the IN?s & Out?s
- Create a professional team
- Get three written viewpoints from professionals on all maintenance challenged properties
- Compare the properties sales price to others in the immediate trade area
- Learn the market trends in your market
- Have ALL buildings inspected by a professional building inspector
- Create your own realistic financial analysis
- Find out the history of the property including why the Seller is selling
- Make sure you have adequate capital reserves
- Get title insurance
- Review and understand the mortgage documents
- Get a police report to determine crime in the area
- Go the city building department to insure property is up to code
- Speak with the residents about the pros and cons of the property
- Use Ronald Regan?s credo, ?trust but verify?
RED LIGHT
- Do not buy a negative cash flow property
- Do not believe the pro forma that the broker/agent has given you on the property
- Do not buy without doing complete due diligence
- Do not buy with a loan due in a short period of time
- Do not buy without a fully executed contract
- Do not forget to review all the service agreements, leases and other documents
- Do not over leverage the property
- Do not use someone else?s assumptions before buying
- Do not close without getting security deposits credited to you
- Do not buy unless you have reviewed the historical performance of the property
First and for most, it?s critical to do a complete financial analysis of the property. During this process, you will determine whether to proceed with the potential deal.
Some basic yardsticks for calculating value are: price per unit, price per square foot, and capitalization (cap) rate. Each property type has a range of values that other investors are currently paying in the marketplace. It?s important to check with market sources such as appraisers, brokers, and other buyers to establish the range in the particular location you are looking to buy in. Make sure you are comparing ?apples-to-apples?. For example, make sure you compare similar two bedroom units against similar two bedroom units, and don?t include one-bedroom units.
What is the breakeven occupancy rate? Breakeven occupancy is the level of economic occupancy that a property needs to meet all its outgoing bills. To calculate the breakeven occupancy rate, you add all the operating expenses plus the current debt service and divide this figure by the POTENTIAL gross income. You?ll note that the greater the leverage on the property, there will be a higher breakeven occupancy. Based on the comparable market occupancy, it could mean that you are headed for negative cash flow. For example, if the market occupancy is 93% and your breakeven occupancy is 95%, then most likely you are headed for negative cash flow.
What is a market study? A market study outlines the conditions in the marketplace that you are buying the property in. See if you can obtain any market studies from county officials, chamber of commerce, local newspapers, property owners, property managers, local apartment associations, and/or brokers. Here are some things to look for in a market study:
- Type of construction
- Age of property
- Who pay utilities
- Lease terms
- Unity type comparison
- Condition of comps
- Occupancy history
- Amenities
- Resident profile
- Move-in cost such as non-refundable fees, security deposits, and concessions
Also, check out the level of supply and demand for your property type. Is the market over or under supplied? How many units are being built for the year? How many units are being absorbed (rented) for the year? What concessions are being offered in the marketplace? Be careful when investing in over-built markets.
What is a Pro Forma? A pro forma is an annual projection of income and expenses the property is anticipated to experience. Make sure you do extensive fact finding before you put together your pro forma. Do not use the broker?s pro forma. Here are some things that should be included in your annual pro forma:
Rental Income ? Based on what you can actually expect to rent the units for
Vacancy ? Based on realistic expectations of current & future market expectations
Concessions ? Based on market constraints
Other income ? There are MANY types of other income
Operating expenses
Utilities
Repair & Maintenance
On-site payroll
Property management fee
Advertising/Marketing
Administration
Property Insurance
Property Taxes
Reserves
When putting your pro forma together, make sure you are realistic with the numbers. Many investors do not allocate enough for vacancy, R&M, reserves, and marketing. You don?t want any surprises after you have bought the property. I?ve included only very general information.
Ok. After doing your market and financial analysis, you decide that you?ve got a good deal. Now you need to begin your due diligence. Remember, TRUST BUT VERIFY. Sellers have been known to keep pertinent facts from buyers, and, in some cases, out right lie to buyers. Here is a very general outline to go by when doing your due diligence:
- Unit mix - Are you buying a property with 3-bedroom units in a college town?
- Units size ? What are the market demands for unit size
- Property history ? What?s the reputation of the property
- Property condition ? Get a professional to tell you
- New competition ? Any new building planned in your area?
- Road work ? Any planned road work in front of your property
- Floor plan ? Do your floor plans fit the market?
- Parking ? Is there a parking problem?
- Storage ? Is there adequate storage?
- Security ? What?s the crime like in the area?
- Utilities ? What utilities do you have?
- Existing mortgage ? Do you understand the current mortgage documents?
- Property insurance
- Property taxes
- Historical operating numbers for last two years
- Service agreements
- Lease documentation
- Capital improvements in last three years
- Resident profile
- Budget
- Work order history
- Personal property inventory
- Verify floor plan sizes
- Pending legal matters
- Preliminary title report
Ok. There you go. Again, I?ve only included very general information so it is advisable to get more detailed information so that you have a better understanding of this process.
Finally, make sure you spend the necessary money to insure that you have done a complete analysis and due diligence of the property. I don?t know about you, but I hate surprises especially if it?s going to cost me a lot of money. It?s better to spend the money before you buy the property than to spend ten times that amount because of a surprise that you found out after you bought the property. Remember the Fram oil filter commercial. Pay me now or pay me later, Well, the later means BIG bucks. So, spend the small bucks to protect yourself in the future. I?ve been involved in deals where big institutional buyer?s are buying a $30 million property, and they easily spend $30,000 on due diligence. Guess what? I?ve seen them walk away from deals after spending the $30K. It?s cheaper for them in the long run. Most of the very successful people in this business aren?t any smarter or luckier than you. They just don?t make the stupid mistakes that others do. Go ahead, spend a couple of extra bucks to make sure that you limit your exposure to unexpected events.
CALLING ALL ROOKIES. Please print this post, and look at it before you close on a deal. I don?t want you to have to come see me when your up to your eye balls with unexpected problems. I took my time to post some helpful thoughts so you take your time and completely research your properties before you buy them!
Well, it?s not Sunday morning any more???.
Good Luck!
Craig
Re: Buying tips & Due Diligence (very long) - Posted by robin
Posted by robin on September 12, 2003 at 01:25:37:
Thanks Craig for taking the time to help others.
Re: Buying tips & Due Diligence (very long) - Posted by Wendy (CA)
Posted by Wendy (CA) on February 26, 2002 at 24:01:33:
Thanks Craig! This is great information especially for a newbie such as myself. You’re awsome…
Wendy…
Re: Buying tips & Due Diligence (very long) - Posted by JoeS
Posted by JoeS on February 25, 2002 at 07:41:14:
Great job Craig; if more new investors/flippers would just DO all that, our business would thrive. We have received several black eyes in this business, mostly due to scam artists. There will always be scams in every endeavor where there is money. BUT, many new people also cause problems by not being educated enough BEFORE they put a house under contract and then ask what their next step is,
Remember…this is NOT a “get rich quick” business, no matter what the tv gurus say! Read the tiny print in the infomercial, “results are not typical!” You can make a lot of money in this business, and this site will help tremendously. Read all the letters, articles and success stories several times. Follow the info posted by Craig, and don’t be afraid to ASK before you sign! Happy investing.
Re: Buying tips & Due Diligence (very long) - Posted by Daniel Burger
Posted by Daniel Burger on February 25, 2002 at 24:07:14:
Craig,
This is great… and I also followed your previous advice (yesterday?) and I bought the Unofficial Guid to Real Estate Investing - I’m almost done with half of it!
Dan
Re: Buying tips & Due Diligence (very long) - Posted by Lance Brown
Posted by Lance Brown on February 24, 2002 at 23:31:36:
Craig,
Thanks for your time and great information!
Lance
Re: Buying tips & Due Diligence (very long) - Posted by Erik
Posted by Erik on February 24, 2002 at 21:22:19:
Your information was very well put together and even though its general, as a newbie it is exactly what i was looking for. Kind of like putting it in order. Thank you…