Due Diligence For Real Estate Investors

real estate due diligenceDo your due diligence when investing in real estate. You’ve heard that before, but what is due diligence? A simple definition: “The investigation and verification of the details of a particular investment.” Start the process before the offer, but in the offer you also will want to include clauses that allow you to have inspections done, look at certain documents, and review the books.

Due Diligence

Due diligence should always include a look at the books. Review the last 24 month’s income and expense statements, and watch for anything unusual, like expenses that are too low or income that seems higher than usual. Look at the rent roll, and investigate whether rents are over or under the market rates for the area you are in. Check the payroll records if there are employees, and watch for surprises, like accrued vacation time that you’ll have to pay as the new owner.

Always verify income. You want to see rental agreements signed by the tenants, as well as rental histories, which might show if there are any problem tenants or late payments still due. Documents for rental deposits should show amounts and where the deposits are (which bank).

Look at the service contracts and agreements. Ask if they transfer, or if you are free to change to better (possibly cheaper) services. Among others, you’re looking for property management, landscaping, snow plowing, pool cleaning service, and heating and cooling system maintenance agreements.

Do your initial exterior inspection. Walk around with pen and paper, and note anything unusual or in need of repair. Arrange for professional inspections where needed. Be sure that the electrical and plumbing systems are up to date and meet current codes. Estimate of how many years of use the roofing has left, and look at driveways, landscaping, and the condition of exterior paint.

Your due diligence should include an interior inspection. Meet some of the tenants if you can. Look for any problems you’ll have to fix in the coming years. Watch for water damage or fire damage, pest problems, and obvious “problem tenants,” or “problem apartments.” Are there empty units that are listed as occupied? Get the necessary pest inspections and safety inspections. Some Fire Marshalls will do a free inspection to verify that the building meets current codes.

Call local authorities. Ask about any zoning or encroachment issues, or permit problems. Have there been any fire code violations, and were they fixed?

It is usually best to use professional help when doing your due diligence. Your accountant can decipher the books better than you, and notice anything that doesn’t add up. A lawyer can review your offer and other documents. She can also tell you what other things you should be doing.

Take notes. Do something about serious issues (have them fixed or adjust your offer). Most problems you’ll run into when buying income properties are not entirely unforeseeable. They can be avoided or resolved if you use your due diligence checklist diligently.

5 thoughts on “Due Diligence For Real Estate Investors”

  1. I would like to point a part of real estate due diligence that is commonly overlook and could potentially ruin an otherwise good investment. Many times buyers have to move quickly to purchase commercial buildings when they show up on the market . Because of this many things are taken at face value and not investigated in more depth. Building owners overstating the rentable square feet of their building is one area which I have personal knowledge of. I have measured millions of square feet in my career and about 80% of the time there is some sort of discrepancy between what is listed on the leases and what is physically present. In one case I uncovered 10% less rentable square feet in the building. This potential pitfall could destroy an otherwise profitable ROI when the new building owner goes the rent out his newly acquired space.

    It is essential potential buyers hire professionals with measuring experience and knowledge of rentable square feet standards such as BOMA. Many times architects don’t think in terms of rentable square feet. They are more concern with how buildings are designed and making them ascetically pleasing. Also don’t count on your broker to find the problem. The fact is that the vast majority of commercial brokers don’t know about measuring or the associated standards. Also you won’t find many brokers who will bring up issues that could jeopardize the deal and their commissions. At the end of the day buyers should hire someone who fiduciary responsibility is to them.

    Jonathan Pollack
    Managing Partner
    Lease Analytics

  2. Great article on Due Diligence, and I might add that we have used this site as a resource for our clients, also. Keep up the good work, and more articles please!


    Russ Lyons | Sotherby’s
    Sedona, AZ Real Estate

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  4. When going to buy or sell a home, your first step should be finding an honest and hard-working realtor. You can find a real estate agent by keeping an eye out for advertisements, calling your local real estate broker, or through the internet.

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