5 Basic Due Diligence Steps For Any Prospective Investment
Posted by JD Esajian // March 22, 2019
You can do everything right on six consecutive deals but if you are sloppy with the due diligence on the seventh, the consequences could be severe. As basic as it sounds, it is important to always keep the flow of profits moving in the right direction. Making a small profit on a deal is always better than taking a loss. The most common cause for getting involved in a bad deal is often sloppy due diligence.
Due diligence must be considered a necessary evil. You need to have the same systems and routine on every deal you look at. The minute you become lazy, or sloppy, you increase the chances of overlooking a glaring item that could end up making the difference between success and disappointment. Never get involved in a bad property simply because you didn’t put the work in. Here are five due diligence areas you should review before your next prospective deal.
- Market comps. Everything in real estate is based on comparable sales. There are times when you will get a deal that on the surface looks too good to be true. Instead of overreacting or getting too excited you should let the data act as a guide. Look at the sales in the market over the past 90 days. The closer the sales, the more accurate they will be. However, proximity isn’t the only item to look for. You need to account for the size, style, bedroom count and age of the comparable against the subject. If you are comparing apples to oranges, you may not have the value you perceive. The same is the case with outdated comps. A sale that happened six months ago isn’t a true representation of what is going on in the market today. Your ability to break down the market and analyze comparable sales will give you a true reflection of the market, and your subject property value.
- Value potential. The goal of any investment is to realize a profit. You are not looking to add properties to your portfolio, but to make money on them. Regardless of the purchase price, or the perceived discount, you need to look for ways to add value. Sometimes you will walk into a property and this will be a slam dunk. The kitchen is outdated, the quality is poor, and the layout can be improved. Other times you need to think outside the box and be a little creative in your workup. With any improvements you have in mind you need to attach a correlating cost of repairs. Changing everything on a property sounds great, but if the expenses outweigh the return the property doesn’t make too much sense. This is generally where new investors run into trouble. They underestimate just how much updates and upgrades cost or they suppress these items because they want to get the property and try to make it work. By doing this all you are doing is delaying the inevitable and getting involved in a property that is not worth the time.
- After repair value. All improvements are not created equally. Improving a property in a desolate market, will not have the same impact as it would in a thriving area. As much as looking at sales can act as a guide when making an offer, it also helps you know what you are working with on the back end. You won’t realize a profit until you sell the property. If your estimated value is not in line with the market, your profit margin will shrink, or be eliminated if you miss your mark badly enough. As is the case when you buy, you need to make sure you are comparing apples to apples. You should look at every property that has sold in the last 90-120 days and see if there are any recurring themes or trends. Use these to your advantage and put them in your property. Any way you can create value and improve your after-repair value should be explored.
- Seller motivation. It is essential to know where you always stand in negotiation. This will directly influence your offer and how you shape it. A seller that is motivated by foreclosure or relocation will be more apt to negotiate than one who doesn’t have to move. This must be taken into account when you present your offer, and with every subsequent counter offer. You also need to gauge the competition for the property. If the property is in high demand you should expect to compete with several offers. If you don’t adjust your offer accordingly you will have no chance of getting the property.
- Sales problems/timeline. Once you think you know the property, the market and the seller you need to consider any items you may have missed. Always start with an evaluation of the town. Are there any potential problem areas with town hall, inspections or rental application licenses? Next, think if there will be any problems with the seller. Bank owned properties present different concerns than transactions done by a traditional seller. Finally, you need to consider the timeline of the sale. A sale done in 15 days is much different than one done in 60. Markets and economic conditions can change quite a bit over the course of two months.
By treating every prospective deal and property the same you reduce the chances of something slipping through the cracks. At a minimum, always review these five areas before getting involved with your next property.