How To Conduct Real Estate Due Diligence

Underwriting and due diligence is the most important part of the real estate investment process. Putting capital into the wrong investment can result not only in money lost but serious liability issues as well.

Underwriters put a tremendous amount of time, effort and knowledge into conducting property due diligence . . . before presenting an opportunity to  investors.

Here’s a quick overview of how to conduct real estate due diligence and underwriting.

Understanding Real Estate Underwriting

Underwriting is the process used to evaluate and determine the potential of various investment real estate opportunities. Underwriting that isn’t conducted properly creates below-market performance, expensive liability issues, and loss of capital for investors.

Good underwriters combine a boots-on-the-ground, big-picture approach for underwriting with sophisticated software modeling. They analyze a countless number of various data points, and both qualitative and quantitative factors to evaluate the risk-return potential of each prospective investment.

Detailed Due Diligence Steps

Once a potential investment has been identified, a lead underwriter is assigned to the property. The underwriter ensures that the property meets a stringent risk-return profile by performing an extensive and detailed analysis.

There are literally hundreds of data points used in a detailed due diligence process including:

Financials

  • Review last 3 years of tax bills
  • Capital expenditure (CapEx) review for last 3 years and current budget
  • Current month’s tenant improvements (TIs)
  • Schedule of tenant security deposits
  • Outstanding TIs and leasing commissions due
  • Utility records
  • Current invoices from service contract providers and utilities
  • Insurance quote review
  • Loss report from current insurance company for last 3 years

Building

  • Building and site plans including subcontractor warranties
  • Existing Phase I report
  • Insurance quote from 3 vendors
  • Property owner association (POA) document review, where applicable
  • Easement agreement review
  • Building service contracts, including leasing broker and property management companies
  • Maintenance and CapEx log review
  • Warranties
  • Property management agreement
  • Tenant contact list
  • Certificate of insurance
  • Copies of zoning and government permits, and written confirmation of code adherence
  • ALTA survey on file
  • Certificate of occupancy, improvements, and renovations for last 3 years
  • Current property condition reports
  • Copies of zoning reports
  • Warranties for all mechanical and structural systems such as HVACs, roof, and riser system
  • Notice of past, current, and pending litigation, citations or violations

Reports

  • Property condition assessment ordered
  • Phase I update ordered, if needed
  • UCC and judgment lien searches
  • Research any restrictive covenants, easements, and agreements

Comparables

  • Contact area brokers experienced in asset type being acquired
  • Obtain lease comparables – with both historical and current asking rents – for surrounding properties
  • Generate demographic information

Loan

  • Loan commitment letter from lender
  • Estoppels signed by tenants
  • Subordination and non-disturbance agreement (SNDA)
  • Property appraisal
  • Deed of trust/mortgage
  • Security agreement
  • Assignment of rents
  • Fixture filing
  • UCC-1
  • Contract assignments
  • Escrow closing instructions
  • Broker opinion of value
  • Partnership/LLC borrowing authorization
  • Corporate manager borrowing resolution
  • Signature authorization form
  • Primary and secondary lender commitments, if applicable
  • Lender loan documents
  • Budget and proforma review and approval

Title

  • Order title search from escrow
  • Order updated survey, if needed

Miscellaneous

  • Schedule site tour
  • Deposit earnest money
  • Register legal entity to hold property
  • Create operating agreement
  • Set up bank account for holding entity

Post Closing

  • Schedule and confirm property visit by asset management company and management committee member
  • Confirm all client-specific asset acquisition requirements are met
  • Notify in writing asset manager, property manager, and accounting firm of new ownership, when applicable

If at any point during this rigorous due diligence and underwriting process the underwriter decides that the property does not meet its requirements, they should not hesitate to walk away from the prospective deal.

Three Things To Know Before Signing A Commercial Lease

commercial lease

Negotiating and signing a commercial lease is much more complicated than a residential lease.

Here are three things to think about before signing a commercial lease.

Three Types Of A Commercial Lease

Every commercial lease is different, but they do fall into three general categories:

  1. Gross Leases – everything such as utilities, common area maintenance, and janitorial is included in the monthly rent
  2. Triple Net Lease – nothing extra is included in the rent
  3. Modified Gross Lease – some things are included in the monthly rent and some things are not

Landlord Expense Pass Throughs

The things that aren’t included in the base rent are items that can really add up.  Known as expense pass throughs, these charges can also surprise a lot of tenants.

CAM fees – or common area maintenance fees – are the tenant’s proportional share of the landlord expenses to maintain the common areas of a property.   CAM items can include routine charges for services such as:

  • Landscaping
  • Utilities
  • General repairs
  • Janitorial
  • Parking lot sweeping

Personal Liability

Landlords and real estate property managers always try to make a commercial lease as strong as possible.  If a tenant goes bad and stops paying the rent, the landlord will look for as many ways as possible to collect.

Unlike residential leases that are usually only one year in length, commercial real estate leases often have terms of between five and ten years.  While that can be good for a business initially, it can be a big problem for the owners if the business shuts down.

Until a replacement tenant can be found, the business owners can be held personally liable for the total amount of unpaid rent agreed to in the commercial lease contract.

 

How Do Real Estate Leasebacks Work?

real estate leasebacks

Real estate leasebacks can be a great arrangement for both buyers and sellers.  They also work well with both residential and commercial real estate transactions.

What Are Real Estate Leasebacks?

There are three main elements to a real estate leaseback that work with any real estate  niche:

  1. Seller finds a buyer who wants an income property
  2. Buyer buys the property, and the seller remains as a tenant
  3. Buyer gets consistent rental income, seller frees up equity for other uses

How To Structure Real Estate Leasebacks

Real estate leasebacks aren’t seller financing and they aren’t like a lease purchase.  That’s because the real estate has already changed hands.

The buyer needs to do its due diligence on the seller, who is going to become the tenant.  Just because the seller owns real estate doesn’t mean they will have the money to pay the rent after the sale closes.

That’s what’s known in the real estate business as being property rich and cash poor.

Before closing escrow both the buyer/landlord and seller/tenant should have a written lease agreement in place, credit reports and background checks done, with monies from the sale forwarded to the buyer to cover any deposits and upfront rents.

Potential Problems With Real Estate Leasebacks

Real estate leasebacks can be a win-win situation for both the buyer and the seller.  At least for the time when the seller is leasing back.

But what happens when the lease is up and the seller vacates?  Buyers can suddenly find themselves holding a property that is difficult to rent to a new tenant.

Problems can occur with real estate leasebacks when the property is unique or has special deed restrictions placed on the property by the seller.

For example, convenience store operators often do sale-leasebacks as part of their normal business strategy.

But they will also put restrictions on the deed to prohibit the property being used as another convenience store for several years after the lease expires.  The result is that the buyer will be unable to lease to another convenience store and may have difficulty finding another good tenant.

How To Market A Pocket Listing

pocket listing

A pocket listing is a listing that isn’t on the multiple listing service. Pocket listings are found in both residential and FSBO commercial real estate.

Sellers and real estate agents have pocket listings for a number of reasons.  But regardless of why, pocket real estate listings can be difficult to sell.

Here are three great ways to market a pocket listing.

Get Neighbors To Market Your Pocket Listing

Everybody loves a secret, especially neighbors who know that a place is for sale.

By letting the neighbors know you have a pocket listing, you’re putting word-of-mouth advertising to work for you.  It’s also the ultimate way of putting six degrees of separation to the best possible use.

Internet Real Estate Sites

The internet is the perfect place to market pocket listings that aren’t on the MLS.

Websites like Zillow, Trulia, and even Craigslist are great places to advertise a pocket real estate listing without having to go through the trouble of putting the property on the MLS.

This is also a good technique to use when you really want to zero in on qualified, serious buyers.

Most of the real estate agents on the multiple listing service are weekend warriors.  At most they’ll do one or two transactions a year, which means you’ll quite likely end up dealing with an amateur and their buyer client.

Social Media Real Estate Marketing

Marketing your pocket listing on social media is another great way to let people in your sphere of influence know you’ve got a great off market property for sale.

Part of your circle of friends probably includes real estate agents making six figures a year.  These are the types of agents that you want to share your pocket listing with.

They’ve got the experience and the contacts to help get your pocket listing sold to the most qualified buyer.

Are Traditional Real Estate Companies Bound To Fail?

traditional real estate companies

To answer this question allow us to change gears for a moment and consider what Steve Jobs had to say about Apple Computer back in 1995.

Specifically, he talked about how Apple will eventually fail.

Granted, this thought is near-blasphemy for a countless number of retail stock market investors, mutual funds, and investment gurus.

After all, the price of Apple stock recently hit an all-time high.  Warren Buffett owns nearly $45 billion of the company, and Apple accounted for an incredible 23% of the entire S&P 500’s gains in May.

How in the world could Apple possibly fail?

According to Steve Jobs, companies with a monopoly market share forget about what it means to build a great product.  There’s no difference between a good and a bad product, and no feeling in the hearts of the people who run the company about wanting to help their customers.

Other than perhaps the size of the display screen, what’s the big difference between the last several generations of iPhones . . . except for a rising price?

Eventually companies decline because of the lack of quality products and failure to adapt to the new realities of the marketplace.  Steve Job’s belief that companies must adapt or eventually die is also applicable to the real estate industry today.

Traditional real estate companies

Media as diverse as the Pew Research Center and USA Today claim that the decline in home ownership and the rise of the ‘renter class’ is due to rapidly growing home prices and an inventory shortage.  Would-be homeowners are forced to rent because they can’t find anything to buy.

But perhaps a more likely explanation for more people renting homes than buying is that consumer demand is simply changing.

As more Baby Boomers retire and sell their family homes, they are intentionally choosing to rent, or moving into assisted living or senior housing.

At the same time, the younger generation prefers to rent a home rather than own.  Factors such as the growing gig economy and 1099 employment, the lack of mobility that home ownership brings, and the rapidly growing ways to invest in real estate other than owning a home, all make home ownership much less attractive than it once was.

The traditional real estate industry still operates under a business model of new home construction and a resale market that focuses primarily on home buyers that are owner occupants.

This is in stark contrast to the changing wants and desires of the real estate consumer, and a perfect example of Steve Job’s warning to companies who focus on their own needs rather than wanting to help their customers.

Three First-Time Home Buying Tips

first time home buying tips

Here are three first-time home buying tips that will go a long way toward enjoying your new home.

These three first-time home buying tips all focus around saving money.  That’s because buying your first home will always, always, always, take more money that you might think!

Down Payment Assistance

Many first-time home buyers think that asking the seller for down payment assistance is an embarrassment.  But smart home buyers think of this as a way of using OPM or other peoples’ money.

This first-time home buying tip works especially well with sellers who have a lot of equity in their home, and with buyers who have few contingencies in their purchase contract.

Closing Cost Credits

This is similar to asking for assistance with the down payment.  It works well with sellers who don’t even have that much equity in their home.

The fees when buying a new home can really add up.  In addition to the normal buyer costs such as doing inspections, there will be fees from the home owner association, title and escrow company, attorneys, and lenders.

Individually these can be small dollar amounts compared to the purchase price of a new home.  Most sellers are quite willing to negotiate a closing cost credit with a qualified home buyer of the house for sale.

Home Updating Escrow Reserve

First-time home buyers can also ask the title company to hold money in reserve for needed repairs.

The funds come from the seller, but are held by an independent third-party – such as the escrow, title company, or an attorney – to directly pay contractor bills.

Any left over money gets returned to the seller.

Other First-Time Home Buying Tips

In addition to getting as much money back from the seller as possible – even in a seller’s market!  First-time home buyers should also:

  • Try not to underestimate the cost of repairing & rehabbing
  • Visit the neighborhood during different times of the day and week
  • Don’t be afraid to renegotiate the purchase contract if any red flags appear during the inspection period

Land Loans And Real Estate Financing

land loans

Land loans is a term that frequently comes up when selling real estate.

Despite the name, land loans aren’t just for selling land – although that’s how the term originated.

Other Names For Land Loans

Other names for land loans are deeds of trust, seller financing, or private equity loans.

The term ‘land loans’ comes from a type of seller financing – as opposed to traditional bank or lender financing.  A land loan is when the seller retains title to the ‘land’ until the loan is paid off.

Why Use Land Loans?

There are three ways that land loans are generally used to buy and sell real estate:

  1. An owner has a property that is difficult to sell.  Maybe it’s a buyers market or the seller doesn’t have the money to make repairs.
  2. A buyer can’t qualify for traditional bank or lender financing.  The buyer may have credit issues or wants to use the property for an unconventional use.
  3. A legal technique where a seller can defer payment of capital gains tax

Let’s Make A Deal

Land loans are a creative way to finance real estate.  There are no hard and fast rules to follow, so selling real estate using a land loan can be tailored to the specific needs of every buyer and a seller.

It’s always a good idea to have the sales contract in writing.  Many buyers and sellers using a land loan also like to have an independent third party handle all of the loan payments and disbursements as well.

Last but not least, a seller carrying a note with a land loan should always think of him or herself as a bank.  Especially if they decide they want to sell the deed of trust to an investor before the note becomes due.

Is Hosting On Airbnb A Good Idea?

hosting on airbnb

A good way that first-time home buyers can save money on their new home is by hosting on Airbnb.

Airbnb hosting is also a good niche for vacation rental property managers to focus on.

Here are four things to consider about hosting on Airbnb.

Hosting On Airbnb Is Easy

The process for becoming a host on Airbnb is pretty easy.

But as Airbnb grows in popularity, there are more places listed for rent.

Because of that professional real estate copywriting and marketing are becoming more and more important.  It’s also a good idea to have professional pictures of your property taken before you offer your place for rent on Airbnb.

Airbnb hostings can be very competitive.  Making a good first impression makes a big, big difference between getting bookings on Airbnb and not getting them.

Airbnb Hostings Mean Extra Money

Some people make money on Airbnb by renting out an extra bedroom or listing their place on Airbnb when they go on vacation.

Then there are Airbnb hosts who pretty much rent their place out full time while they travel around the country or even around the world.

People who freelance and are able to work remotely – and those who have virtual businesses – love hosting on Airbnb.

Challenges With Hosting On Airbnb

Each time a guest leaves – and before new ones arrive – Airbnb hosts will need to make sure their place is thoroughly cleaned and ready to go.  Having a reliable cleaning company is critical and important to avoid getting bad reviews from guests on Airbnb.

Hosting on Airbnb also means having a kitchen that is completely supplied with cooking supplies, dishes, glasses, pots & pans.

Many 5-star Airbnb hosts also find that guests appreciate welcome gifts such as a bottle of wine, along with some cheese and crackers.  Remember, it’s always that extra little touch that people remember the most!

Property Management Business Plan Tips

property management business plan tips

Here are three property management business plan tips to think about before expanding your real estate business.

Focus On A Single Asset Class

One of the most important things to do when developing a property management business plan or a comprehensive real estate business plan is to focus on a specific real estate asset class, and then ‘drill down’ to a specific sub-class.

An example of this on the residential side would be single- or multi-family homes.  Then then focus on a specific price range, area of town, or number of units in the property.

An example of this on the commercial side would be multi-tenant retail or office.  After selecting the type of commercial property you will property manage, determine the class of property (A, B or C) and the property size in terms of square footage.

Developing A Solid Property Management Business Plan

It might seem counter-intuitive by narrowing the type of property you will manage.  But narrowing your focus is great for your real estate business for three reasons.

First, tenant personalities and issues will be more similar.  Their wants and needs will be as well.

The things that a medical tenant requires are much different from what a mom-and-pop small retail business will need.

Second, owner personalities will be more alike as well.  Real estate investors who buy office property are much different from those who invest in small multi family buildings.  Plus you’ll learn how to avoid a problem property owner.

Third, you’ll develop a skill set much quicker when you manage only certain type of real estate asset classes.

This will let you grow your property management business faster.  You’ll be able to transfer the skills you’ve learned in working with similar tenants and owners to other like-kind real estate.  You’ll also be able to target your property management marketing to the audience most likely to respond.

Great Marketing Tips For Property Managers

marketing tips property managers

RentTrack recently reached out to me for an article on marketing tips for property managers.

Here are a couple of great ideas that property managers can use for marketing any type of property.

Know Your Target Market

One of the most important tips for property managers and leasing agents is to know your target market.

And it isn’t just people who want to rent a place to live.

Some properties are better suited for singles or working professionals.  Others for couples just starting out, and some rentals are great for families.

You don’t want to accidentally discriminate in your marketing copy.  But do spend some time thinking about what type of renter is going to be attracted to your rental house or condo.

Make A Simple Website

Having an online presence is pretty much a given in today’s competitive real estate market.

But it’s important not to give too much information to people who want to rent your property.  Instead, focus on gathering info on the tenant and capturing leads.

Make it easy for the prospective tenant to learn more about the rental property by having a short description, map and pictures.

Be sure to provide a rental application for easy download, along with instructions on how to submit it, and what your employment and tenant income qualifications are.

More Marketing Tips For Property Managers

Here are four more great marketing tips for property managers include:

  • Reach out to as many prospective renters as quickly as possible in as many ways as possible
  • Don’t negotiate on the rental amount, deposit, or your tenant application requirements
  • Make it easy for prospective tenants to get in touch with you
  • Include links to your profile on social media sites such as LinkedIn and Facebook

Experienced real estate investors, leasing agents & property managers know that it’s always better to find and keep great tenants than having to go through a costly and time-consuming eviction if the tenant decides not to pay its rent!