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.

Top 5 Benefits of Investing in Real Estate as Part of a Portfolio

Investing in real estate is an excellent way to diversify your portfolio with a physical asset that generates income while simultaneously acting as a hedge against inflation. Due to consistent demand, real estate values also increase over time, increasing the potential for profit even more.

Industry experts list these top 5 benefits of having investment real estate in a portfolio:

#1 Passive Income and Increasing Values

The value of real estate keeps increasing for two reasons:

  • Rental rates, particularly in the multifamily housing sector, are continuing to rise due to demand.
  • As more investors look for quality real estate opportunities, increased bidding activity results in cap rate compression and increased values.

Income-producing real estate also generates passive cash flow month after month. Passive income can be used to pay off mortgage debt sooner, build equity faster, and leverage that equity to purchase more property.

#2 Tax Laws Are Real Estate Friendly

Current tax law is extremely friendly to real estate investors. Non-cash expenses such as depreciation allow investors to reduce the amount of taxable net income. When the time is right to sell, Section 1031 exchanges can be used to defer the payment of capital gains tax by relinquishing one investment property and acquiring another like-kind property.

#3 Hedge Against Inflation

Real estate investors are protected against the short-term and long-term effects of inflation. As prices increase, rents rise, and asset values grow.

According to the Census Bureau the average rate of inflation in the U.S. is about 3.2%, and at the average rate of inflation prices double every 20 years. But commercial real estate has more than outpaced the rate of inflation. In fact, over the past 10 years, average prices for office property, shopping centers, and large apartment buildings have more than doubled, according to the Federal Reserve Bank.

#4 Using Leverage Magnifies Returns

Positive leverage can be used to magnify the returns from investment real estate. Depending on the type of project, you can borrow between 50% and 90% of the property purchase price at interest rates that are lower than the anticipated annual return on the investment. Traditional portfolio components like stocks and bonds aren’t nearly as easy to use as collateral for financing.

#5 Variety of Investment Opportunities

Real estate provides a wide variety of opportunities to investors. Popular income-producing options include single-family rental housing, multifamily property, commercial buildings like offices and shopping centers, and vacant land.

It’s also possible to realize the benefits of investing in real estate without actually buying a property:

  • REITs: real estate investment trusts, real estate mutual funds, and real estate ETFs – or exchange traded funds – allow investors to buy shares of publicly-traded real estate funds.
  • Crowdfunding: online real estate investment platforms let investors buy fractional shares of institutional-quality office buildings, retail property, and multifamily projects.
  • Real estate partnerships: joint ventures with an experienced managing partner responsible for the hands-on, day-to-day operations of the investment works with passive investment partners who contribute money instead of their time while sharing in the profits and appreciation in value that the property generates.

Real estate burnout and how to avoid it

real estate burnout

Because real estate can be a 24/7 business it can easily lead to real estate burnout if you allow it to. Here are some of the best ways to avoid burning out in real estate while still being a six-figure earner.

Finding the work-life balance that works for you avoids real estate burnout

When you’re first starting out in real estate it might seem like you’re living to work. It’s true, in a highly competitive business like real estate there are dues to pay and hours to put in. But balancing work and play will make you more productive.

Three ways to balance your work life and avoid burning out are:

  • Take the same day off each week
  • Set the right expectations with clients upfront
  • Focus on a single real estate niche

Avoid real estate burnout by closing your office

Just because the real estate business can be 24/7 it doesn’t mean that you have to work around the clock, week in and week out. Closing your office one or two days a week means no phone calls, emails, or text messages.

These tips work even if you don’t have a physical office to close. Closing your office is as much mental as it is physical.

Avoid burning out by setting the right client expectations

Setting the right expectations with clients also helps agents void real estate burnout. If your office – or yourself, if you don’t have a physical office – is closed on Sundays or the weekends, let clients know right up front.

Many real estate agents are afraid do to this because they’re afraid of being seen as non-responsive. But in fact, the opposite is true. By letting customers and clients know that you have set business hours they’re much more likely to view you as the real estate professional that you really are.

Focusing on a single niche helps avoid real estate burnout

A lot of real estate agents, even those that have been in the real estate business for a while, believe that they have to be all things to all people. They figure the more they do, the more money they’ll make. Unfortunately this is one of the major factors in real estate burnout.

Focusing on a single real estate niche helps avoid burnout by concentrating your skills, knowledge, time and effort on what you’re best at. If you do that, the money – and the clients – will follow.

Five examples of real estate niches are:

  • Buyer representation
  • Commercial property management
  • Office leasing agent
  • Coworking office specialist
  • Multifamily sales specialist

 

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.

 

Five Real Estate Rental Property Expenses Not To Forget

real estate rental property expenses

Here’s a list of five real estate rental property expenses not to forget about when calculating your ROI. They apply to whatever real estate niche you’re working in.

As a good real estate accountant or bookkeeper will say, ‘Report all of your income and expense as much as you can’.

Tenant Credit Reports

Checking the credit and background of prospective tenants is a must-do and one of the most important tips for a real estate landlord or property manager.

While the cost of running an individual report is small, the annual real estate expense for credit reports can really add up.  Especially if you have a large multi family property or several single family rental homes.

Leasing Fees

Surprisingly, many beginning real estate investors overlook expensing out the finder’s fee paid for leasing the rental property.

One reason this happens is that the leasing agent will collect the upfront monies from the tenant – such as the first month’s rent and security deposit – then remit to the owner this money less the leasing fee paid out of those upfront monies.

The landlord mistakenly only accounts for the money he or she actually receives instead of the gross income from the tenant.

Back Office Property Management Time

The time spent on little tasks like answering incoming phone calls, balancing the bank statement, and endorsing rental checks can really add up over the course of a year.

One way to account for this time spent managing your real estate investment is to use a stop watch or timer on your computer.  Then, log the minutes on a spreadsheet along with the date and a brief description of the task.

Onsite Property Management

Just as with the back office time, onsite property management time can add up as well.  It’s also one of the most overlooked real estate rental property expenses.

This category includes tasks such as driving by or walking the property, meeting a vendor onsite, and checking out the competition.

Market Research

Speaking of the competition, don’t forget to expense the time spent researching your market.

This can include things such as dues and subscriptions, property drive-bys, shopping the competition, and online research.

Common Real Estate Rental Property Expenses

Some of the most common expenses with a real estate investment property include:

Real Estate Loan Scams

real estate loan scams

Whenever a real estate market heats up, real estate loan scams also rise.

Here are three common real estate loan scams to watch out for if you’re buying – or selling – real estate.

Seller Financing

Now, seller financing in and of itself isn’t a real estate loan scam.  But, this method of buying and selling real estate can be, if you’re not careful.

For buyers, seller financing can turn into a real estate loan scam if you pay the seller directly.  To protect yourself, always go through a independent third party such as an escrow company or attorney.  They will track payments received, the loan balance, and money disbursed to the seller.

For sellers, always remember that you are the bank, since you are carrying the note.  Sneaky buyers can turn seller financing into a real estate loan scam by providing you with bad credit information or selling the property to someone else without your knowledge.

Lease Purchase

Lease purchasing – real estate can also turn into a type of loan scam if you’re not careful to have everything in writing.  Also be sure to have written in your lease purchase contract what dollar amount or percentage of payment is applied toward the purchase price of the property.

Remember, a lease purchase agreement is different from a lease purchase option.  With an option, the tenant/buyer has the option to purchase at a predetermined price, but doesn’t have to.

Interest Only Mortgage As Real Estate Loan Scams

Using an interest only mortgage to buy real estate can also end up being a real estate loan scam if you’re not careful.

With an interest only mortgage, payments by the buyer only go toward interest and not principle.

In a real estate market where prices keep rising that’s OK.  But if the market suddenly drops, buyers can quickly find themselves upside down with negative equity on the property.

How To Buy A Home In A Safe Area

buy a home in a safe area

Buyers are often surprised to find that if they want to buy a home in a safe area, they oftentimes need to do their own research.

That’s because many laws – especially in the U.S. – prohibit real estate agents from telling buyers about the safety of an area.

Here are three easy things that can help you to buy a home in a safe area.

Buy A Home In A Safe Area With Multiple Visits

Many home buyers make the mistake of only visiting the home they are buying once or twice.  And that’s usually at the same time on the same day of the week.

To make sure that you’re buying a home in a safe area it’s important to make multiple visits are different times.

Going by the house at midnight on a Saturday is a great way to find out if there are a lot of noisy parties.

Visiting in the early evening or weekday mornings is a good way to see what the neighborhood is like when people are home.  It’s also a good way to meet your potential new neighbors.

Talk To The Neighbors

Speaking of which, there’s nothing wrong with introducing yourself to your next door potential new neighbor.

In addition to making new friends, it’s also a good way to gather intelligence about the home you’re thinking about buying.

Online Research

There’s so much information on the internet today that can help you to buy a home in a safe area.

Things like crime statistics and locations of sex offenders are important.  Aerial views of the neighborhood, and the locations of schools, churches, and shopping centers are also just a few key strokes away.

 

Three Easy Ways To Increase Your Home Value

increase your home value

Here are three very easy ways to increase your home value and get buyers to pay more for it.   After all, like the saying goes, why spend (a lot) of money when you don’t have to?

Best Way To Increase Your Home Value

Real estate is all about location, location, location.  But real estate is also about appearance, appearance, appearance.

Improving the curb appeal of your home and its appearance is easy and relatively inexpensive.  Things you can do to improve the appearance of your home and increase its value include routine landscaping, decluttering, and fresh paint in today’s designer colors both inside and out.

Updated Fixtures

New faucets, electrical outlets and switches, and door handles are pleasing to the eye of the new home buyer.  Replacing these items is also pretty inexpensive and can usually be done without using a high-priced handyman or contractor.

You can increase your home value by thinking of updating fixtures as improving the curb appeal of the inside of your house.

Energy Efficient Appliances

For home owners who have a little extra money in their budget,  upgrading to LEED certified, energy efficient appliances can pay off in both the short- and long-run.

Are you thinking about selling your home in the not too distance future?  First-time home buyers will appreciate – and pay extra for – the work you’ve put into updating the appliances in your home to today’s Energy Star standards.

If you’re more of a buy-and-hold home owner, then the money you save by having energy efficient appliances will quickly add up over a few years.

Highly-rated air conditioning units, heating furnaces, water heaters, and kitchen appliances can help save a surprising amount of money with today’s energy efficient standards.

 

 

Real Estate Time Management Tips

real estate time management tips

Here are two real estate time management tips to help take running your real estate business to the next level.

Emails Take A Lot Of Time

There are certain tasks in any business that are affectionately called ‘time sucks‘.

Time sucks are things that, well, take up a lot of time without giving you anything in return.  Like more income, for example.

Email can be a huge time suck in any business, but especially in real estate.  That’s because real estate agents only get paid when a deal is done . . . and not by the hour or on a salary.

Even for correspondence that is time sensitive, checking, sending & receiving emails should be limited to two or three times each day.  Many people schedule their email times for first thing in the morning.  Then again around lunchtime, and toward the end of the day.

Have A Routine & Stick To It

Another good real estate time management tip is to have a routine and stick to it.

Devote a certain amount of time each day – at the same time each day – to tasks such as real estate marketing & prospecting, or client outreach, and administrative work.

Remember, having a successful real estate business isn’t about how many hours you work each day.

It’s about how smart you work!

Relationship Between REITs and Rising Interest Rates

reits and rising interest rates

In today’s rising interest rate environment, many real estate investors are wondering what the relationship is between REITs and rising interest rates.

Here are three factors to consider.

Asset Quality of the REIT

Experienced real estate investors understand that not all real estate assets are created equal.  That’s why a time-tested truism is that real estate is all about location, location, location.

But in a hot market with real estate prices rapidly rising year after year, it’s easy to forget about quality and focus solely on quantity.  Sometimes traditional real estate companies do this all too often.

As interest rates continue to rise, REIT managers may have a hard time refinancing if they made the mistake of buying a low-quality asset at too high of a price.

Property Loan Refinancing Timelines

Loans on commercial investment real estate and larger multi-family property are usually made for only a few years at a time.  That’s because lenders know that volatility in the real estate market can appear at any time.

Another reason for short-term real estate loans is that lenders what to ensure that the asset is being maintained and that the real estate property management is top notch.

It’s important for both residential and commercial REIT investors to understand when each individual loan becomes due and what the prospects are for refinancing.

Real Estate Assets of the REIT

Investors concerned about REITS and rising interest rates should also investigate the quality of each individual asset that the REIT owns.  This will help to identify potential problems when the time comes to refinance.

Some items to research include:

  • Uniqueness of property
  • Competitive environment
  • Occupancy and tenant types
  • Asset class – retail, office, industrial, multi-family residential
  • Economic drivers of the market area

REITs and Rising Interest Rate – The Crowdfunding Alternative

Investors who are worried about specific REITs and rising interest rates often find that crowdfunding can be a good alternative to buying a publicly-held REIT.

That’s because crowdfunding organizations such as RealtyMogul and Fundrise raise capital for one specific asset purchase at a time.  This makes it much easier for the individual real estate investors to determine whether the real estate investment makes sense for their portfolio.