Due Dilligence - Sharing steps I took to walk away from a deal

[Michael Gertz]

Hi Everyone -

Just thought I would share an experience that I just had on my own. 

I didn't have a model of due diligence with my latest effort.  All I had was my assumptions, and however you want to break up that word, I now know that I need to be better at due diligence BEFORE I go into a deal rather than later.  Luckily there are many ways out with a good attorney so I was able to manage this unscathed.

On the other hand, the one rule I always follow, is that if your gut is telling you NO then you need to follow your instincts before, or in my case, after making a deal and really do the work to see if your decision is the right one.  I want to go into a deal with ultimate clarity on my goals, some certainty in its outcome, and a properly designed baseline plan of execution as you never know where deviations may arise (may require some changes). 

Real estate is a liability and when you sign your name to any papers you become owner of it whether you like it or not.  It can be a dream come true like my other investment properties where rents flow in on time, everytime, no issues with the city or the property, no lawsuits, fires, thefts - and life is good.  It can also be a nightmare - especially when you take a chance looking only at the expected profit verse your what your overall investment objectives are and how they match up.

The topic of DUE DILLIGENCE arises and I always did some research which I considered was satisfactory.  Investing in my neighborhood really did not require the extra mile of review that one should take when investing in some other backyard.

This time, I was planning to buy a property in Montclair NJ down by Mission Street (not my backyard).  For those that know Montclair, its broken up by a few parts, most of which is good.  Mission street, not so good, but I thought - how bad can it be?

Properties were selling from low 200's to 300's that had potential rental income of 3000 per month - descent cap.  I found a property - offered 195k was accepted and we began the process.  I was excited at the fact that I potential had a great deal in the works.  The place needed about 35k rehab but once that was done this could be a cash cow.

Passed attorney review and all of a sudden I had a rumble in my stomach when I thought about the property.  Did I do any due diligence when making this offer?  I mean its Montclair...right? It cant be so bad....can it?  Wait why did I get it so cheap when this market is so high...?  Do I really know this area?  Hmm.  Let me get answers so we can get this done the right way.... So I decided to do some but where do I start?  How can I effectively weigh the pro's and cons to what this property represents and does it meet my objectives.  So here was my plan.

1) Travel the immediate neighborhood day and night.  When I went during the day, it was quiet, but at night - gangs on each corner...hmmm

2) Google the streets and blocks for crime stats or opinions - All spoke of highest crime in Montclair and constant crime.

3) Check the police blotter for recent calls - a majority were on or around this block... ouch.

4) Call the planning board to inquire on when ground will be broken on any gentrification projects. - This was interesting as the planning board member didn't seem like she wanted to speak to me at first....I convinced her in which she stated "the density in that area is not changing".  "The city has nothing happening and NO developers have submitted plans for build out down there".  "The land is privately owned and the owners are doing nothing".

There goes my thoughts of a starbucks on the corner.

5) I called local real estate professionals to get their assessment of the area and what type of renters would desire that area.  Overwhelming section 8 and mentions that they would not go there at night to pick up rent....hmm

6) I immediately called my broker and said what have all the listings sold for; in which, he sent me what everything is LISTED at.  yeah 250-300k but NOTHING sold.  I went on Zillow and found houses selling between 135-160K - My good deal just went sour.

7)  I created a fake ad on craigslist in an effort to see if the demand and quality of persons looking in the neighborhood would correct my negative experience so far.  Guess what...it didn't.  In my other investment areas I receive 10-15 requests over a weekend minimum.. Here I received 1 section 8 potential.

My Objectives from the beginning were as follows:

A) My objective is to rent to professionals who commute to the city, moderate income brackets,  and are not section 8.

B) Crime is a factor so I am looking for an area where crime, harassment and safety of my tenants is not something i need to worry about beyond the usual petty theft.

C) My wife wants to property manage the property and her safety is worth more than the risk of a bad neighborhood.  She needs a place to manage that will not jeopardize her well being.

Objectives not met.

I called my attorney and walked away from the deal.

This was a learning lesson for me.  I haven't been in the game in about two years, and I have had an itch to begin a rehab for months.  My desire to purchase, rehab, and collect checks was so strong, that it almost stopped me from sticking to my plans and objectives.  This effort required me to refocus on how and why I invest, as well as, what I am investing in. 

I think this practice is common in this realm, as the idea of reward and success in our real estate efforts are a driving force - the desire to be successful, the desire to be free; however, we as investors will always require the discipline to stick to our plan...unless there is a ridiculously good deal that we just cant pass up, in which plans may change!

I hope this helps stir those creative juices on how to perform due diligence.  I look for other stories to be shared so we all can thrive.

Best wishes & Happy Holidays!

Mike