Due Diligence Tips for Your Next Investment Opportunity

Due diligence can be a game changer for your real estate deal or investment opportunity. Regardless of the state of the economy or the market, knowing what you’re getting into and who you’re doing business with will always help mitigate some risk.

As investors, we’re conditioned to spot motivated sellers and opportunities for a great deal. Many of us are inspired to act quickly when that “perfect” deal appears. But that isn’t the time to cut corners, especially if a deal seems too good to be true.

I learned this after I saw a for sale sign on a property, called the number, and was offered a bargain price. They lived in the house and showed me personally everything that was wrong with it, which wasn’t very much. They needed to get out, and we’re willing to offer me a 25% discount if I could come in with a cash offer.

I was excited. But the red flags started showing up when they continually offered discounts and didn’t want to pay for title insurance. I did more research and found out that these “sellers” were renting the property. Better yet, they were about to be evicted!

I caught this before giving them any cash, but it could have easily gone the other way. As my father used to say, “It is difficult to cheat an honest man. Go through the proper steps and processes no matter how good the deal is.”

Whether you’re investing in real estate or other alternative assets, it’s important to fully evaluate not only the deal, but also who you’re dealing with. What steps can you take to make sure the opportunity is all it’s cracked up to be?

Due Diligence Tips by Investment Type

Real Estate

I’m a big believer in walking the property before buying real estate or even lending on it. I have gotten burned by not doing that.

I put some money into an apartment complex, but I didn’t fly out to see it. I reviewed the proforma numbers and they looked good. The numbers looked great, but I didn’t go up to see the property in person. After the deal started to go south, I did check it out, and I realized that the maintenance hadn’t been done on the property. As soon as we bought it, we needed to put in new air conditioners, electrical work, plumbing, etc. The leases were as we were told, but we didn’t know that management was regularly giving tenants discounts off rent due to the condition of their units.

If I bought a $200/$300 airline ticket, I would’ve seen these issues at the very beginning, and it would have saved me both money and headaches.

Also, make sure that those you’re working with aren’t over-extending themselves, or you may find yourself way more active in a deal than you intended to be.

For example, I had invested in some houses, and the guy who was rehabbing them was working on about 50 houses total. He did a good job for the first year or two on them, and then it just got out of control. He had too much business, which led him to a nervous breakdown. The other investors and I had to step in and take over the project. Although we did make it out with our money, it was a wasted opportunity and a lesson learned.

Other things to look at when considering a RE investment include who owned it, what they bought it for, when they bought it, what liens are against it, the neighborhood, crime rate, schools, property taxes, if banks are lending in the area, and how many people are renting in the area versus owning.

Of course, you can also go on Google Maps to learn all sorts of information about the neighborhood, like how close industrial areas are, how many houses have pools, how many parks are in the area, how clean and wide the streets are, what parking is like, etc.

Before you enter any real estate investment, you want to have your exit strategy in mind. If you’re a buy-and-hold investor like me, you’ll want to have a good understanding of what you’re buying, who will be renting from you, and how long you want to hold it. That said, you must be prepared for the unexpected and consider other possibilities as well.

When I get an appraisal, I want to know the comps in the area, but I also want to know the rental value and the replacement value. I look at each of these values and use the lowest, leaving room for change. If the house burned down today, could I rebuild it to the way it was with that value or have zoning laws or building restrictions changed?

Even if you were planning to sell the property or the borrower intends to refinance, the banks may not be lending money or people may not be borrowing, and you may be forced to hold the property. If that’s the case, will you be able to rent it out without being at a loss? Will you make a return that’s acceptable to you?

If you’re looking at multifamily or commercial properties, much of the due diligence is similar. However, it is generally less emotional and more academic, regarding price, income, and return on investment. Tax returns, profit and loss, and balance sheets play more of a role. Although views, closeness to public transportation, schools, shopping, etc. is important for pricing, these benefits may not be the end all be all when someone is looking for a home to raise a family.

Safety is always a concern when performing due diligence. You don’t want the added worry over the safety of your tenants, their children, you and your staff, or management going for repairs or other problems. Maybe look at break in rates in your area. Is the property on a well lit street? Are their 24 hour businesses nearby? Different areas require different concerns. Talk to the existing tenants to find out more about the neighborhood.

Private Lending / Notes

My best recommendation is to do due diligence on both the real estate collateral and on the individuals borrowing money. Are you okay with owning the property if you had to foreclose? What risk are you taking on by lending to this individual?

For individuals, consider why they didn’t go to the bank, their exit strategy, intentions for the deal, track record, amount of reserves, qualifications, credit score, how attached they are to the community (how long they’ve lived there), etc. If it’s a rehab, you also want to know who the subcontractors are and their track record.

Now you can utilize social media to learn more about people. There are also services out there that run background checks and provide in-depth information.

It’s smart to complete this type of due diligence before lending money and to let the potential borrower know that you are doing so upfront.

For example, I had an investor friend, who called me when she was having trouble finding someone she had already invested with. Married at the time, she invested in a fund managed by a cousin of her husband’s roommate in college. Now divorced, she couldn’t find this guy anywhere.

Moral of the story: do enough research on who you’re investing with before entering the deal. Not afterwards.

For additional due diligence tips for private lending, check out my recent article, “.”

Other Alternative Assets

Similarly, when it comes to investing in other alternative assets, such as precious metals, you’ll want to do your research on the company you’re investing with.

For example, will they buy the metal back? How much are they charging for the metal, plus packing, shipping, storage, etc.? You will need to understand the margins regardless of whether you’re buying or selling.

If you are investing in funds, know the managers. Check out their backgrounds and any licenses sanctions, criminal or civil infractions, and fines. Plus, how long has the company itself been in business? What is its track record? Who makes up the rest of the team, and is there frequent turnover?

If you don’t know how to evaluate a company, ask your attorney and utilize resources, such as background checks, reviews, or the better business bureau listings.

Some investments are for accredited investors and are not as closely watched by the SEC. Before you invest, make sure you know if the investment is registered with the SEC, and if it’s not, know why it isn’t. The government can only do so much to help. It’s up to you to review the investment opportunity closely.

Regardless of which asset type you’re investing in, keep your eyes peeled for these red flags.

Red Flags

You might want to be wary of an investment opportunity if all the investors are senior citizens or from the same church. While it may be an excellent deal, if you know the person you’re investing with personally, it’s a good idea to ask a third-party to help evaluate the opportunity, as it may be easier for them to be unbiased. Trust but verify.

With real estate, a big red flag is if a motivated seller wants to circumvent certain processes like obtaining title insurance.

For other investments, be wary of those who try to rush your due diligence process. A clear red flag is urgency. For example, I walk away when I hear the words, “The deal won’t last. You’ll miss out, and another one will never be as good.” Always know how much money is being raised and when the fund is expected to be complete/full, but take the time you need to be comfortable. Plus, due diligence status should be maintained through the investment. It’s not a “set it and forget it” process.

Another common problem happens when money is due, and they trade another note with a bigger principal and higher interest rate. Lack of documentation is a big red flag too, including if there’s no proof of fair market value or you’re not able to see audits or tax returns.

The lack of transparency into operations and accounting should be a glaring red flag. Or not returning phone calls (i.e. going dark). I like to watch the tv show “American Greed” to see how smooth the scammers / con men are. No matter how nice they seem, always run them through the due diligence process.

If you’re not sure how to vet a company, go through an attorney. Often, attorneys have access to tools and software to run background checks, including criminal, civil, credit, etc. in multiple states and municipalities. They have the “know how” and experience to review documents and find the inconsistencies and risks and can advise you of such.

One lesson that I’ve learned the hard way, after a commercial deal gone wrong, is that you should always verify that due diligence is done properly when outsourced. Although it can be easier to let someone who’s qualified do all the due diligence, it still helps to be vigilant and involved.

What due diligence lessons have you learned the hard way over the years? And for those just starting out, what investments are you looking into?

If you have questions about the due diligence process for a certain investment type, be sure to share below!