Due Diligence: What I Need to Say ‘Yes’ or ‘No’ to a Deal

Even if they aren’t written down, experienced investors have certain “Go” or “No Go” criteria for deals they will consider. Many investors focus on specific asset types, such as precious metals, real estate, notes, or business ventures. Maybe they even have it narrowed down to different categories, such as commercial, multi-family, or fix-and-flip real estate. With real estate, many investors also have geographical preferences, such as a well-known local market or another thriving area with increasing jobs.

Beyond that, when a deal comes across an investor’s desk, certain factors can make it sparkle or doom it all together.

Some of these factors are easily understandable, such as matching the size of the investment to the investor’s available resources. Complex partnership and exit structures may appear to increase risk. Successful track records of those offering the investments may increase confidence. Conversely, ambitious projected returns or the absence of risk mitigation and contingency planning may make achieving the investment’s objectives unrealistic. ROI calculations and expense ratios need to make sense and include buffers for the unanticipated, like this past year’s enormous runup in lumber prices.

To evaluate potential investment opportunities, it may help to bring a virtual team of experienced specialists to the task. Even if you can’t afford to keep attorneys and tax specialists on retainer, you can build a network or trusted contractors, inspectors, title inspectors, and others by asking more experienced investors for recommendations and advice.

Due diligence steps differ depending upon the type of property – single or multi-family rental, fix-and-flip, vacation, commercial, or raw land. Not sure where to start?

Below are some of the things I look at (and look out for) when evaluating a deal.

Due Diligence Factors

Players Involved

If you’re investing passively in a residential fix-and-flip or apartment complex rehab, dig into the track records of those offering the investment. How long have they been doing this? How many projects have the completed successfully? Do they have any bankruptcies or lawsuits on their record?

What is their reputation within the industry and with past investors? Ask to speak with some of them and for other references. Use public-source information to investigate reputations. If you are buying the property, who is the seller and why is the property being sold? If you’re investing in vacation rental property in a distant city, who will manage, maintain, repair, and rent the property?

Location / Market

You’re not only investing in a piece of property, but also in the surrounding neighborhood, city, region and underlying economic, and demographic dynamics. Is the property in a growing area with an expanding economy and job opportunities? Or is it located in a transitional neighborhood experiencing gentrification or revival? What are crime rates and school districts like? Do amenities, shopping or public transportation need to be close by?

How does the property compare to other similar properties, either as is or after you complete proposed renovation? Does area inventory of similar properties underserve, meet, or exceed existing and future demand? Is it on a flood plain or are there nearby land use plans that will impact its value?

Property

It’s not just space with a roof that you’ll rent or flip. It’s a “machine” with many moving parts. So, get it inspected (structure, roof, electrical, plumbing, HVAC, pest) and appraised by licensed professionals. Make sure the property is clear of any outstanding liens and the title is clear. Understand local zoning regulations, disability requirements, easements, and homeowner’s association (HOA) restrictions, especially if you intend to modify the property.

Numbers

Treat the investment like a business. Have a plan for it that accounts for all costs and anything that might impact revenue (such as occupancy length and rates), profitability (like accurate maintenance, utility costs, and taxes), and return on investment (how you will finance the investment). Get adequately protected with property, liability, and title insurance.

Part of treating your investment as a business is also looking ahead.

Exit Strategy

Are you selling the property within a certain time horizon at a target price, keeping it in a portfolio for rental income, or passing it along to beneficiaries as part of your legacy?

Finally, have contingencies built into you plan in case your forecasts were inaccurate or something unexpected happens. Inflation has increased recently and with it the price of energy and materials. Will this be transitory or more sinister? As 2020 taught us, some events cannot be anticipated, but your numbers should factor in known risks on the horizon.