Are you doing the RIGHT due diligence on your investments?

Now is the best time in U.S. history to take advantage of the bank owned property real estate market, get some great built in equity, cash flow and most importantly BUILD LONG TERM WEALTH. However, most investors do not do the right due diligence when purchasing properties or know how for that matter. If you are one of them, do not kick yourself too badly, even though you may be kicking yourself later if you do not do something about it. Once you go through all of your current investments thoroughly you will be in a position to make the right decision to hold, sell or adjust your investments to increase your returns or mitigate any losses.

So, how do you do the right due diligence? Do you need to be a professional real estate investor, attorney, CPA, or other financial professional? Well it helps, but it is not necessary. If you do not feel you are experienced enough to do your homework the right way, hire someone who does. The extra cost of hiring a professional now will save you major headache and possible losses down the road. However, hiring a professional that has their interest aligned with yours and that has experience in your specific investment type is key. You wouldn’t hire a criminal attorney to evaluate your real estate transaction or a CPA that specializes in manufacturing tax law for your real estate tax planning would you? The fact is that this is done quite often. Ask around for professional team members that know your specific investment and situation.

 

Okay so your saying, what if I want to do it myself because I do not trust even the most seasoned professional with my money. Well get prepared to drink from a fire hose because I am about to take you through a step by step guide to do the right due diligence on every property purchase so that you know what you are buying.

 

NEIGHBORHOOD ANALYSIS

 

One of the biggest mistakes you can make when purchasing property is buying in a bad neighborhood. What is a bad area? When you are walking through the neighborhoods look for crack heads, 30” rims up and down the street, un-kept houses and major foot traffic. These would all be pretty good signs you may not want to buy there. Many investors just starting out (including myself) have made the mistake of buying in the wrong neighborhoods and trusted the seller when they say that it’s a “quite family owned neighborhood” only to find out that during the day the place looks great, but at night it’s an entire different ball game. I recommend going by the property or properties you plan on purchasing during the day on a weekday and again at night or on the weekends to really get a feel for the neighborhood. In addition, the tenants you are going to rent to in these bad neighborhoods are going to miss payments more, cause more damages to your units and have a higher likelihood of moving out in the middle of the night and having their friends steal your water heater, AC unit and all of the copper piping. Hey those hot ticket items can probably buy a lot of crack! One property manager told me that the AC condenser copper that costs between $1,000 to $3,000 to replace nets the crack head a whopping $25! Bet that helps you sleep well tonight. What do you do if you have already purchased in one of these neighborhoods unknowingly? One way to go is to get a section 8 tenant. They are required to take better care of your unit and you get guaranteed rents. Another way to go is to sell as fast as possible and even possibly take a loss on it to get out of the property. It’s better than losing money over your mortgage payment month after month because of the extensive vacancies, bad debt and repairs!

 

MARKET VALUE ANALYSIS

 

Let me start off saying one really important factor you need to consider when buying property today. YOU ARE IN A DECLINING MARKET! What does this mean? It means you need to pay very close attention to what the market value of the property is TODAY. Not 3 years ago. Many wholesalers, sellers and real estate agents will try to sell you on the highest appraised value ever received for that property. However, you should be buying property based on what the current financeable value is IF you plan to sell or refinance. If you are buying a property with cash and holding for long term cash flow it is less important if the property has the right comparables for financing but it still is a signification of the current value of the property. Good wholesalers and real estate professionals know how to find properties with these requirements and many times you as the investor do not know the difference or will never check. In order to get a property financed in today’s lending market banks require appraisers to use 3 comparable property sales within the last 6 months and within 1 mile. Banks can differ on these requirements and personally if a property does not have a minimum of 6 comparables within 3 months I would not buy it if I am going to sell or refinance. If it takes 3 months to purchase, renovate and sell the property (sometimes it can take a month just to close escrow) then you want to still be able to use the comparables you pulled when you sell. Keep in mind there are many professional real estate investors that wholesale properties, but do not assume you will be able to find a buyer before you have to close escrow. You should have the funds ready to close escrow if need be. You definitely do not want the reputation of not closing your deals with the local real estate agents and asset managers. We also take it one step further and get an appraisal on every property before we close escrow as well as pull the property tax assessors tax appraisal as a secondary check on value. As a side note there are many properties available today for much cheaper than the norm for the market you are investing in. For example, I invest in Memphis, Tennessee and there tons of properties available under $10,000. Keep in mind you get what you pay for. Many of these properties are un-financeable properties and the properties look like they have great cash flow on paper. However, when you get down to it the vacancies, repairs and bad debts make your cash flow significantly under expectation if not non-existent. All of these factors need to be considered when looking at the market value of your property and which investments to chose from.

 

CASH FLOW AND RENTAL ANALYSIS

 

First things first, how do you compute cash flow? Most sellers will tell you, rent minus property management, property taxes and insurance equals cash flow. You as an investor need to watch out. Do not be fooled. Always, always, always include a monthly vacancy allowance and monthly repairs allowance when doing your cash flow analysis. If you do not include these items on a monthly basis you are going to find that the return on your money you thought you were getting was not what you expected at year end. Many sellers rely on this downright lie to trick less educated or experienced investors into thinking their return on investment is higher. I never understood this “buyer beware” attitude with investing. Do they not see that if you sell a good asset with accurate returns you will get return business and REFERRALS, the life blood of any real estate investor? Okay, okay back to the analysis. In addition to the cash flow calculation you always want to take into consideration the tax benefits which can easily increase your cash flow return on your money with extra tax breaks. You can even get really creative and do a cost segregation analysis or build green for extra tax breaks which is a great way to inch up that return a little on each investment. Also when you are computing your return on investment there are a couple of different factors to consider. First you have your return due to the cash flow which is basically your NET rent after all expenses and the mortgage payment if you have one. Next you have your tax breaks. Then you have your principal reduction on the loan every year and lastly you have the built in equity when you purchase the property. All of these items should be considered when you are looking at your return on investment and total increase in WEALTH. Next you have your rental analysis. When doing this you want to ask property managers that manage properties in your specific areas, call for rent signs in your area and there are numerous sites you can go to in order to get an assessment for what the rent is. Be conservative on the rental amounts as it affects your return on investment significantly.

 

RENOVATION ANALYSIS & INSPECTION

 

When doing your renovation it is VERY, VERY important you have good team members in place that know how to renovate property and know how to cut costs. I recommend having more than one renovation team. If you only have one team they typically get a little sloppier and the price slowly rises over time. If you have more than one team you can switch back and forth to pressure them not to increase price and take better care when doing the renovation or you can go to someone else. There are a million and one ways a contractor can gouge you but if you do your homework you can significantly reduce that risk. First thing you can do is get a renovation bid, go through it with a fine tooth comb and find out what materials they are going to purchase and request that you pay for the materials cost directly. This takes a HUGE amount of risk off of you because the contactor then cannot hide costs in materials. Take a look at the large ticket items as well. Does the property need a new roof, electrical, plumbing, foundation, AC & Heating unit? Look at those major items and any additional items and compare them item by item with the inspection report. If there is anything on the inspection report that is not on the renovation bid make sure the contractor is aware of it and is planning on getting fixed. This will take some major liability off of your hands for known repair items that you made sure were taken care of and will give your buyer that extra sense of security. Most people tell me not to over renovate. I actually do a little extra on every renovation to put it above the rest. What does that do? It helps you sell the property faster and/or rent the property faster as well, which both makes you a more successful investor. Also, I have found that when you do a better job on your renovations your tenants tend to take better care of the unit and do not cause as many damages. Do not forget that once you get the property finished you want tons of pictures and video for marketing.

 

CLOSING

 

So who has ever been charged extra fees, costs, points or insurance while closing escrow on a property? If you have purchased one property in your lifetime you probably have been charged extra. Did you really think it cost $200 to pull your credit report? Well do not feel too badly about it. The fact is that pretty much every single fee, point or cost on the closing statement is negotiable. So negotiate! If you are closing multiple transactions or giving the Title Company and lender more business there should be a reduction in costs. Review the HUD closing statement in detail for these additional fees. Some of them hide themselves as “lender fees, broker fees, loan charge fee, processing fee, broker origination fee, settlement or closing fee, document preparation fee, notary fees, shipping & handling fees” just to name a few. You also want to make sure on every closing that your closing statements are correct and reflect the entire transaction and have FULL disclosure with the lender and seller/buyer. This will get you out of any problems down the line and make sure you do not cross those legal bear traps. For the closing make sure you have had the time to complete your entire due diligence package before purchasing. Get the appraisal, before pictures and video, inspection report, renovation estimate, cash flow and profit analysis, assessors report and do your neighborhood analysis all before closing. These things are key and you do not want to slack off on them or you will find yourself losing money on your investments very quickly.

 

PROPERTY MANAGEMENT

 

Property management is the single most important factor in determining if your property will produce positive cash flow if you have done the math right on the front end. If you do not have good property management in place you will have major problems down the road. I know we did. We had managers stealing from us with increased repairs, renovation costs, saying tenants did not pay, and the list goes on and on. We even had one management company try and throw in the contract that they get paid the management fees weather it was rented or not and then they had the exclusive right to sell the property and make a 6% commission. Now that is shady. So they have no incentive to rent the unit and once we get tired of it and want to sell they get to sell too! I do not think so! Now I know this all sounds scary but there is hope. Make sure you find a management company that has the right incentives in place. No mark ups on repairs and management fees only when the property is rented are two major must haves in the contract. I also write in every management contract, “If ever I feel that the manager is not acting in my best interest at any time, I have the right to cancel the property management agreement, void the contract without notice and take over the management of the property immediately.” This little wording saved me a few times and is a great clause to add. Now we have our own in-house property management company which is, in my opinion, the only way to go once you have enough properties in your portfolio. This cuts out a lot of the headache and you can manage your properties the way you want them managed.

 

CONTINUED ANALYSIS

 

Never forget, your investment needs to be analyzed on a quarterly and annual basis to determine if you are getting the return you your money you are expecting. Review those statements on a monthly basis and contact the management company with any questions as well. This helps with decision making down the line and helps mitigate any inefficiencies early to increase your returns.

 

At OCG Properties, LLC we help our clients do all of the right due diligence on every investment and put together a financial plan so they can attain financial freedom through real estate. If you have any questions or would just like to talk real estate please feel free to visit our website at www.ocgproperties.com, email at [email protected] or call 424-757-4680 and we would be glad to help. Thanks and happy investing!

 

• Mathew Owens, CPA

OCG Properties, LLC