Diligence - An Important Part of Any Private Money Deal

 

Imagine merrily going about your day. Sun shining. Birds chirping. Then....you get a call on a deal. It's a real beauty. Seems like the planets lined up in your favor (and it's about time, too!). It's a nice 4-unit in a good area. Definitely a B or B+ building and it's 100% occupied. The owner needs to sell yesterday because he went on some Howard Hughes type kick and wants cheeseburgers put on a tree outside his hotel room in Vegas every day at 4pm. Bad news for him, good news for you. You get some info emailed to you and go look at the property. You start drooling a little bit and maybe start counting the money you're going to make a little bit (sometimes you can't help it, you're human!). Next, you get the purchase agreement signed and get the earnest money check sent over. You contact your private investors and inform them of the deal. Several are "in" based on your phone conversation with them and would like you to email the paperwork over to them so they can begin arranging the funds.

Yes!

You're elated and pumped up. This is quite an exhilarating feeling - your feet are light and your stride is sure. You go out for dinner and order the finest wines and the rarest steaks. Monopoly 3D extraordinaire you have become.

But wait...

The next morning comes and you realize that you have a due diligence period in your Purchase Agreement (at least you should!). This is sometimes called an inspection contingency. You've already looked at the property, got into all the units, so you're pretty comfortable. You blow it off, start looking for your next deal and finalize the closing details on this one. Deal closes with no problems. You take over managing the property and all goes well...at least at first. A few months later you get a call from a tenant. Sounds kind of routine at first (man, those tenants like to complain, don't they?). Well, you listen a little bit and what they're telling you sound a bit strange. Too elaborate to be made up. You take a drive out to the building to check it out. You start to look around in the basement and, to your horror you see it: a mud tunnel. Evidence of termites!

Gadzooks!

You immediately call an exterminator, who quotes you an insanely high fee to cure the problem. The fee for this is easily worth a few months worth of cash flow on the property. But, you got take care of the problem. Curious, you ask the tenant how long he's known about the termites (or "funny cracks" as he called it). He says he's seen them for quite a while, told the former owner who did nothing about it. A pang of guilt hits you. You should have caught this before you bought the property and made the owner re mediate the problem or compensate you for fixing it. Too late now.  Ok, that problem is solved. You go back t your life, collecting checks and everything is good. Until, a couple of weeks later when you get a funny letter in the mail. It's from an attorney. Turns out the owner of the property next to yours has hired this friendly legal fellow to send you a 'nasty-gram'. Seems like your neighbor feels that the cement wall that encompasses your tenants parking lot and carports is actually on her property. She alleges that the wall is negatively impacting her resale value. You are politely asked to move the fence so that it is not on her property anymore. There's a deadline before a lawsuit will be filed. Hogwash!, you say. You think the neighbor is a blowhard and disregard the letter. You add it to your toilet paper bin for your next camping trip. But, sure enough, a few weeks later a lawsuit ends up being served on you at your office. Not fun. Now, you have to hire an attorney on your behalf to look into the matter.

Your attorney spends a few hours researching. He goes to the courthouse, checks public records, talks to other attorneys and come back to you with his recommendation: Move the wall.  You can't believe it. However, your attorney goes on to tell you that the brick wall marking off the parking area is actually several feet over into your neighbors lot. They have every right to have you remove it (upon his analysis of property and case law in your area). This is going to cost you thousands of dollars. Between this and the termites, your entire year's worth of cash flow has evaporated like a single rain drop hitting rock in the Gobi Desert.

How did this happen?

You now have to tell your private investors that their return for the year will be a whopping 0%. Not a good thing. The kick in the pants is this: you could have eliminated these costly problems by conducting proper due diligence. You could have spent some time and maybe a few hundred bucks going through the details and inspecting more closely. Now, you're out and your investors are also out of the money. When working with private money, due diligence is extremely important. You don't ever want to have to tell your investors that they won't be making a return or (worse) they have lost money because of a bone-headed move or laziness on your part.

If the seller fights you on the diligence - walk away from the deal.

Happy (and headache-free) investing.