What Items Should You Check During Due Diligence?

Now that we have established why it is important to have a way to back out of your contract, let’s talk about each aspect of the contract in more detail and what you need to do for your due diligence.

When you make an offer, you have to make a lot of assumptions. Your due diligence period gives you the opportunity to verify that the assumptions you made are correct. If you discover that they are wrong, you have 3 options. You can either continue with the contract as is, you can cancel the contract, or you can renegotiate the contract. Just because something isn’t the way that you expected it to be doesn’t mean that you have to walk away. In fact, you may find that something is better than you anticipated.

For example, when you are reviewing the financials, you want to make sure that you get actual documentation. You don’t want to just take the sellers word for it. You want to be able to review their books and when possible, view their tax returns. You want to see exactly what they are deducting for expenses. Once you know what their gross income is and what their expenses are, then you can evaluate whether or not you are going to have the same expenses or if yours are going to be different.

They may be allowing Uncle Fred to have 2 units for free because he does the bookkeeping for them. Aunt Denice might get a unit for free because she does the office cleaning and Uncle Mark might do the maintenance which is why he gets a free unit. Obviously, this isn’t something that you are going to continue once you own the property. As a result, you will need to determine what the actual costs are going to be to run and maintain the property. You may find that the numbers are very different.

On the other hand, they may have a 40% occupancy rate because George is managing the property for free because he gets to live in the 2 bedroom apartment that is attached to the office. He doesn’t know what to do to get the property rented and so he just kicks back in his living room unless someone comes along with a payment or a question. As a result, the property is way under occupied and poorly performing. Your feasibility study suggests that the occupancy rate should be closer to 80% so your gross income is going to double. This doesn’t mean that you should suddenly pay more for the property.

Always check your numbers. Always assume that you are going to have renters that move out as soon as the current owner leaves. Whether that is because they are afraid that you are going to raise the rents or because they are friends and family members who were padding the books. If you assume that this is going to happen, you won’t be surprised when it does. Make sure that your numbers will work while you are able to get the property to the occupancy levels that you are hoping for.

There will always be surprises along the way, but doing an in depth due diligence will help keep those surprises to a minimum. In our next articles we will talk about more due diligence items that you need to research while you are under contract. As always, happy investing.