The real estate market is at a uniquely advantageous point to buy rental property, but many (particularly newer) investors end up losing money anyways because of a very simple mistake: Misplaced Trust.
The traditional financial planning industry has indoctrinated you so hard — encouraging you to blindly trust self-styled 'experts' with your money — that when you start buying investment real estate to take control of your financial future, a mind-set change is crucial.
The reality is that the same problems exist in the real estate industry as they do in the securities industry — there are unscrupulous people on the one hand, and there are well-meaning amateurs and non-specialists who provide ill-informed advice on the other hand. Mis-placed trust into either of these scenarios can be very expensive for you.
What Are Some Clear Red Flags to Avoid?
One major red flag to look out for would be any real estate investment firm or seller who tells you they have already done the due diligence for you on the property you are about to buy. If you ever have a seller or real estate investment company tell you the property has already been inspected, that you should just use their inspection report to save money, or that you should otherwise minimize your due diligence, that is a clear sign to run in the opposite direction.
Another red flag would be any real estate professional who does not specialize in the micro-niche of what you are looking to buy. An example would be a real estate agent who primarily serves primary home owners and not investors. Or a real estate agent who primarily deals with commercial real estate when you want to buy residential investment property. Don’t work with anyone who is not an investment property specialist working in the niche where you want to buy (and only that niche) every day.
But in addition to the obvious amateurs, non-specialists, and unscrupulous stand-outs who scream "shady" from a mile away, there are also many shades of gray as all parties have their own financial incentives in play which many times do not align with your financial interests. And all of this makes up the complex milieu that is the real estate investment landscape.
So, How Do You Successfully Navigate All This and Avoid Falling into a "Trust Trap"
The short answer is to structure your own due diligence regiment and execute it identically every time, even if you are buying from the same seller or real estate investment firm over and over again. One or even multiple successful deals with the same company should not drop your due diligence guard, even a little.
This way your need to "trust" other people is minimized. You can always add to, refine, or modify your due diligence regiment as you learn and experience new things, but to start with, here are some basics that should definitely be included:
- Independently confirm "investor-advantaged" market fundamentals.
Since you want to buy in the best market regardless of where you live, you’ll want to start your due diligence at the market level. This entails confirming the MACRO-market fundamentals like market-wide job growth and population growth. It also includes MICRO-market fundamentals, like confirming the rental rates, vacancy rates, and market trends in the area where you are buying your property. Today there are advanced tools available for you to instantly identify the market rent and local vacancy rate at the address level when you are evaluating specific properties.
- Independently confirm all expenses associated with the property.
Verify the property taxes, insurance, property management fee, home owner association fee if any, and get a good faith estimate for your mortgage payment from your lender if you are financing.
- Independently analyze the projected cash flow with repair and vacancy estimates.
Once you have verified all the "hard" expenses, do your own cash flow analysis instead of accepting the pro-forma you may have received from a seller or real estate investment company. Ensure that in YOUR cash flow analysis you account for the inevitable expenses of maintenance and vacancy, and that you have those factored into both your "cap rate" and "Cash on Cash Return" analysis. In order to effectively evaluate property, it is important that you not rely on self-styled ‘experts’ but that you personally understand real estate investment analysis.
- Independently valuate the property.
If you are using conventional financing, the lender will require a formal appraisal. Some investors valuate a property using closed market comps by getting a Broker Price Opinion (BPO), and some cash-flow investors just use the "income approach" to value based on the property’s cash flow analysis. But, whatever your criteria, ensure that you independently valuate the property.
- Hire an independent home inspector.
This is a must, whether buying a new property or a renovated property. Always ensure you hire the inspector so they work for you and are accountable to you. Based on the results of the inspection, if there are outstanding items that need to be repaired before closing (and there almost always are), be sure to negotiate with the seller and get a repair addendum signed for which items will be fixed at the sellers expense before closing.
- Read and understand every agreement you sign.
If you have any question about the purchase agreement or the property management agreement, ensure you raise those questions up front and get them answered and, if appropriate, get the agreement modified so that you are comfortable. It is often easy to add an addendum with a point of clarity that you feel needs to be in there. You also have a right to have your agreements reviewed by a lawyer or other competent professional.
By executing your own due diligence regiment methodically, every time, your need to ‘trust’ others diminishes significantly because you are objectively evaluating each property on its own merit. By educating yourself on how to do this, you are empowering yourself and taking real control of your investments. This is not particularly time consuming once you systematize it, and it puts you in control of your financial future.
What additional due diligence do you do in your regiment? Let us know below in the comments.