The Science & Art of Due Diligence

By Janet LePage

The Importance of Due Diligence

There is a saying in the real estate business that you make the most money on the day you buy a property, not when you sell. Although many agree, this rings true only with the caveat as long as you do complete and thorough due diligence .

We like to think that buying a property is like online dating. When you look at someone s online profile you are looking at the best that person has to offer. Their pictures show their best side and they tell you all about the most interesting and attractive parts of their personality. Similarly, a real estate listing is going to show you the best pictures the seller has of their property and list all of its most attractive features.

Buying real estate is like committing to marriage, but when you get your offer accepted you are only going on the first date. You only commit to marriage with someone when you have discovered everything there is to know about this person and you are accepting them with all their quirks and shortcomings. In the real estate world, due diligence is going to get you from that first date to the point of knowing everything there is to know about this property, including learning what you can live with and identifying those red flags — the things you most certainly cannot live with — in a property purchase. For example, if you don’t do your due diligence then you don’t know if you need to get Pro Choice Orlando Roofing to fix the roof. Or if you’re next door to something like a railway that will scare off potential renters. Or if you’re paying too much as there’s quite a bit to repair inside.

The Science of Due Diligence

There is a science to the way you perform due diligence in order to save yourself time and money. It is also important that you understand all of the components of due diligence in order not to miss something that could cost you money.

The Cost of Due Diligence

Whether you are buying a family home or a multi-family investment property, in order to complete your due diligence you are going to have to spend some money which you will not get back. You have to ask yourself how much you are willing to risk to see if this investment makes sense. When we tie up a multi-family property we expect to spend anywhere between $10k and $40k, which would not be refunded if we walked away from that deal. That s why we try to do as much of our free or low-cost due diligence up front before we start writing bigger cheques.

3 Kinds of Due Diligence

1. Financial and Operational Analysis

It makes sense to start with the quickest and cheapest type of due diligence: financial and operational analysis. One of the first things we do on any multi-family property we are considering buying is to conduct a lease audit against the rent roll. We look at every lease that exists on the property. We want to know whether the current operator conducted a credit check and criminal background check on each tenant and how thorough the owner is about how well tenants keep their lease. This tells us a lot about how the building is currently run.

The next thing we do is read online reviews and speak to the tenants and building managers. We want to know their top three things they like about living in the building and what they would like changed. If they have moved out, we want to know why and where they have moved to. We also visit the building both at night and during the day. We always say that when buying multi-family real estate one should be looking for a building with very few cars there during the day and one that is quiet at night.

Some of the other things you can do for free to start off your due diligence are to analyze financial statements to build your own budget, audit current service contracts and figure out what you could cancel and what you cannot, conduct a comparison of other buildings in the neighbourhood, get a police report for the property, read up on community and city by-laws, and make sure you get a title report and have it checked by your lawyer.

2. The Physical Asset Inspection

On a multi-family property a lender will require you to have a Phase I Environmental Site Assessment (ESA) and Building Condition Report carried out. You can expect to pay around $2,500 for each of these reports.

When we are conducting our due diligence on a property we always carry out a physical asset inspection. We take a checklist and mark off the condition of everything we see on that property. We want to know what we will need to repair on day one, what we will need to repair when a tenant moves out, and what will need to be replaced in year three so we can build those costs into our financial model.

Red flags during a physical asset inspection are those things that will cost a lot to fix. Problems with the air conditioners, roofing, boiler, drainage and pipes could lead to large spends which will not necessarily be reflected in your profit when you sell the property. Some issues, such as broken roof tiles, are easy to fix as you can just hire Raleigh roofing contractors to repair them but others are more expensive and could eat away at your profits. This is why an inspection is so important. Also, small issues can develop into bigger problems if they’re left unnoticed. What could have been a simple job of replacing a few tiles could turn into needing to contact someone like WilsonRoofing.com to replace the whole roof.

Moreover, when working at height for prolonged periods of time, investing in high-quality safety equipment is crucial. For instance, in case you were not already aware, rooftop walkway systems are designed for maintenance personnel and other workers. They provide an ideal safe access solution when working on rooftops as they raise the walking surface and protect the underlying roof from damage from foot traffic. Consequently, you can learn more about some of the different safety measures that roofing industry professionals must take by researching roof walkway systems suppliers in your area.

3. Financing Requirements

Most real estate purchases are going to need some kind of financing unless you are a cash buyer. It is important to make sure that financing is weaved into your due diligence schedule so you know when you are going to pay fees. We recommend completing financing requirements last because it usually requires the greatest costs of the due diligence process and that money is not going to be refundable if you do not complete the deal.

Negotiating & The Art of Due Diligence

The art of due diligence is how you use what you have learned to your advantage in your re-trade; this is when you go back to the seller and ask for a reduction in costs or a change in the terms of the deal.

We use what we have learned during conducting due diligence to our advantage to save money. We get at least two quotes for all of the work that we identify as needing to be done; one quote from a high-priced, top-quality contractor and one from our in-house maintenance team or preferred contractors. We then present the seller with those gold-standard quotes rather than the more realistic quotes that would be sufficient.

When we go into a negotiation we present a very dire picture to the seller of all the additional work that needs to be done which was not discussed earlier in the process. This allows us to negotiate and hopefully end up somewhere in between what the seller thinks the repairs are going to cost us and what the work will actually cost, which is what we need to cover.

Investment Partners

If you are thinking about investing we would also advise you to do your due diligence on your joint venture/investment partners! Review all the information they ve given you and find ten questions to ask about their business background and capital sources if you don t have ten questions to ask them you haven t done enough research!

Top Tips

1. Create a due diligence project schedule. Make sure you give yourself enough time to do your research, including thorough checks and obtaining quotes. We create a work-back project schedule from when the inspection period is over, mapping out backwards from the end date and work out when we will do each step and when we will need to start spending money.

2. Everyone is guilty until proven innocent. Never assume that information given to you by the seller is accurate. We prove out all documents given to us. If the seller says 90% of the units in an apartment block are occupied we walk the property and count them. In a house, if they say they have had a new furnace installed, we have someone take a look at it to confirm this.

3. Be physically present for all inspections. Everyone interprets things differently but the buck stops with you. Someone who inspected the property may say that the showers are in great shape, but in great shape to whom? We want to know by seeing for ourselves exactly what state the showers are in.

4. When in doubt get a quote. If the realtor tells you a new furnace will cost $2k, get a quote for it and find out for yourself.

Janet LePage holds a double major in Computer Science and Business with a Project Management Professional designation. She climbed up the telecommunication corporate ranks as one of the youngest directors for two of British Columbia s top 10 largest companies before focusing her passion on real estate investing. janetlepage@gmail.com

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