Due Diligence

real estate due diligence is the focus of this guide for passive real estate investors. First, it highlights the main idea behind the topic. It also outlines the risks and questions worth reviewing. As a result, you can approach the discussion with a clearer framework.

What to know about real estate due diligence

Core ideas for real estate due diligence

In the multifamily industry, the term “due diligence” is common. The term is perfectly descriptive when you stop and think about it. In addition, the word “DUE” infers that something is owed. And that whatever is due must be given or paid. In other words, it is a debt! In addition, a debt of what? Well, of DILIGENCE.

The dictionary defines “diligence” as “careful and persistent work or effort.” Some synonyms of diligence are conscientiousness. In addition, rigor, dedication, concentration, and effort. Anytime you are looking at an investment with us, know that it comes with a debt of diligence. We owe it to you to make sure that every deal runs smoothly. In addition, there are no costly surprises along the way.

Risks and tradeoffs

In our industry, this term is applied to the underwriting process. Early in the deal analysis, we verify the cost of running the property. These costs include such things as contract services (landscapers, pool companies, janitorial services, etc.), payroll expenses, unit turn costs, advertising costs, and other associated costs. It’s not always smooth sailing. It is not uncommon for a property manager to improperly account for a cost and/or associate it with an incorrect code skewing the overall cost to run the property. If the property is self-managed, there may be some discrepancies in the payroll expenses. Also, it’s critical to verify what the market rents are and how far the subject rents can be pushed. While the broker data is valuable and is used in the initial analysis of the deal, we never rely solely on someone else’s data. We always verify. These are some of the issues that scream for attentiveness before even pursuing a deal.

The most common usage of the term “due diligence” refers to the verification of an asset before it is purchased. This is broken down into two sections, 1) the Financials and Data; 2) the Physical Asset.

What this means for investors

The Financials and Data: This includes an appraisal inspection to verify the property’s value. The bank will not lend more money than the property is worth in the eyes of an appraiser. During this time, we also have our management team conduct a lease audit to be 100% sure all the data adds up. Have the tenants been properly vetted? Have they all paid the proper deposits and amenity charges? Have all tenants with pets been charged a pet fee? What is the overall demographic of the asset in terms of employment? Is there a large concentration of tenants employed by one company? If there is it could cause issues if that company conducts layoffs. We want a nice diversity of employment in different sectors and at different companies. We owe it to the deal, and to you, to make sure all these things are ideal.
The Physical Asset: This due diligence includes a phase one site assessment that verifies that there are no environmental issues with the property such as an old oil tank buried in the ground that is leaking into the retention pond… ground contamination from a neighboring dry cleaner… or a high concentration of radon gas in a section of the property. These potential issues come with a high cost to remediate and could jeopardize the financial stability of an asset. This verification period often includes a “green study” which outlines the property’s energy efficiency and ways to raise the efficiency level and lower the cost and impact on the planet. It’s a win-win. We also conduct a property inspection to verify that there are no issues related to deferred maintenance that need to be addressed. This inspection is more extensive and includes looking at the roofs, the windows, the siding, the landscaping, the common areas and amenity spaces, the electrical, plumbing and mechanical systems, and any other pertinent systems or structures. We want to be aware of all potential issues that could cost capital to repair.

Questions to ask

Moreover, these are just a few high-level procedures out of many that we are attentive to for every acquisition. Due diligence is an obligation to verify that we have properly calculated the cost and any potential capital expenses. In addition, we always know that we are getting the value we pay for.

It is this obligation to verify “with a magnifying glass” that allows us to achieve the returns we project to our investors. We owe this level of due diligence to ourselves as business owners, and to you, as our investor.

Key takeaways for real estate due diligence

Start with the goal and timeline that fit your wider financial plan.
Next, review the assumptions, risks, fees, and possible outcomes.
Finally, compare the opportunity with other ways to use your capital.

Put real estate due diligence in context

Practical next steps

Every investment decision depends on the investor, the deal, and the market. Therefore, use the ideas above as a starting point for deeper due diligence. Review source documents, ask direct questions, and seek qualified advice when needed. For more guidance, explore our passive real estate investing education.

A clear review of real estate due diligence

real estate due diligence deserves a clear and practical review. These short checks can support a more informed decision.

Start with a clear goal.
Next, define the time horizon.
Review each key assumption.
Compare the likely outcomes.
Test a less favorable case.
Ask who controls each decision.
Confirm the fees and incentives.
Study the market and the deal.
Check the supporting documents.
Look for clear communication.
Compare other choices.
Keep the full plan in view.
Write down the main risks.
Review the source of returns.
Check the exit assumptions.
Understand the tax questions.
Consider the need for liquidity.
Match the choice to your goals.
Ask direct follow-up questions.
Confirm the reporting process.
Review the operating plan.
Check the team’s experience.
Compare the best and worst cases.
Keep expectations realistic.
Use qualified advice when needed.
Document the final decision.
Review the decision over time.
Watch for changing conditions.
Stay focused on the long term.
Finally, act with a clear reason.

A practical review of Due Diligence

First, define the goal for this decision. Next, write down the result you expect. Then, identify the facts that support that result. Finally, note any facts that could change your view.

For example, compare the likely return with the main risks. In addition, check the timeline and the amount of control you will have. However, do not rely on one attractive number. Instead, review the assumptions behind every estimate.

Before you act, ask who will manage the work. Also, confirm how that team will report progress. If conditions change, decide how the plan can adapt. As a result, you can judge the opportunity with more confidence.

Moreover, compare this choice with realistic alternatives. For instance, consider liquidity, taxes, fees, and timing. Likewise, review the downside as closely as the upside. Therefore, your final decision can reflect both your goals and your limits.

In short, use a clear process. First, gather the facts. Next, test the plan. Then, ask direct questions. Finally, choose only when the answers support your strategy.