Property analysis or doing your “due diligence” is a critical part to any smart investment strategy. If you think about it, this is where the money is made. If you don’t know anything more than the property is below market value, then you are probably going to lose money. You must have a solid exit strategy on any successful real estate transaction. Some even say that “you make your money when you buy the property not when you sell it,” so say that ten times fast.
Once you have found the property then you need to put together a pro forma in order to see what the numbers look like. The quickest way to do that is to request a pro forma from the seller or the seller’s agent. Obviously the seller is going to try and paint the prettiest picture that they can for you so don’t be surprised by how good the numbers look up front. Once we have the property under contract we will request the real numbers on the property also know as financials, which should consist of at least two years of rent rolls and two years of tax returns.
Keep in mind that the pro forma is to paint a rosy picture and the tax returns are designed to paint a terrible picture (to pay the government the least amount possible if anything at all). So reality should fit nicely somewhere between these two pictures. What we are looking for is to be as accurate with the numbers as we can so as not to miss anything and make mistakes.
To help us not forget anything here is a checklist that you need to do before purchasing a property. You may use all of these suggestion, you may have to do a few more or you may not use hardly any of them depending on the deal you are working on.
Commercial Property Check list
Move forward only on green lights
1. Why is the seller selling their property?
a. This is a critical bit of knowledge that most people overlook. The seller will teach you how to sell them on your deal.
2. www.ofheo.gov to take a look at statistics in the area
3. www.bestplaces.net to check the statistics and demographics of the area
4. www.uschamber.org to find the local chamber of commerce and see what the future holds for the area and specifically this property.
5. Go to the city planning department and find out if the area is pro-growth
6. Check with the local police department for calls to the property over the last year
7. Call the local fire department for fire code violations and regulations that need to be in place for safety issues
8. Check with the local planning department to see what plans are for the area
9. Get a one page appraisal by licensed appraiser
10. Personally inspect the property
11. Order a phase one environmental report
12. Have a property Inspector inspect the entire property for foundation, termites, pests, roof, CO, radon, mold etc. problems
13. Get a full appraisal
14. Review the Rent Rolls for the past two years
15. Review the Financials for the past three years
16. What is the normal lease term?
17. What is the physical occupancy level last year:_____%
18. What is the property condition: ____ Excellent____ Good____ Fair____ Poor
19. Property value as of the last appraisal: $_________
20. Date of last appraisal: _________
21. Current lease rates at the property are: ____ Above____ At____ Below market rates.
22. What percentage of the property is occupied by Students?: _____%Military?: ______%Seniors: ______%
23. List any tenants or entities that occupy or control more than 20% of the space:________________________
24. What percentage of the income is attributable to retail tenants?: _____%
25. Do any units have…
a. Aluminum wiring?:____
b. Less than 60 amp electrical service?: ____
c. Well water?:____
d. Septic system?:____
f. Do any units require space heaters?:____
g. Furniture that is included with the rent?:____
h. Deferred maintenance (interior or exterior):____
i. Is the property in a flood zone?____
j. Is the property in an earthquake zone?:____
k. Is the property / leasing manager located on-site?:____
l. Are there any ground leases? (attach detailed terms of the lease if Yes):____>
m. Is the property dependent on a single industry or school for tenancy? (attach details if, Yes):____
n. Do any tenants receive government subsidies? (attach details if Yes and not on the rent roll).____
o. Has the property benefited from tax exempt bond financing or government subsidies?:____
Once you now better understand the overall picture of what is taking place then don’t be afraid to renegotiate the original contract using the new information that you have found. You will have much better leverage after having dug up all the secrets about the property then before. On the other hand somewhere along this process you may find some yellow or red lights so let me explain what those are.
A yellow light isn’t something that will kill the deal but can and should be resolved before moving forward. If you can’t get it resolved then you need to be willing to walk away. So for example you find out that the roof has not been replace in the past 30 years and it leaks. Here you would renegotiate with the seller to either have them replace it or have them lower the purchase price accordingly.
A red light is an item that will stop you right in you tracks and you immediately back out of the deal. For example you find out that the property is sitting on a toxic waste dump. You wouldn’t renegotiate with the seller (unless you specialize in this kind of clean up) you would just back out of the deal.
Property analysis or due diligence is one of the most important steps that you will take and you will quickly realize that this is where your money is made and lost as an investor.