HOW TO CONDUCT DUE DILIGENCE
BEFORE YOU PURCHASE A PROPERTY


Buying real estate entails many challenges, whether you are new to real estate or not. Setting up a timeline and educating yourself about the process are vital to making a prudent and profitable purchase. You can start with appropriate mentoring, which the Marshall Reddick Real Estate Network offers to its members as a free service.

Your success as a real estate owner largely depends on the steps you take to conduct your due diligence on the following: (1) THE LOAN (by researching the Lender); (2) THE PURCHASE (by researching the property itself, the Realtor with whom you will work, and surrounding area); (3) THE RENTAL PROCESS (by researching the Property Manager); and (4) PAPERWORK requirements associated with your new business.

THE LOAN:

Lenders provide the money to fuel your real estate business, and determining whether you can afford a property is the initial step. It is essential to determine the best loan program possible for providing both cash flow and an ultimate “exit strategy” depending on how long you plan to hold on to the property. The due diligence steps you need to take regarding the lender are as follows:

  1. To obtain a source for the financing you need and determine how much you can afford, you need to get prequalified with one of the Network’s preferred lenders, who specialize in working with real estate investors. It is a 15-minute process over the phone where you will give the lender your basic financial information (i.e., your Assets, Liabilities, Income, and Expenses). With this information, the lender will tell you how much you can afford to borrow. Do not give your Social Security number at this point. Call one of the Investment Counselors at the Network to assist you in creating a financial report, if needed by the lender.
  2. Get a Good Faith Estimate (or GFE) which spells out your total costs to purchase the property. It includes fees charged by the lender, title company, escrow company, and any legal fees, as well as the estimated monthly payments such as principal, mortgage interest, property taxes, insurance, and any Homeowner’s Association fees (if applicable).
    To determine your level of cash flow, you will need to factor in the property management fees (usually 8 to 10 percent of the monthly rent check), as well as 10 percent of your annual rental income for potential vacancies and repairs.
  3. Part of conducting due diligence is to consult more than one source. You will want to call at least one other lender to compare loan terms. Feel free to call one of our Network investment counselors for assistance in determining the best option.
  4. Once you decide which lender to work with, get prequalified for the loan (at this point, you will give authorization to access your credit). You will get a final figure on the loan amount so you can start the purchase process.
  5. Consult your CPA and/or financial planner as to how the purchase will impact your overall tax and financial condition. The loan initiation fees, mortgage interest, and any rental expenses are all tax-deductible (however, the amount of your down payment is not).

THE PURCHASE:

Deciding on the best area to purchase is one of the most critical steps in accomplishing your business and financial goals. Once you are prequalified and have determined the price range you can afford, you will want to perform due diligence as follows:

  1. Understand the criteria of a sound investment:
    1. Affordability: stay within your budget
    2. Down payment: determine the least amount of money to put down that will still cash flow. Remember to leverage with care; you want to have at least some equity in the home as a financial cushion should property values unexpectedly drop and you need to adjust your rental price downward for a time.
    3. Look for a good rental market where jobs are plentiful and there is not an oversaturation of rental properties.
    4. Similarly, look for strong economic growth with major, successful employers in the area.
    5. Desirable location: seek a metro area with as many of these features as possible: good schools; a university; major hospital services; a transportation hub; cultural amenities; large employers (including military bases); nearby rivers, lakes, ocean, mountains; low crime; low property taxes.
    6. Likewise, steer clear of areas with higher crime; an eroding economy; poor neighborhoods; dumpsites; high pollution; noise traffic (such as next to an airport, railway, or freeway); high property taxes; rent controls.
  2. Call one of the Network’s Investment Counselors at (949) 885-8180 to get mentoring on great locations to purchase and available programs in those areas.
  3. Access the website for a list of Realtors. To know how to conduct your due diligence with each Realtor, contact the Network for a list of questions to ask when you interview them by phone.
  4. Trust but also verify the information you receive from the Realtor about a property by doing research on the Internet. For an impartial assessment of a home’s value, you should ask a Realtor for comparable prices of surrounding homes, get an independent appraisal (usually $300 - $400), and/or go to any of these free websites:
    1. www.zillow.com
    2. www.cyberhomes.com
    3. www.realtor.com
    4. www.dqnews.com – (State of California only)
    5. www.trulia.com
  5. As mentioned above, research the rental market and economic growth of the city and state where you are considering a purchase. Do some online research about job growth, population growth, demographics, and other issues that may impact your rental business. Request an economic package from the Network on a given area (we have a growing library). Check the county website to verify property tax rates. Also start a search for potential property managers (the Realtors with whom we work often have referrals).
  6. When you are ready to buy, call the Realtor to prepare the purchase contract. Review the contract with the help of some legal advice. We recommend that you get in touch with a Prepaid Legal Representative at (949) 885-8180 to learn more about obtaining very reasonably priced legal assistance to help you review the contract.
  7. Decide how you want to hold title to the property, i.e., as sole owner; joint tenants; tenants in common, etc. Each of these has legal ramifications. Seek legal counsel if necessary to determine the most appropriate method for your situation.
  8. Get at least three insurance quotes to compare rates on insuring your property. To get started, please call our office at (949) 885-8180.
  9. Be proactive by staying in touch with the Realtor and escrow officer during the entire purchase process until escrow closes (that is, until the final purchase and title transfer documents are executed). Before close of escrow, select a property manager and start the property management contract to get the property ready to rent.

THE RENTAL PROCESS:

Property managers are vital to the success of your rental business. Before you purchase a property to rent, remember to research the rental market as the rental income and relative ease of finding a renter will affect your level of cash flow. The due diligence steps to do this are as follows:

  1. Contact the property manager first referred by the Realtor from whom you purchased through the Network. A property manager affiliated with the Network gives members a discount on property management fees.
  2. Call one of the Investment Counselors at (949) 885-8180 to receive mentoring on what services a property manager provides, qualifications you should look for, and how to maximize the benefits of this relationship.
  3. Get additional information on various rental markets and property management rates at the following websites:
    1. www.rentals.com
    2. www.allpropertymanagement.com
    3. www.rentometer.com
    4. www.zilpy.com

Go online and type the city, state, and words “property management” to get additional referrals.

  1. Call each property manager and compare information on the following: average rental income for the area; anticipated rental expenses (including their monthly fees, initial charge to place a tenant; and Homeowner Association fees, if any); number of rental properties in the area; average length of time to rent the property; and number of units the property manager handles. Use this to determine the cost and credibility of each management company. You can get our question list for potential property managers by calling (949) 885-8180.
  2. Before close of escrow, start the property management agreement with your new management company to prepare the property to rent as soon as possible. Read the contract carefully or consult legal advice for assistance.

PAPERWORK REQUIREMENTS:

As a real estate investor, you need to be organized with accounting and paperwork. Open a separate checking account for your rental property and do not comingle your personal finances with your rental business. Prepare a filing system for all the documentation associated with the rental property.

  1. Create separate folders for the closing papers, mortgage statements, insurance documents, property management statements, Homeowners Association information, property taxes, and expenses.
  2. Document all activities and expenses related to the rental property, including your communications with the lender and property manager; travel costs to visit your property; repair costs and other miscellaneous costs; real estate seminars taken, etc. Expenses associated with your rental business are tax-deductible.
  3. Prepare a spreadsheet accounting for all the rental income and expenses and give this to your tax preparer along with the year-end Form 1099 documents you receive from the bank and the property manager. Some items on the closing statement (HUD 1) are tax-deductible as well.