Due diligence is the process of looking closely at the details of a potential investment, verifying material facts and evaluating the investment potential of the property. While there are numerous factors involved, due diligence is the foundation upon which successful and profitable business investment in real estate is built.
Anything worth doing is worth doing as well as possible, especially when it comes to hundreds of thousands, if not millions of dollars. Your ability to separate fact from fiction determines your return on investment.
Keep in mind that due diligence is a LOT more than looking at the numbers. Let’s use a commercial apartment property as an example. In reality, there are four critical areas that determine the value of a multi-family investment.
Financial analysis
Market analysis
Tenant analysis
Property analysis
For the sake of this article, we will not go into an analysis of these four key areas, but instead focus on rooting out the hidden gains that are discovered when we do the four key areas Diligence with the following goals in mind:
The REALITY of a ROI based on our trademark Do the Diligence analysis.
The independent value of the property in the market.
Current Income-Producing Property Features vs. Hidden Earning Features We Uncover.
The final price we are willing to pay based on our Do the Diligence analysis. Consider these goals to determine your true return on investment.
Maintain a disciplined objective approach when examining the financial information provided by the seller. The evaluation of your financial statements should reveal concrete benefits in income, costs and profits and, ultimately, cash flow. At the same time, your analysis not only verifies the reported figures and assumptions, but must also determine a true value as an independent producer of investment income. Most of the price you offer reflects the property’s ability to generate income in the here and now, not as it could be once you have made value-added improvements. Never buy a property with proforma income projections.
Determining the true value of an investment is an acquired skill that improves with experience. A seller will present the property’s paper assets as much more attractive than they actually are. That is your job. Your job is to discover accounting tricks to reveal real numbers. Here are some common examples of financial slights:
Distorted lease rent payments. A building can be occupied with tenants who have been allowed to constantly pay late or pay nothing, with no contingencies being carried out immediately through soft management.
Overly optimistic projections of expected returns. A property may advertise its proximity to the market to an area that has a higher return on investment than it is currently experiencing.
Disguise of cost centers that hide the real picture. Marketing, maintenance and administration fees that are actually excessive for the property or misallocated to the market.
Treat recurring items as extraordinary costs to remove them from the income statement. Inflated or delayed maintenance fees disguised as one-time costs.
Failure to disclose capital expenditures or general and administrative costs in the periods leading up to a sale to inflate cash flow. For example, a property may decide to postpone its on-site laundromat contract renewals so that those new figures are not immediately visible on the books, misleading the investor about renegotiating the contract and increasing costs.
A careful examination of historical and prospective cash flows reveals the independent true value of the proposed acquisition. Look beyond the reported numbers and rely on your team’s on-site visit when doing the due diligence to check costs versus reported revenue.
Getting to real numbers generally requires the close cooperation of the salesperson. Any adversarial stance on the part of the seller is almost always a signal to dig deeper.
Of course, no matter how deep you dig, many facts You can stay hidden if you don’t know where to look or how to find a hidden profit potential. Discovering so many discrepancies in represented value versus independent value will improve your position when bidding and is crucial to your acquisition and return on investment.
A complete Do the Diligence analysis system is available from Investor Tours University.
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