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Due Diligence

Due diligence is an essential step in real estate investment. Due diligence includes the process of reviewing the physical real estate, market conditions, prospective market conditions, financial data, and assumptions regarding the real estate to ensure that assumed and reported information are correct. After selecting the property type and geographic location, the investor needs to ascertain he has accurate information regarding the physical asset, financial performance, tenant base and future prospects for the subject property. Due diligence helps the investor accomplish those tasks. Due diligence can provide in-depth data and insights for these areas and mitigate the risk of a real estate investment. The costs associated with due diligence are minimal compared to the costs of making an imprudent investment decision.

In addition to investors avoiding unfavorable investments, due diligence can:

  • Improve his investment return by considering a larger number of prospective investments and refining them to a subset which best fits in his investment objectives.
  • Enable investors to quickly pass on potential investments which do not merit a complete analysis;
  • Save money and reduce the time an investor spends evaluating a possible investment by more quickly declining an investment which does not fit the investor's criteria or that is not consistent with what was presented; and
  • Provide the investor with a better understanding of the benefits, costs, risks and opportunities related to an investment.

The financial costs and time expended by the investor and the opportunity cost (of not pursuing other more attractive investments) related to fully analyzing a real estate investment are substantial. Due diligence helps to reduce these costs.A preliminary due diligence analysis to test the investment hypothesis can lead to terminating review of a potential investment before substantial expenses have been incurred. In most due diligence cases, the business person leading the investment effort has developed an "investment hypothesis". Potential "investment hypotheses" include the following:

  • This property will generate a 7% unleveraged yield without any upgrading.
  • This property is 30% occupied due to poor management. By focusing on leasing, the purchaser can achieve stabilized occupancy of 90% within 12 months while leasing at $18 per square foot.
  • The subject class A apartment complex was built 15 years ago when the level of finish was at a lower level. The subject property currently has both a good resident profile and is in good physical condition. By spending $8,000 per unit to upgrade the level of finish with items such as granite countertops, better appliances, upgraded cabinets, the rental rates can be increased from $.90 per square foot per month to $1.05 per square foot per month.

Investors cannot save both time and money by performing an initial review of the investment hypothesis. Most of the due diligence services can be performed by a skilled and experienced real estate appraiser. An investor can leverage his time and focus on more "value added" activities by allowing a skilled appraiser to perform due diligence tasks. In many cases, the investor has too many other time consuming commitments and responsibilities to personally perform an in-depth analysis or to visit the property to confirm the investment hypothesis before proceeding with an acquisition. If it is possible to eliminate investments which do not meet the investor's criteria before negotiating the contract to purchase the property, the investor can save legal fees related to the contract, time involved in negotiating the contract, time working with the lender, the cost of third-party lender - related records and any additional due diligence the investor would perform.

Depending on the investment hypothesis, the investor's familiarity with the submarket where the property is located and the subject property itself, the following due diligence tasks merit consideration:

  • Market rent analysis;
  • Market analysis (occupancy, absorption, construction and rental rate trends);
  • Financial analysis/financial modeling;
  • Construction cost analysis (upgrading and curing deferred maintenance);
  • Code compliance;
  • Organize procurement of third-party reports;
  • Evaluate options regarding the level of renovation or upgrading;
  • Highest and best use analysis;
  • Market study;
  • Feasibility study;
  • Lease audit;
  • Lease abstraction;
  • Detailed examination of the seller's financial statements;
  • Comparison of seller's financial statements with bank statements;
  • Obtain survey;
  • Interview management companies;
  • Interview leasing companies;
  • Property tax analysis and forecast.

The list of due diligence tasks which should at least be considered is daunting. However, the time and cost related to properly performing due diligence is insignificant compared to the time and cost to remedy a poor investment.An ill-conceived investment can be a huge drain with regard to financial resources and time.

O'Connor & Associates' staff complement of over 50 real estate professionals can handle any or all of these to due diligence tasks. These professionals are supported by a support staff of over 100 who are accustomed to complex assignments. Our team has experience in all aspects of real estate including acquisitions, due diligence, ownership, appraisal, property tax appeals and dispositions. Reduce your risk and stress by utilizing O'Connor & Associates' breadth and depth of experience to evaluate your real estate investments.

To obtain more information on O'Connor & Associates due diligence services, call or email John Fisher at 713-686-9955.


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